Download - Climate Change Course
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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
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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.
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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
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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
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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
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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
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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
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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
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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?
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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.
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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
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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.
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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!
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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
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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
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Examples of Cap -&-Trade:Examples of Cap -&-Trade:
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
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Examples of Cap -&-Trade:Examples of Cap -&-Trade:
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/ -
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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
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Kyoto Protocol Kyoto Protocol Annex B CountriesAnnex B Countries
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Historic EmissionsHistoric Emissions
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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%
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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%
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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.
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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.
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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.