1
Climate Change
2
What is climate change?
• IPCC:
A change in the state of the climate that can be
identified by changes in the mean and/or the variability
of its property and persists for an extended period,
typically decades or longer.
Climate change may be due to
1. natural internal processes or
2. external forcings, or
3. to persistent anthropogenic changes in the
composition of the atmosphere or in land use.
3
4
5
6
7
The economic side
• Why is there any economic problem?
▫ Greenhouse gas emission benefits the emitter and hurts
the world external effect
▫ Nobody owns the atmosphere so everybody uses it as a
dumping site for the emissions Public good
▫ Benefit accrue today while adverse consequences
mostly affect future generation
8
What can we do?
• Repair the market by
▫ Making people pay for emissions
 Taxes
 Emission permits
▫ Paying people for not emitting
 subsidies
▫ Directly controlling firms
 standards
9
More than “standard” economics?
• Why is there any economics problem?
▫ Future generations are not participating in today’s
market! How to trade welfare over time?
▫ We cannot predict the consequences of today’s action
with certainty! Should we, therefor, not care about the
consequences? Or should we do everything to
minimize the risk of a future harm?
10
Economic Impact of Climate Change
• How do economists estimate the economic impact of
a change in climate?
▫ Statistical analysis of individual impacts (like crop
yields)
▫ Full blown complex integrated assessment models
(IAMs): simulations of stylized models of the economy
that try to predict overall costs of climate change
11
Any other problems??
• Even if we know what policy instruments work, and
what emission levels would be globally optimal▫ How do we reach international cooperation?
▫ There is no “world government”
▫ Individual countries can benefit from non-participation
in international emission reduction agreements (free
riding)
12
Regulations
Source: PEW(2005)
For example: 2.2 billion tons of CO2*11 €/tCO2*$1.5/€
13
Should the Government Intervene with
Pigouvian Taxes?
• A.C. Pigou (1938) argued that an externality cannot
be mitigated by contractual negotiation between the
affected parties.
• Pigou argued that direct coercion by the government
or judicious use of taxes should be used against the
offending party.
• These taxes are referred to as Pigouvian taxes.
14
An Externality Tax on Output
15
An Externality Tax on Output
MSC = MPC + MDpollution
$
a
MPC1
b
Demand
Q*
Q1
Quantity of steel
16
Pigouvian Taxes
• An externalities tax equal to the divergence between
MPC and MSC would raise the steel firms’ private
costs.
• The tax would shift the MPC curve by an amount
equal to the distance from a to b
• The market would arrive at an optimal equilibrium of
Q*.
• This is known as internalizing an externality.
• More precisely, the tax should be placed on the
externality itself (the amount of pollution emissions)
rather than on output (amount of steel).
17
Marginal Damage Function
• The marginal damage function represents the
damages that pollution generates by degrading the
environment.
• The marginal damage function specifies the damages
associated with an additional unit of pollution.
• The total damages generated by a particular level of
pollution is represented by the area under the
marginal damage function.
18
Marginal Damage Function
19
Marginal Abatement Cost Function
• Abatement Costs are those costs associated with
reducing pollution to a lower level so that there
are fewer damages.
• Abatement costs include:
▫
▫
▫
▫
Labor
Capital
Energy needed to lessen emissions
Opportunity costs from reducing levels of
production or consumption.
20
Marginal Abatement Cost Function
• The marginal abatement cost function
represents the costs of reducing pollution by one
more unit.
21
Optimal Level of Pollution
• Optimal level of pollution minimizes the total social
costs of pollution (the sum of total abatement costs
and total damages).
• This level occurs at the point where marginal
abatement costs are equal to marginal damages.
22
The Optimal Level of Pollution
Cap
23
Economic Incentives and Minimized
Total Abatement Costs
• Consider the following graph.
• A polluter is polluting at an unregulated level of 10
units.
• The government imposes a tax equal to t dollars per
unit of pollution.
• The polluter compares the tax of t dollars to the
marginal abatement cost (MAC) of reducing
pollution.
• As long as the MAC is less than the tax, polluter will
reduce level of emissions.
• Each polluter will chose an emission level which
equates MAC and the tax.
24
Economic Incentives and Minimized
Total Abatement Costs
25
Economic Incentives and the Certainty
of Attaining a Target Level of Pollution
• If the aggregate marginal abatement cost function is
know, then achieving a targeted level of pollution is
easily accomplished.
• If the aggregate marginal abatement cost function is
not known, the appropriate tax level is much harder
to determine.
• Consider the following graph, where evidence
suggests that the true MAC function lies between an
upper and lower bound set of MAC’s.
26
Economic Incentives and the Certainty
of Attaining a Target Level of Pollution
27
Economic Incentives and the Certainty
of Attaining a Target Level of Pollution
• Suppose policymakers believe MAC1b is the true MAC.
In an effort to achieve an emissions level of E1, they
impose a tax of t1.
• However, if MACt describes how polluters will respond,
the emissions level will be E2.
• E2 is higher than the desired level of pollution.
• Because the choice of pollution abatement and production
technologies is sensitive to specific tax structures, it may
not be easy to change the tax to achieve the desired level
of pollution emissions.
28
Economic incentives and incentives for
research for a firm
Firm cost initially =
a + b + c (tax bill) +
d + e (abatement cost)
damages,
costs, $
Firm cost after R&D =
MAC initially
a (tax bill) +
b + e (abatement cost)
MAC
d
e
Abatement
after R&D
t
c
b
a
29
Tax versus Cap-&-Trade (Quantities)
• Pros for tax?
▫ …
No price volatility
▫
Revenue allows for “double-dividend”
▫ …
Can address distributional effects (consumers)
• Pros for cap-&-trade?
▫
▫
▫
▫
…
Emissions certainty
…
Can raise revenues through auctioning
…
Can address distributional effects (producers)
Political feasibility in countries that are “taxation-averse”
(e.g. U.S.)