Question: What does an economist do?

ENVS 39B Climate Change: Causes, Impacts, Responses & Solutions

10/25. The Economics of Climate Change

We are going to answer two questions

How much carbon emission is too much?
What can economics help to create tool to reduce carbon emission?

How much carbon emission is too much?

Robert Baratheon is a huge burger lover. One day he walks into a burger place and finds the menu to be the following. Which burger should Robert choose?

Burgers	No. Sausages	Price	Willingness to Pay
Veggie Burger	0	$4	$5
Cheeseburger	1	$6	$8.5
Double Cheeseburger	2	$8	$11
Triple Cheeseburger	3	$10	$12.5
The Ultimate Cheeseburger	4	$12	$13

Maximize net benefits

Burgers	Price	WTP	Net Benefit
Veggie Burger	$4	$5	$1
Cheeseburger	$6	$8.5	$2.5
Double Cheeseburger	$8	$11	$3
Triple Cheeseburger	$10	$12.5	$2.5
The Ultimate Cheeseburger	$12	$13	$1

Some Algebra

WTP: $-0.5Q^2+4Q+5$

The demand for beef sausage:

P = 4-Q

Price for beef sausage

P = 2

Net benefit is maximized when price equals marginal benefit

Q = 2

What are we doing here?

We are essentially evaluating the trade-off between:

The joy of consuming an ADDITIONAL sausage
The lost opportunity of using the resource to:
- Buy 3 apples
- Subscribe to Netflix
- Sit on a massage chair for 3 minutes

So, what happens when the good in question is GHG emission?

We need to find:

A demand curve
- how much damage will one extra unit of GHG cause to our society?
A supply curve
- How much will it cost to reduce one extra unit of GHG emission?
An optimal level of pollution that equates supply and demand

Climate change leads to societal-wide impacts

Decreasing agricultural production
Rising sea level
Increasing inter-personal conflicts
Decreasing ability to learning and testing
Increasing human mortality

…

Economist has been working hard on quantifying these damages

Reducing GHG emission is also costly

Solar PVs
Hydro-power
Electric cars
Re-forestation / Conservation

…

And also this:

From mid-March to mid-June 2020, $CO_2$ emission decreases by ~18% in the United States (Greestone 2020)
- By the end of the year, ~4% reduction for the year 2020
- RCP 2.0: 8% reduction every year until 2050
$PM_{2.5}$ levels decrease by 36% globally during the lockdown months (Venter et al. 2020)
$NO_{2}$ levels decrease by 60% globally (Venter et al. 2020)

The US lost ~30% of its GDP in the second quarter

The best estimate for cost: $3,000-5,000 per tonne of $CO_2$

This is using a missile to shot a cow - Michael Greenstone

2. What can economics help to create tool to reduce carbon emission?

Neo-classical economics: A complete and competitive market leads to an efficient allocation of resources.
- Such that the total welfare of the society is maximized
Market failure: when Adam Smith is wrong
- The “free-market” is no longer efficient if the market is not complete

Climate change as a market failure

Climate change is a classic problem of market failure caused by externality
- Externality: costs/benefits unaccounted through market transactions
If unregulated, externality will cause us to produce too much, and price too low
- e.g., the current electricity price does not take into consideration the cost of carbon emission (SCC) created during the generation process

So, what to do about it?

The most efficient solution is to implement carbon pricing
Two major ways to do so:
- Carbon tax: charge a fixed fee everytime GHGs are emitted into the air
- Cap-and-trade market: issue a fixed amount of emission allowance, and allow emitters to buy and sell the allowance
Mathematically the two approaches are equivalent without uncertainty (Weitzman 1974)

How does carbon pricing solve the problem?

Each gallon of gasoline - 8.89 kg CO2
Under SSC = $$$50/ton -> $$$0.44 per gallon carbon tax (~15% increase)
What will happen if gas price increases by 15%?

36.4 fewer miles (0.84%) driven by the average American (Liu 2021)
More usage of public transportation
No need to demonize drivers - with proper incentives behavioral changes will follow