Market Mechanisms: Understanding the Options

Climate change poses a significant risk for a broad range of human and natural systems. Policies to reduce emissions are critical if we are to avoid the most costly damages associated with a rapidly changing climate. Compared to traditional command-and-control regulations, market-based policies can more cost-effectively reduce greenhouse gas (GHG) emissions by creating financial incentives for GHG emitters to emit less. Ten U.S. states and many jurisdictions outside the United States have established market-based programs to reduce GHGs. Market-based policies would be among the options available to states to reduce GHGs from power plants under the U.S. Environmental Protection Agency’s proposed Clean Power Plan. This brief describes the theory behind market-based approaches; their success in cost-effectively reducing GHGs and other emissions; and a range of market-based options, including: a carbon tax, a cap-and-trade program, a baseline and credit program, a clean or renewable electricity standard, and an energy efficiency resource standard.