Are market solutions likely to be successful in tackling climate change?

Cameron Jones- Guest Writer

Greenhouse gas emissions such as CO2 (emitted by transport, for example) being released into the air are causing the Earth to heat up, by trapping heat in the atmosphere rather than letting it out. 

Anthropogenic climate change has accelerated this by burning fossil fuels (Friends of the Earth, 2017). Through a carbon tax along with opening energy markets to competition, it is hoped market solutions will play a large part in reducing CO2 emissions.

The implementation of a carbon tax:

Currently, the free market provides at Q, P, but there is a negative externality, meaning that the full marginal social cost (MSC) is not considered. The gases not only affecting the marginal private costs (MPC) to the people in the market, but spilling over to the wider society in the form of poorer air quality and thus the MSC is significantly higher than the MPC.

The deadweight loss given the misallocation of resources is shown as the shaded triangle. A unit of tax is applied, internalising the external cost of emitting CO2. This pushes the price to rise from P to P’ (making it more expensive), and the quantity goes from Q to Q’, a clear reduction in CO2.

(Adapted from “Microeconomics and behaviour” by Frank, RH and Cartwright, E, 2016)

This would lead firms to invest in cleaner technological innovation and infrastructure (Climate Leadership Council, 2017). In addition, it raises tax revenue because of the price inelasticity of demand (PED) that greenhouse gases hold (PED shows how much demand decreases if price goes up by 1%, PED is said to be inelastic if it has a minus number between 0 and -1). 

For example, petrol, one of many sources of greenhouse gases, has a short-term PED of -0.25 and a long-term PED of -0.64 (Goodwin et al, 2011). This price inelasticity is paid for mainly by the consumer (as shown by top yellow rectangle), because the producer passes it on in the form of higher prices, due to the essential nature of the good. 

This raises a significant amount of tax revenue, which can then be put back into the green economy that we hope to create by promoting subsidies for clean energy and R&D (research and development).

However, the poorest in society will most likely pay more income towards the tax, take for example a car and 2 people, one on £20k and another on £100k. The one on £20k will pay proportionately more in taxes than the one that is on £100k because firms will pass on the costs of the tax in the form of higher consumer prices that will be proportionally higher for low income households. It is regressive as the informational requirements are not there, there must be a tax across the board but this leads to the poorest members of society paying more proportionately. 

One way of getting around this is by promoting cleaner methods of transport like trains or bikes so that people on lower incomes have alternative methods of travel and even increasing the benefits that people on lower incomes can afford almost like a green dividend. With the prospects of ‘Zoom’, people no longer have to travel to countries to do business, the digital revolution is just one click away (BBC, 2020). 

This would also be more effective than a quota because of the revenue gained from the carbon tax and the costly nature of keeping an eye on quantities of carbon released to monitor quotas.

Opening energy markets to competition:

UK energy markets have grown more liberalised and the concentration ratio (0 being there's perfect competition and 1 if there is one Monopoly) has slowly lowered. In 1989 there were 6 major power producers, by 2015 there were 51 (Government Paper, 2016). In the U.S., states which were open to competition (rather than beholden to monopoly regulated utilities) tended to show a decrease in energy prices rather than an increase (Hartman, 2018). 

All of this resulted in incumbent firms either being encouraged to switch to more carbon efficient solutions (due to lower prices of utilities, allowing them to invest in cleaner methods) or losing out to cleaner firms. 

Interventions could be aimed at increasing demand elasticity for clean energy, boosting competition in local areas and lessening the concentration of hydro/solar/geothermal units by increasing geographic locations so that they aren’t concentrated in one place. 

The competitions and markets authority (or the other countries equivalent to the CMA) could analyse mergers between the aforementioned sources of energy, easing up licences to open up a hydrothermal unit to encourage more competition. These are just some of the methods governments could impose for a clean economy (Rangel, 2007).


To summarise, a carbon tax could be implemented to encourage firms to invest in cleaner infrastructure and R&D but may result in increased cost to the consumer.

However, we cannot ignore the fact that a carbon tax is regressive, thus we need to invest in cleaner methods of both transport and benefits. This can be accompanied by deregulation of alternative methods of creating energy, ergo, we will hopefully make the green economy without sacrificing economic growth.


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