Living and Learning the Cap-and-Trade Market

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Michelli Murphy

Summary:

Three University of Arizona professors have developed a teaching module that lets students become part of the cap-and-trade market.

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When it comes to teaching, lectures just can’t compete with experience.

That’s why three University of Arizona professors have developed a teaching module that lets students become part of the cap-and-trade market instead of simply taking notes about it.

Coal-fired power plants like the Navajo
Generating Station located near Page, Arizona are one
category of ‘major emitters’ expected
to participate in a regional or national
cap and trade greenhouse gas program.
Credit: ©Ralf Broskvar, istockphoto.com

A cap-and-trade market is designed to curb climate change by setting a limit on the amount of carbon dioxide major greenhouse gas emitters can produce. Permits to pollute are distributed to regulated firms, which are allowed to buy or sell their permits to comply with the carbon emissions cap.

In theory, the market will increase the efficiency of meeting the ever-lowering cap by allowing firms to buy or sell their permits in the most cost-effective way.

For those firms who can reduce carbon emissions cheaply, selling permits may be more profitable than using them. Conversely, those firms that would need to invest in major infrastructure overhaul to reduce emissions may be better off purchasing extra permits.

Developed by economics professors Stan Reynolds, John Wooders, and Martin Dufwenberg, the two-part teaching module includes an experiment where students will play the role of regulated business firms, followed by a discussion about the economic and climate change issues associated with a cap-and-trade market.

“As emissions markets develop, there’s going to be a demand for people who are educated about how the markets work,” Wooders said.

Regulated firms will need people to navigate the market, and the government will need people to regulate those firms, he said.

Figure 1. The Western Climate Initiative includes
25 partner and observer states and provinces in the
United States, Canada, and Mexico.
| Enlarge This Figure |
Credit: Rebecca Macaulay, CLIMAS, The University of Arizona

In the U.S., one multi-state cap-and-trade system is already underway and another is in the works. The Regional Greenhouse Gas Initiative, formed in 2003, is creating a system to lower carbon emissions among its nine northeastern states. Its counterpart in the West is the Western Climate Initiative (WCI), formed in 2007 to decrease carbon emissions of seven western states and four Canadian provinces.

The WCI has proposed a baseline regulation level of 25,000 tons of carbon per year, meaning organizations emitting less would not be included in the initial cap-and-trade system.

The cap-and-trade market model isn’t new. In 1990, Congress amended the Clean Air Act to include a cap-and-trade system to reduce sulfur dioxide and nitrogen oxide emissions, which cause acid rain. In 2005, the European Union adopted the cap-and-trade model to reduce carbon emissions to comply with the United Nations’ Kyoto Protocol.

With the creation of U.S. carbon emissions markets in sight, the teaching module isn’t just for students.

“We hope to present and stimulate discussion between graduate students and faculty who are doing research on climate change,” Reynolds said. “We want them to understand the role of the market and economics. There’s some hope of stimulating interdisciplinary research.”

The module will serve as a supplement for economics classes and as a basis for presentations, Reynolds said.

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