Which of the following best describes a cap-and-trade system?

• A. A policy where firms are taxed for every unit of pollution they emit.
• B. A voluntary agreement among firms to reduce emissions without government intervention.
• C. A market-based approach where the government sets a limit on total emissions and allows firms to buy and sell permits to emit up to that limit.
• D. A regulatory system where the government directly sets emission standards for each firm.

Answer: (C)

Verified step by step guidance

1. Understand that a cap-and-trade system is a market-based environmental policy designed to control pollution by setting a total allowable limit (cap) on emissions.
2. Recognize that the government issues or allocates permits (also called allowances) that represent the right to emit a specific amount of pollution, and the total number of permits equals the cap.
3. Firms can trade these permits among themselves, buying additional permits if they need to emit more or selling permits if they can reduce their emissions below their allowance.
4. This trading creates a financial incentive for firms to reduce emissions cost-effectively, as firms that can reduce pollution cheaply will sell permits to firms facing higher reduction costs.
5. Contrast this with other approaches such as taxes on emissions, voluntary agreements, or direct regulation, which do not involve trading permits or setting a total emissions cap.