5 The Cost of Meeting Emission Reduction Targets: Pollution Permits A market for pollution permits is created when a limited amount of "property rights" on emissions are distributed to economic agents. These represent a "right to pollute", proportional to the amount of property rights owned by the agent. These rights can be traded between economic agents (and between ED countries). 24 The rights are distributed according to a grandfathering principle. An economic agent then has to compare the cost of reducing emissions below its endowment, to the benefit from selling his permits to the market. At the equilibrium point, the permit price will be equal to the marginal cost of abatement. The pollution permits case (PP) does not assume any accompanying macro- economic policy that would aim at removing some other distortion and at obtaining additional gains from that removal. Five different scenarios aiming at emission reduction of CO 2 ranging from 5%-25% have been constructed given the names PP5-PP25. A co-ordinated policy has been assumed, where the permits are traded between all European sectors and households in order to realise the percentage reduction of total CO 2 emissions. 24 A theoretical description of pollution pennits is provided in a previous chapter. P. Capros et al., Climate Technology Strategies 2 © Physica-Verlag Heidelberg 1999