Today, most of the world’s trade is accomplished through free markets (WTO 2011). Suppliers and consumers meet in many different types of markets to trade goods and services. Through trade, the marketplace establishes prices and quantities traded. It is through the prices and quantities traded that the market serves one more critical role: the market is our coordinator.
How do suppliers decide to increase production and boost prices? When the market tells them that their product is highly sought after (when shortages exist). Think how the market has told high tech firms to make more computers and fewer VCRs over the last decade. This is the market directing resource use.
How do consumers know when to change? When the market tells them that the old patterns can or should be changed, when the price of the old activities rises or falls. Think how the market has told consumers that they should switch to more fuel efficient cars and heating systems after the OPEC crisis. This is the market directing resource use.
Most environmental services (services performed by the natural environment) have no market governing their use. Many people consider these environmental services to be free. As a result, people tend to over-consume environmental services.
Carbon markets are an attempt to create a market driven price signal for an environmental service – the natural environment’s ability to filter carbon from the air. Faced with a real price, consumers of these environmental services will reduce their consumption of this service. The carbon market that is currently being developed is an example of a tradable permit system.