What externality is carbon pricing trying to address? Explain why this is an externality. What roll does government have in addressing externalities Carbon pricing is an instrument that captures the externalcosts of greenhouse gas (GHG) emissions-the costs ofemissions that the public pays for, such as damage to crops,health care costs from heat waves and droughts, and loss ofproperty from flooding and sea level rise-and ties them totheir sources through a price, usually in the form of a price onthe carbon dioxide (CO2) emitted. A price on carbon helpsshift the burden for the damage from GHG emissions back tothose who are responsible for it and who can avoid it. Insteadof dictating who should reduce emissions where and how, acarbon price provides an economic signal to emitters, andallows them to decide to either transform their activities andlower their emissions, or continue emitting and paying fortheir emissions. In this way, the overall environmental goal isachieved in the most flexible and least-cost way to society.Placing an adequate price on GHG emissions is offundamental relevance to internalize the external cost ofclimate change in the broadest possible range of economicdecision making and in setting economic incentives for cleandevelopment. It can help to mobilize the financial investmentsrequired to stimulate clean technology and market innovation,fueling new, low-carbon drivers of economic growth.There is a growing consensus among both governments andbusinesses on the fundamental role of carbon pricing in thetransition to a decarbonized economy. For governments,carbon pricing is one of the instruments of the climate policypackage needed to reduce emissions. In most cases, it is alsobe a source of revenue, which is particularly important in aneconomic environment of budgetary constraints. Businessesuse internal carbon pricing to evaluate the impact ofmandatory carbon prices on their operations and as a tool toidentify potential climate risks and revenue opportunities.Finally, long-term investors use carbon pricing to analyze thepotential impact of climate change policies on theirinvestment portfolios, allowing them to reassess investmentstrategies and reallocate capital toward low-carbon or climate-resilient activities. Carbon pricing can take different forms and shapes. In theState and Trends of Carbon Pricing series and on this website,carbon pricing refers to initiatives that put an explicit price onGHG emissions, i.e. a price expressed as a value per ton ofcarbon dioxide equivalent (tCO2e). Considering differentcarbon pricing approaches, an emissions trading system (ETS),on the one hand, provides certainty about the environmentalimpact, but the price remains flexible. A carbon tax, on theone hand, guarantees the carbon price in the economicsystem against an uncertain environmental outcome. Othermain types of carbon pricing offset mechanisms, results-based climate finance (RBCF) and internal carbon prices set byorganizations. Scaling up GHG emission reductions andlowering the cost of mitigation is crucial to decarbonizeeconomies. Given the size and urgency imposed by theclimate challenge, a full range of carbon pricing approacheswill be required, alongside other supporting policies andregulations.

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Externality is the negative or positive spillover by the consumer or producer which affects the…