What is the effect of carbon pricing on firms' incentives to reduce emissions?

• A. Cheaper to pollute
• B. Has no effect
• C. More expensive to adopt green options
• D. Makes it cheaper for firms to go green than continue polluting

Answer: (D)

Carbon pricing puts a clear cost on emitting carbon, so the amount a firm spends depends on how much it pollutes. Firms compare the cost of reducing emissions (abatement cost) with the price they would pay for the emissions themselves. When the price on carbon is high enough, cutting pollution becomes cheaper or saves money in the long run, so firms invest in cleaner technologies and practices rather than continue polluting. This economic signal tilts decisions toward lower emissions, making it cheaper to go green than to keep polluting. For example, if paying for emissions costs $50 per tonne but a cleaner option costs $40 per tonne to implement, the firm saves money by abating. If the carbon price is too low relative to abatement costs, the incentive is weaker, but the overall effect is a shift toward emission reductions driven by the cost comparison.