b) The idea was to create high enough prices so that switching over to low carbon fuels. However, because of the low demands and excess supplies, market prices of permits have not risen to the degree that would make it profitable for producers to switch to low carbon fuels. As a result, the ETS has been unsuccessful in inducing firms to switch from using high-carbon to using low-carbon fuels.As shown in the diagram, assume that the government sets the reserve price at Pr. If the market operated freely, the equilibrium price would be Po and the equilibrium quantity would be Qo. By setting the reserve price at Pr, the government only sells Qr of its permits. Alternatively, the government by only bringing Qr units to the market could have pushed up the price of the permits to Pr. This is precisely the idea behind the auctioning mechanism.In the diagram above, suppose initially the reserve price is set at Pr. Evidently from the demand curve, for any price above Pp, there are no buyers for a single unit of the permit. In order to sell positive amounts the government would have to set a price below Pp.Suppose as in the graph above, government sets the reserve price to Pr1. As a result, Qr1 units are sold. If the reservation price is lowered, a larger number of permits will be sold, and each unit will be sold at the price that the buyer with the highest willingness to pay values the unit at. Thus, the government could have driven up the prices to Pr1 by bringing only Qr1 units to the market.Essentially the effect of the tax has been to shift. Demand for Iron Ore from China.
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