Global warming and its dramatic effects like melting glacier, storms and the vanishing species can be related to the aftermaths of greenhouse gas (GHG) emissions. Global emissions are changing our planet. Governments are trying to control emissions through various techniques.

Two main market tools to reduce GHG emissions are carbon trading system and carbon tax.

Carbon trading is also referred to as emission trading. It is a tool used in the carbon market to limit GHG emissions. Carbon trading takes place under cap-and-trade schemes or credits to pay/offset GHG cutbacks.

Regulators set a cap on allowable emissions. Then these are distributed or auctioned as emissions allowances towards the cap. If a firm does not have sufficient allowances to cover their emissions, then it must reduce emission to comply with the cap or buy spare credit. Industries can also save their extra allowance for future use or sell them to other firms.

Cap and trade scheme work with government issues annual allowances to companies to emit a certain amount of carbon. The total permits become the cap on carbon emission. If any company emit carbon more than the set limit, then it will be taxed. A company can also sell its permits to other companies if they are emitting less carbon than their allowable cap.

The setting of a cap and price determination is a function of demand and supply controlled by regulatory authorities. If the cap is set too high, then companies would reduce their emission overtime and also brings down the value off the permits. If a cap is set too low, then demand for permits would go up and so the price. A carbon tax can increase production costs, which can be passed to consumers.

Regulatory authorities have set safety range to keep the price of permits in a specific range. In the case of higher prices, the authority releases some additional permits to stabilise the prices.