climate change course

8/8/2019 Climate Change Course

1/25

11

First Theorem of Welfare EconomicsFirst Theorem of Welfare Economics

Pareto efficiencyPareto efficiency

No welfare enhancing trades can be madeNo welfare enhancing trades can be made

It is impossible to make somebody else better off withoutIt is impossible to make somebody else better off without

making somebody else worse offmaking somebody else worse off

First theorem of welfare economics: theFirst theorem of welfare economics: the

equilibrium of a competitive market economy isequilibrium of a competitive market economy is

Pareto efficient ifPareto efficient if

all goods areall goods are privateprivate no difference betweenno difference between private/social costprivate/social cost differencesdifferences

Formalizes Adam Smiths concept of an invisibleFormalizes Adam Smiths concept of an invisible

handhand


2/25

22

Invisible HandInvisible Hand

Every individual neither intends to promoteEvery individual neither intends to promotethe public interest, nor knows how much he isthe public interest, nor knows how much he ispromoting it. He intends only his own security,promoting it. He intends only his own security,his own gain. And he is in this led by anhis own gain. And he is in this led by aninvisible hand to promote an end which was noinvisible hand to promote an end which was nopart of his intention. By pursuing his ownpart of his intention. By pursuing his owninterest he frequently promotes that of societyinterest he frequently promotes that of societymore effectively than when he really intends tomore effectively than when he really intends topromote it.promote it.

It is not from the benevolence of the butcher, theIt is not from the benevolence of the butcher, thebrewer, or the baker that we expect our dinner, butbrewer, or the baker that we expect our dinner, butfrom their regard to their own interest.from their regard to their own interest.


3/25

33

Invisible HandInvisible Hand

Idea behind invisible handIdea behind invisible hand

Societal perspective:Societal perspective: A good should be produced if the utility to the userA good should be produced if the utility to the user

exceeds the cost of producing itexceeds the cost of producing it

Firm perspectiveFirm perspective Can make a profit if the utility to the user (theCan make a profit if the utility to the user (the

maximum he/she is willing to pay) exceeds the cost ofmaximum he/she is willing to pay) exceeds the cost of

producing itproducing it


4/25

44

Key Concepts I: Private / Public GoodKey Concepts I: Private / Public Good

Public versus private goodsPublic versus private goods

Private goodPrivate good Rival: if I eat an apple, somebody else cant eat theRival: if I eat an apple, somebody else cant eat the

same applesame apple Excludable: I can keep other people from eating myExcludable: I can keep other people from eating my

appleapple

Public goodPublic good Non-rival: if I walk in a park, my neighbor can do soNon-rival: if I walk in a park, my neighbor can do so

at the same timeat the same time

Non-excludable: I cant keep my neighbor fromNon-excludable: I cant keep my neighbor from

walking in the parkwalking in the park


5/25

55

Key Concepts II: Private / Social CostKey Concepts II: Private / Social Cost

Private costs (benefits) of an actionPrivate costs (benefits) of an action

accruing to the actor onlyaccruing to the actor only

Social costs (benefits)Social costs (benefits)

total costs of activity including those thattotal costs of activity including those that

accrue to people other than the actoraccrue to people other than the actor

Example: driving a carExample: driving a car

Private costs: fuel, maintenancePrivate costs: fuel, maintenance

Social costs include pollution, road wearSocial costs include pollution, road wear


6/25

66

External EffectsExternal Effects

Any difference between private and socialAny difference between private and social

costs is referred to as an externality orcosts is referred to as an externality or

external effectexternal effect

Recall how markets workRecall how markets work

in seeking profits firm produce a goodin seeking profits firm produce a good

If utility to consumer (maximum willingness to pay)If utility to consumer (maximum willingness to pay)exceeds the cost of producing itexceeds the cost of producing it

Problem: if private cost are different from socialProblem: if private cost are different from social

cost, firm doesnt act in societies best interestcost, firm doesnt act in societies best interest


7/25

77

0

2

4

6

8

10

12

14

16

A B

Choices

Cos

ts

Private-Social difference

Private

Left - social cost 15, private 10Left - social cost 15, private 10

Right - private & social cost of 12Right - private & social cost of 12

orporation will choose A as private cost is lower


8/25

88

Examples of Private v. SocialExamples of Private v. Social

Conserving tropical forestsConserving tropical forests

Private benefits: may be small for landownerPrivate benefits: may be small for landowner some sales of non-timber forest productssome sales of non-timber forest products

Eco-tourismEco-tourism

Social benefits:Social benefits: carbon sequestrationcarbon sequestration

biodiversity conservationbiodiversity conservation

EtcEtc


9/25

99

SummarySummary

Markets work very well whenMarkets work very well when

Assumption of first welfare theorem are metAssumption of first welfare theorem are met goods are privategoods are private

private & social costs are equalprivate & social costs are equal

Less satisfactory otherwiseLess satisfactory otherwise

market failure & rationale for interventionmarket failure & rationale for intervention

How best to intervene?How best to intervene?


10/25

1010

Market FailureMarket Failure

Social benefits > private benefitsSocial benefits > private benefits Good is underprovidedGood is underprovided

Provider has too little financial incentive, i.e.,Provider has too little financial incentive, i.e.,doesnt capture all benefitsdoesnt capture all benefits

Example: rainforestExample: rainforest

Social costs > private costSocial costs > private cost

good isgood is over-provided Provider does not account for all costs itProvider does not account for all costs it

imposes on societyimposes on society

Example: transportation, fossil fuel.Example: transportation, fossil fuel.


11/25

1111

Policy ResponsesPolicy Responses

What to do if there is a difference betweenWhat to do if there is a difference between

private and social costsprivate and social costs

Impose a tax (or subsidy)Impose a tax (or subsidy)

equal to difference between private and social costsequal to difference between private and social costs introduce of property rightsintroduce of property rights

Based on the view that an excess of social overBased on the view that an excess of social over

private costs arises from the inability to own certainprivate costs arises from the inability to own certain

key resources, such as the atmosphere.key resources, such as the atmosphere.

Afterwards market outcome will be Pareto-Afterwards market outcome will be Pareto-

efficient againefficient again


12/25

1212

Side note: Equity & EfficiencySide note: Equity & Efficiency

First welfare theorem maximizes the sizeFirst welfare theorem maximizes the size

of the pie, but says nothing about itsof the pie, but says nothing about its

distributiondistribution

Pareto efficiency is separate fromPareto efficiency is separate from

distribution and any concept of equity.distribution and any concept of equity.

It states that all opportunities for mutual gainIt states that all opportunities for mutual gain

are exploited. But not that the outcome is in anyare exploited. But not that the outcome is in anyway fair.way fair.


13/25

1313

Greenhouse GasesGreenhouse Gases

Two views on COTwo views on CO22emissionsemissions

social costs of burning fuels > private costssocial costs of burning fuels > private costs Solution: impose a carbon tax.Solution: impose a carbon tax.

use of the atmosphere for waste disposal withoutuse of the atmosphere for waste disposal without

any paymentany payment atmosphere should be someones propertyatmosphere should be someones property

if we want to pollute it we have to obtain their permissionif we want to pollute it we have to obtain their permissionand compensate them for damage to itand compensate them for damage to it

Leads to tradable SOLeads to tradable SO22/CO/CO

22permitspermits

Requires well-defined property rights!Requires well-defined property rights!


14/25

1414

Cap & Trade SystemsCap & Trade Systems

Amount to establishing property rightsAmount to establishing property rights

in environmental assetsin environmental assets Give out limited, tradable rights to carryGive out limited, tradable rights to carry

out an environmentally harmful activityout an environmentally harmful activity

Leads to mitigation bankingLeads to mitigation banking


15/25

1515

Examples of Cap -&-Trade:Examples of Cap -&-Trade:

Title IV of Clean Air Act AmendmentsTitle IV of Clean Air Act Amendments

SOSO22 permit marketpermit market

Number of permits: 50% of historic emissionsNumber of permits: 50% of historic emissions

Permits are grandfathered (allocated based onPermits are grandfathered (allocated based onhistoric emissions)historic emissions)

Advantage of permit market:Advantage of permit market: Firms with lowest abatment cost will abateFirms with lowest abatment cost will abate gives firm incentive to innovategives firm incentive to innovate

Initial cost estimates by industry > 1000 per ton SOInitial cost estimates by industry > 1000 per ton SO22 EPA: 250-350 per ton SOEPA: 250-350 per ton SO22 (Phase 1)(Phase 1)

500-700 per ton SO500-700 per ton SO22 (Phase 2)(Phase 2) Permit price ~150 per ton SOPermit price ~150 per ton SO22


16/25

1616


Fox River in WisconsinFox River in Wisconsin

Allowable firms to trade pollution rightsAllowable firms to trade pollution rights

Problem: each trade had to be approvedProblem: each trade had to be approved

Only 1 trade in many yearsOnly 1 trade in many years

Lessons: Permit market works bestLessons: Permit market works best

Clearly defined property rightsClearly defined property rights

Many potential buyers and sellersMany potential buyers and sellers

Low transaction costLow transaction cost

Uniformly mixing pollutantUniformly mixing pollutant


17/25

1717


Wetlands bankingWetlands banking

www.wildlandsinc.comwww.wildlandsinc.com

KyotoKyoto Chicago Climate ExchangeChicago Climate Exchange

www.chicagoclimatex.comwww.chicagoclimatex.com
http://www.wildlandsinc.com/http://www.wildlandsinc.com/http://www.chicagoclimatex.com/http://www.chicagoclimatex.com/http://www.chicagoclimatex.com/http://www.wildlandsinc.com/


18/25

1818

Kyoto ProtocolKyoto Protocol

Cap-and-trade on emissions by industrialCap-and-trade on emissions by industrial

countries and transitioning countriescountries and transitioning countries

No significant restrictions on emissions byNo significant restrictions on emissions bydeveloping countriesdeveloping countries

Clean development mechanismClean development mechanism Develop countries can get credits for reduction inDevelop countries can get credits for reduction in

developing countriesdeveloping countries


19/25

1919

Kyoto Protocol Kyoto Protocol Annex B CountriesAnnex B Countries


20/25

2020

Historic EmissionsHistoric Emissions


21/25

2121

Kyoto - targetsKyoto - targets

European Union (15 members) -8%

US -7%

Canada, Hungary, Japan, Poland -6%

Croatia -5%

New Zealand, Russian Federation, Ukraine 0%

Norway +1%

Australia +8%

Iceland +10%


22/25

2222

Example: Burden-sharing agreementExample: Burden-sharing agreement

(Europe)(Europe)

Austria -13% Italy -6.5%

Belgium -7.5% Luxembourg -28%

Denmark -21% Netherlands -6%

Finland 0% Portugal +27%

France 0% Spain +15%

Germany -21% Sweden +4%

Greece +25% United Kingdom -12.5%

Ireland +13%

EuropeanCommunity

-8%


23/25

2323

Kyoto ProtocolKyoto Protocol

Doesnt tackle India-China problem:Doesnt tackle India-China problem:

Large fraction of world populationLarge fraction of world population Historically low per-capita emissionsHistorically low per-capita emissions

Very few grandfathered permitsVery few grandfathered permits Problems is not theirs but of developed worldProblems is not theirs but of developed world

Could not stabilize emissions without radically newCould not stabilize emissions without radically new

technologiestechnologies

India / China has no incentive to joinIndia / China has no incentive to join

Without participation by China / IndiaWithout participation by China / India Kyoto Protocol will not come close to solving theKyoto Protocol will not come close to solving the

problem so other countries have little incentive to join.problem so other countries have little incentive to join.


24/25

2424

An Agreement on GHGsAn Agreement on GHGs

Developed worldDeveloped world

lead in development of new technologieslead in development of new technologies

might be sufficient to bring developing countriesmight be sufficient to bring developing countries

on boardon board

Clean coal technologiesClean coal technologies

China could use all of its coal, as could IndiaChina could use all of its coal, as could India This would be of immense value to them.This would be of immense value to them.


25/25

2525

An Agreement on GHGsAn Agreement on GHGs

Chinas dilemma:Chinas dilemma: burning coal generates terrible pollutionburning coal generates terrible pollution

domestic political issue.domestic political issue.

Switch away from coal will increase energy costsSwitch away from coal will increase energy costs

Development of clean coal technologiesDevelopment of clean coal technologies valuable to China (reduces other pollution)valuable to China (reduces other pollution)

should encourage China and India to participateshould encourage China and India to participatein an agreement to reduce GHGsin an agreement to reduce GHGs

understanding that tight standards would onlyunderstanding that tight standards would onlyapply once a new technology were in place.apply once a new technology were in place.

climate change course

Documents