Greenhouse EconomicsAnn WangRuby Tumber

July 9, 2013

Agenda Introduction and

background

Economic model

Economic policies

Application to California

Application + Discussion

Introduction & Background

• What is the greenhouse effect?

“the apparent tendency of carbon dioxide (CO2) and other gases to

accumulate in the atmosphere, acting like a blanket that traps radiated heat, thereby increasing the earth’s temperature…[without these gases], the earth’s average temperature would be roughly 0°F instead of just over 59°F , and everything would be frozen solid”

• Human sources of greenhouse gases:• CO2: combustion of fossil fuels

• Methane: landfills and livestock

• Consequences of too much CO2 and other greenhouse gases: • Rising temperatures (global warming)• Rise in average sea level• Deoxygenated bodies of water due to algal blooms• Dust bowls

Introduction & Background

http://data.giss.nasa.gov/gistemp/graphs_v3/

The amount of carbon dioxide in the atmosphere there has exceeded 400 parts per million (ppm) for the first time in 55 years of measurement—and probably more than 3 million years of Earth history.

The last time the concentration of Earth's main greenhouse gas reached this mark, horses and camels lived in the high Arctic. Seas were at least 30 feet higher—at a level that today would inundate major cities around the world.

The Economic Model

• The “good”: Fuels (coal, oil, natural gas)• Private good that is scarce• Demand and supply for this good are both inelastic

• Negative externalities: Pollution, emission of greenhouse gases--> global warming, rising ocean levels, dust bowls

• Few suppliers in the market, monopolies and oligopolies on types of fuels, a lot of consumers because this is a necessity of the public

The Economic Model

external cost

supply (private cost)

social cost (private cost + external cost)

P optimum

demand (private value)

Q optimum Q market

P market

Price of fuels

Quantity demands of fuels

Economic Policies

Opportunity costs of economic policiesWhat is the value of a clean environment?

ProfitProduction

Investments elsewhere

Health costsEnvironmental

costs

Economic Policies

Social Pressure• 1988 Toronto Conference on the Changing

Atmosphere Recommended cut in CO2 emissions by 2005 of

90% of 1988 level—this goal was not met 48 nations in attendance Most important results:

• Climate change on the global agenda• Investment in climate and technology

research• Creation of Intergovernmental Panel on

Climate Change (IPCC)--> United Nations Framework Convention on Climate Change (UNFCCC)

Economic Policies

Regulation: Cap and Trade1997 Kyoto Conference on climate change

By 2012, 38 developed nations should cut greenhouse emissions by 5 percent relative to 1990 levels (Kyoto Protocol)

Developing nations exempt 160 nations in attendance 55 had to ratify for the Kyoto Protocol to be enforceable Different targets for different gases and for different

countries. The total amount of emissions is fixed and allocated to

participating countries Countries can exchange emissions credits

The Economic Model

demand (buyers are collection of the demand of all participating countries AND anyone else--eg environmental groups)

Q

P

Price of emissions credits

Quantity demanded of credits

• "Cap and Trade": Emissions credits (e.g. carbon credits) become a substitute private good and a valuable commodity that can be sold

• Total supply of emissions credits is fixed--cannot be increased

• Incentive: You would sell your credits if the price of credits exceeds the cost of using them--for example, you might have developed cleaner technologies

Economic Policies

Why did prices of emissions credits plummet?• Surplus of permits• Too many handed out for

free• Alternative energy

sources more and more abundant

• Slowed economy led to slowed industries that emit

• It is therefore really cheap to emit—there is no incentive not to just buy credits

• Takeaway: Cap and trade may not accurately predict price fluctuations in the market, which means that it cannot control effectiveness of incentive

Economic Policies

Command-and-Control Regulation: Vehicle Emissions

EPA instituted a legal limit on the amount of emissions that vehicles are allowed to produce

EPA instituted fuel standards gas had to be reformulated (RFG) Did bring down average vehicle hydrocarbon

emissions from 9 grams to 1.5 in 30 years Unexpected negative externalities:

Use of carcinogenic materials to reformulate gasoline; these materials were chosen because of their relative cost in the market of these inputs

Volatile pricing in some locations

Economic Policies

Regulation: Permits (inputs) Permits on drilling, mining, or hydraulic fracking (cost of time and

money to suppliers) Cost of production increases, which shifts supply left-- quantity

demanded decreases

Price of fuel

Quantity fuel demanded

s1

s2

d

p1

p2

q1q2

Economic Policies

Taxation on good (e.g. gasoline tax on consumer)

or on carbon content (e.g. corrective tax on supplier) Would theoretically be the most effective because it is market-

based—you fix the incentive Would make fossil fuels less competitive Demand becomes more elastic in the long term Lower administrative cost than regulation Would generate a lot of revenue, compensate for deadweight

loss Would stimulate research, just like emissions credits Many countries “actively considering” carbon tax Politicians are afraid of using both types of taxation

“If our goal is to get Americans to drive less and use more fuel-efficient vehicles, and to reduce air pollution and the emission of greenhouse gases, gas prices need to be even higher. The current federal gasoline tax, 18.4 cents a gallon, has been essentially stable since 1993; in inflation-adjusted terms, it’s fallen by 40 percent since then”

Economic Policies

Consumer tax on fuel: Directly taxing use of the good. The burden will likely fall more heavily on consumers, whose demand for fuel is very inelastic

d1

d2

Price of fuel

Quantity of fuel demanded

Amount of tax

Price paid by consumers

Price sellers get

s1

Price without tax

Tax on consumer shifts demand downward

Economic Policies

Subsidies for research and alternative energy sources / Changes in technologyCreate substitute goods, shift supply and demand, create positive externalities

• Cars with lower emissions are becoming more affordable • Alternative energy sources

• The majority of energy generation in the world is from coal, which is the largest anthropogenic contributor of Co2.

• Solar, wind, hydroelectric, nuclear are cleaner generators of power.

• Create cleaner fuels • Many so called "Big Oil" providers, such as

Chevron and BP, are working on creating more "efficient" and "cleaner" fuels.

• This is questionable - would Big Oil risk losing profit by creating more efficient fuels?

http://www.chevron.com/

Economic Policies

Education + Social Pressure Shift demand

According to Miller, Benjamin, and North (2012):

"If we are to get individuals to reduce production of greenhouse gases to the efficient rate, we must somehow induce them to act as though they bear all the costs of their actions. The two most widely accepted means of doing this are government regulation and taxation.”

• Energy conservation Convincing the public, especially societies unaccustomed

to flexing their power, to be more austere in their energy usage.

• Supplying alternative and public transportation • Supporting infrastructure that requires less energy (e.g. urban

development)

Roger Leroy Miller, Daniel K. Benjamin and Douglass North, The Economics of Public Issues, 17th edition, Pearson/Addison Wesley, 2012

The Economic Model

S1

S2

P2

D1

Q2 Q1

P1

Price of fuels

Quantity demanded of fuels

• Change in taste --> Demand shifter. Entire demand curve shifts left

• Improvement in technology reduces fuel consumption --> Supply shifter. Entire supply curve shifts left

D2

Current policy scheme: cap and trade in California

On January 1st of this year, California adopted a cap and trade system.

The premise of the cap and trade system relies on the free market to regulate carbon emissions. The state creates permits, which "cap" emissions for biggest polluters - refineries, power producers, and other large industries which utilize large amounts of fossil fuel. These caps create maximal limits on emissions and are comprised of carbon credits which equal their total cap. Industries are allowed to buy and sell extra credits in an attempt to incentivize the reduction of pollution.

Criticisms: • Ineffectiveness, over-

issuing permits (resulting in loss of cost), insufficient caps, "grandfathering" permits

• Example: In the European Union emissions caps were not stringent enough to cause any major emissions reductions.

In Context

Application to current events

Discussion: Which single policy or combination of policies would most likely achieve the socially optimal quantity demanded of greenhouse-has-emitting fuels? Justify your opinion with economic theory.