Basic economics needed to understand climate change policyTopics covered in this sectionBegin discussing details of different policies for reducing emissionsTaxes versus “cap-and-trade” (quotas)Political and “practical” features of taxes and quotasEconomic basis for comparing taxes and quotasUse static model to explain economic difference between taxes and quotasModeling the benefits and the damages from emissionsExplain next slideDetermining efficient levels of taxes and quotasThe advantage of quotas: quotas reduce expected damages (relative to taxes)Expected damages are lower under quotasThe advantage of taxes: taxes increase expected benefits (i.e., reduce expected abatement costs) relative to quotasExpected benefits are higher under taxes (expected abatement costs are lower under taxes)Summarize comparisonAnother perspectiveRelation to global warmingComplications arising from dynamicsIntuition from static model still usefulHybrid policiesDetermining optimal level of abatementThe basic pointComparing costs over different income groupsWeighting costs for different income groupsDiscussion of exampleEffects of giving higher weight to income of poorArguments for and against this kind of weightingElaborate on efficiency argumentMore on the efficiency argumentTwo examples of costs and benefits of climate change policyComparing costs and benefits over timeThe need for discount ratesDiscount rates and discount factorsThe “tyranny” of compound discountingThe social discount rateThe components of the social discount rateShould the pure rate of time preference be constant?Effects of a declining pure rate of time preferenceThe economic value of reducing risksThe reason we would not spend much to reduce these risksExample to show magnitudesSolid line: graph of utility flow if “the event” occurs at (random) time T. Dashed line: graph of utility flow when risk is eliminatedHow much would we spend to eliminate risk?Point of this exampleA different viewA different perspective on low probability eventsThe effect of “truncating the distribution”1Basic economics needed to understand climate change policyOctober 16, 20072Topics covered in this sectionThese notes provide basic theory that is helpful in answering two types of questions:1. Given that we have decided to reduce emissions, what is the “best” type of policy of achieving this goal? (What should we mean by “best” -- most efficient, most politically feasible?) I emphasize taxes versus cap and trade.2. Given estimates of the costs and the benefits associated with GHG abatement, how should we determine the optimal level of abatement – i.e. the level that “balances” costs and benefits? I emphasize uncertainty and time dimension of problem.3Begin discussing details of different policies for reducing emissions•"Best efforts approach". Encourage developed countries to undertake their best efforts to reduce emissions. This is worth doing because it is low cost, but it is not likely to lead to major reductions in emissions. • “No regrets" reforms, e.g. liberalization of energy markets, impose standards that also reduce costs. These are worth doing, their effect is questionable. (Economists' skepticism regarding $20 bill lying in the street. Discuss economic analysis of the costs of achieving California’s AB32 goals.)•Actual US energy-related publicly funded and privately funded R&D has fallen over last 10 years. Better technology will not lead to abatement unless firms have an incentive to use it, and this requires some kind of government pressure.•The two prominent mandatory (economically costly) policies are taxes and cap-and-trade.4Taxes versus “cap-and-trade” (quotas)•They have different distributional effects, depending on how tax revenues or emissions permits are distributed. •They produce the same level of output and emissions under cost certainty (and perfect competition). (Discuss analogy with tariffs and quotas, as explained in an earlier lecture.)•They produce different results under cost uncertainty. The tax enables policymaker to choose the marginal abatement cost (equal to the tax), but it leaves the amount of abatement (the amount of emissions) uncertain. The cap-and-trade has the opposite tradeoff.•For climate change, tax is likely to be more economically efficient, but may not be politically feasible.5Political and “practical” features of taxes and quotas•Political: “Taxes” is a dirty word; “revenue neutral” taxes may not be much better. Quotas are a valuable asset; quota recipients (“grandfathers”) may benefit from quota policy. The quota recipients obtain the asset, and the quota raises entrants costs – if these do not receive quota allocation.•Practical: There are costs of organizing cap and trade and also of collecting tax revenues. Both require that emissions be monitored.6Economic basis for comparing taxes and quotas•The two policies directly control different things. The quota puts a ceiling on the level of emissions. The tax puts a ceiling on the level of marginal cost of abatement.•Use (linear) random marginal abatement cost curves to illustrate point above.7Use static model to explain economic difference between taxes and quotas•This model assumes that abatement marginal costs are random. Draw example of high and low marginal abatement cost curves. Think of these as realizations of a random variable.•Explain the meaning of “expected value”.•Pick a quota and then find the tax that leads to the same expected level of emissions. •With tax the level of emissions is random; the tax determines the expected level of emissions; with (binding) quota, the level of emissions is fixed by policy.8Modeling the benefits and the damages from emissions•Emissions lead to environmental damages. Higher emissions associated with higher total and marginal damages.•Abatement is costly. A higher level of emissions means a lower level of abatement, and thus a lower level of abatement costs. The benefits of emissions = the reduction in abatement costs. Explain why benefits are likely to be concave in emissions.•I’ll explain the advantage of quotas and then explain the advantage of taxes. Determining the efficient policy requires comparing these two advantages.9Explain next slide•Next slide shows the marginal damage of emissions and the high and low marginal benefits of emissions (corresponding to high and low marginal cost of
View Full Document
Unlocking...