Teaching price formation using a cap and trade game (External case study)
“Cap and trade” is one of the most innovative policy options developed by environmental economists. By placing a cap on a social bad and allowing firms to buy and sell the right to generate it, policymakers combine government intervention with market-based incentives to improve welfare and internalize the externality. Such programs represent a great opportunity for instructors to show students how economic theory is used in the real world. Students can learn several important tenets of economics by playing an in-class game based on musical chairs, which creates a market for pollution using a mobile app or paper-based interaction. This active learning method engages students and improves comprehension of price formation, gains from trade, voluntary response to incentives, and an important environmental policy.