The economics of climate change C C 175 Christian Traeger Ch i ti - - PowerPoint PPT Presentation

The Economics of Climate Change – C 175

The economics of climate change

C Ch i ti T C 175 ‐ Christian Traeger Part 3: Environmental Policy Instruments 3 y

Suggested background reading for emerging questions: Suggested background reading for emerging questions: Kolstad, Charles D. (2000), “Environmental Economics”, Oxford University Press, New York New York. Varian, Hal R. (any edition...), “Intermediate Microeconomics – a modern approach”, W. W. Norton & Company, New York. pp , p y,

3 Instruments 1 Spring 09 – UC Berkeley – Traeger

The Economics of Climate Change – C 175

The Economics of Climate Change C 175 ‐ Christian Traeger 75 g Part 3: Policy Instruments Introduction on Instrument Choice Introduction on Instrument Choice

Read: Section 4 of Congressional Budget Office (2003), “The Economics of Climate Change: A Primer”

Spring 09 – UC Berkeley – Traeger 3 Instruments 2

Problem description

The Economics of Climate Change – C 175

 Problem is that actions taken by agents affect profit/welfare of

• ther agents

 If the first group of agents does not take this into account when

making decisions, there is an externality (external effect) g y

 Production and consumption activities cause emissions of

GHGs GHG h d h ff t ith ll ki d f

 GHGs cause enhanced greenhouse effect with all kinds of

negative (and positive!!) welfare effects

 Total (global) welfare not maximised if we rely on ‚the market‘ to

solve the problem: too high emissions

 How can we correct for this externality?

3 Instruments 3 Spring 09 – UC Berkeley – Traeger

Instrument choice

The Economics of Climate Change – C 175

 Possible:

 Market based instruments:

 Bargaining

T / b id

 Tax/subsidy  Tradable permits

 Other instruments:

 Technology control (e.g. BATNEEC)  Damage control, prohibition  Liability

3 Instruments 4 Spring 09 – UC Berkeley – Traeger

Instrument choice

The Economics of Climate Change – C 175

• Which instrument is best?? Possible criteria:

– Ecological accuracy – Static cost-effectiveness – Dynamic cost-effectiveness – Political acceptability (polluters)

3 Instruments 5 Spring 09 – UC Berkeley – Traeger

Scientific/Ecological accuracy

The Economics of Climate Change – C 175

 Aim is to achieve some emission target, or stock of GHGs in the

atmosphere

 Instrument must make sure that we achieve this target!!  Or perhaps there is a trade off ?  Or perhaps there is a trade‐off…?

3 Instruments 6 Spring 09 – UC Berkeley – Traeger

Static cost‐effectiveness

The Economics of Climate Change – C 175

 Instrument is cost‐effective if real resource cost of obtaining policy

target is no greater than that of any other instrument

 Example: pollution abatement in production:  Example: pollution abatement in production:

Necessary condition for abatement at least cost is that marginal abatement cost be equalized over all firms with positive emissions

 Why? > Intuition!  Why? ‐> Intuition!  Formal derivation:  Firm i’s abatement cost: ci(ei), Government’s target: Σiei≤E, i=1,…,N  c ‘(e ) = c ‘(e ) = c ‘(e ) for all i j=1

N

       

 

  1

• N

1 i i N i 1

• N

1 i i

e c ) (e c min E

for all i=1,…,N‐1

 ci (ei) = cN (eN) = cj (ej) for all i,j=1,…N

thus marginal costs same for all firms

 Market‐based instruments (Pigouvian tax, tradable permits) are

t ff ti i t t cost‐effective instruments

3 Instruments 7 Spring 09 – UC Berkeley – Traeger

Dynamic cost‐effectiveness

The Economics of Climate Change – C 175

 Important way to reduce emissions: new technologies  How do policy instruments affect incentives to develop new

technologies?

 Minimize costs to achieve a target over some time horizon:  Minimize costs to achieve a target over some time‐horizon:

dynamic efficiency

3 Instruments 8 Spring 09 – UC Berkeley – Traeger

Political acceptability

The Economics of Climate Change – C 175

 All policy goes via political systems  Politicians sensitive for lobbying

 “Climate policy is costly!!”  “If costs are high, industry will loose jobs!!”

 Policy (target + instrument chosen) must be acceptable for

polluters p

3 Instruments 9 Spring 09 – UC Berkeley – Traeger