Marketable Permit
What is Marketable Permit?
A marketable permit is a tradable allowance to emit a set quantity of pollution, issued under a cap, that a firm can buy or sell instead of abating.
The regulator decides the total quantity of emissions, issues exactly that many permits, and either auctions them or hands them out; from then on the permits trade like any other asset. A firm compares the market price with its own marginal abatement cost: below the price it cuts and sells the spare permit, above the price it buys. Trading therefore drives every firm's marginal abatement cost to the same level, which is the cheapest route to the cap. The contrast with an emissions tax is the standard exam point: permits fix the quantity of pollution and let the price adjust, while a tax fixes the price and lets the quantity adjust, so when abatement costs are uncertain you get certainty about the environmental outcome or certainty about the cost, never both.
Marketable Permit: a worked example
A cap requires 100 tons of cuts across an industry, and the cheapest way to find that hundredth ton costs $30, so trading settles the permit price near $30. Firm X can cut for $12 a ton, so it abates and sells: each permit sold brings in $30 for $12 of effort, a gain of $18 a ton. Firm Y faces $45 a ton, so it buys instead and saves $45 minus $30, or $15 a ton. Both firms respond to the same $30 signal, no regulator had to learn either firm's costs, and the cap still holds at 100 tons.
The mistake students make with marketable permit
The frequent slip is thinking the government sets the permit price. It sets the number of permits; the price comes out of trading and can collapse if the cap is loose or if a downturn cuts demand for permits. A second slip is assuming that giving permits away free instead of auctioning them allows more pollution. Allocation decides who captures the value of the permits, while the cap decides how much pollution there is.
Marketable Permit questions
How is the price of a marketable permit determined?
The price is determined by supply and demand in the permit market, not by the government. Supply is fixed by the cap, and demand comes from firms comparing the permit price with their own cost of abating. In equilibrium the price equals the marginal abatement cost of the last reduction the cap forces.
Should a government use marketable permits or an emissions tax?
Use permits when hitting a specific emissions quantity matters most, and a tax when limiting the cost imposed on firms matters most. Permits fix the quantity and let the price float, while a tax fixes the price and lets the quantity float. With uncertain abatement costs, the choice is really about which kind of surprise is easier to tolerate.
Do permits given away for free let firms pollute at no cost?
No, because a permit used is a permit not sold, so holding on to one carries an opportunity cost equal to its market price. A firm that emits gives up the revenue it could have earned by abating and selling that permit. Free allocation transfers wealth to the firms but leaves the opportunity cost, and the cap, intact.
Formula / Example
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