Consider a hypothetical cap-and-trade market for carbon emissions.
The demand for permits is given by QD = 800 3 − 1 3 P. The government has set the number of permits at 250.
a) Sketch the supply and demand curves for this market. What would the equilibrium price be? What does that equilibrium price represent in terms of the costs or benefits of emissions?
b) Who exactly will end up holding the permits after the market plays out? Explain your answer.
c) Say that there is an innovation that makes clean energy technology cheaper. With the aid of a diagram that shows a hypothetical marginal cost of abatement curve (just sketch out a general shape for this rather than a specific equation), how and why would this affect the market for permits?
d) The May 2020 cap-and-trade emissions allowance auction in California raised only $25 million compared to a typical $600-$800 million. Two possible explanations for this might be the effect of the COVID-19 pandemic, or that the program allows banking of unused allowances to use in later years (you can read more about both of these perspectives at KQED: https://bit.ly/3eZvi4u). How might each of those explanations be translated into our simple model of supply and demand in a permit market?