Editing Externality (section)

====Cap-and-trade systems====
The cap-and-trade system enables the efficient level of pollution (determined by the government) to be achieved by setting a total quantity of emissions and issuing tradable permits to polluting firms, allowing them to pollute a certain share of the permissible level. Permits will be traded from firms that have low abatement costs to firms with higher abatement costs and therefore the system is both cost-effective and cost-efficient. The cap and trade system has some practical advantages over an emissions fee such as the fact that:
1. it reduces uncertainty about the ultimate pollution level. 
2. If firms are profit maximizing, they will utilize cost-minimizing technology to attain the standard which is efficient for individual firms and provides incentives to the research and development market to innovate. 
3. The market price of pollution rights would keep pace with the price level while the economy experiences inflation.

The emissions fee and cap and trade systems are both incentive-based approaches to solving a negative externality problem.