ECC Notes PDF

Assessment Homework 1 (20%) - due Sept. 19 (9.00, before the third tutorial). Homework 2 (20%) - due Oct. 17 (9.00, after the last tutorial). Final written exam (60%, closed book) - Oct. 23. Overview-summary Lectures (week 1-3) Mock Exam [Part 1] - Excl. answers mock-exam (2022) Week 1: In...

Assessment Homework 1 (20%) - due Sept. 19 (9.00, before the third tutorial). Homework 2 (20%) - due Oct. 17 (9.00, after the last tutorial). Final written exam (60%, closed book) - Oct. 23. Overview-summary Lectures (week 1-3) Mock Exam [Part 1] - Excl. answers mock-exam (2022) Week 1: Introduction to Economics of Climate Change Lecture 1A Introduction to climate change; Illustration of Climate change Greenhouse gases (GHGs) are like a cosy blanket around the earth: the more they accumulate, the more they keep it warm. The most important greenhouse gases are: - carbon dioxide (CO2) (main source of GhG emissions); - The main cause is the burning of fossil fuels, like coal, oil, or natural gas. - Fossil fuels are fossils used to produce energy. - Fossils are mostly made of carbon (C). - To release energy, you need to burn them. - The combustion uses (di)oxygen (O2), which pairs with carbon to create CO2. - methane (CH4); - Methane (CH4) is also released from the exploitation of fossil fuels. In addition, livestock (and in particular beef production) are key sources of emissions. - nitrous oxide (N2O); - Nitrous oxide (N2O) is mostly generated through agricultural and some industrial activities. - fluorinated gases (e.g. HFCs); - Fluorinated gases are emitted from more specific applications and processes (e.g., used as refrigerants). - water vapour. - Water vapour is not emitted by humans, but its concentration is still indirectly affected by human activities. Ambiguous effects:  - Emissions of other GhG warm the planet and oceans, which through evaporation increases the quantity of water vapour; - The higher quantity of clouds makes the planet “whiter” which reflects the solar radiation away from Earth. Fluorinated gases are synthetic, but all others occur naturally. Still, human activity affects their level. Economics development is measured by Gross National Product or Gross Domestic Product (GNP/GDP) "There has been a growing concern in recent years that the patterns of economic growth [GDP] being experienced in many parts of the world are not sustainable" (K. Arrow, 2010) Because they are being accompanied by a depletion of many natural resources and a deterioration in various environmental services." Absolute decoupling implies achieving economic growth using fewer resources Relative decoupling implies achieving economic growth with fewer resources per unit of output Trends in carbon concentration: The Keeling Curve The Keeling Curve depicts the level of carbon dioxide in the Earth’s atmosphere over time. How does it work? Wet-bulb temperature is a frequently used measure to describe the interaction between heat and humidity If the relative humidity is 100%, the wet-bulb temperature is equal to the air temperature (dry-bulb temperature); if humidity is lower, the wet-bulb temperature is lower than the dry-bulb temperature More frequent extreme heat waves and a more humid atmosphere pose major health risks. When the air is too hot and too humid, transpiration does not evaporate and the body cannot cool Basically, economic consequences of sea levels rising, average temperature rising, more carbon dioxide in the air etc. (environmental disasters and the impact on the economy) Biodiversity loss, deforestation, water scarcity Economics and the environment are intertwined in more than one way: The root cause of climate change and environmental degradation is human economic activity (closely mirrored by GDP growth) Economic progress/growth has historically driven human flourishing: decimating poverty, widespread education, life expectancy, and much more Many economists (green growth) believe that growth will remain essential in a world of climate change. Others (degrowth) point towards the destructive and self-harmful properties of the economy Economics can be defined such as: the science which studies human behaviour as a relationship between (given) ends and scarce means which have alternative uses” (Lionel Robbins) Summary  1. Climate economics is an emerging and vital field in economics 2. It studies the fundamental tension and interaction between an intertwined economy and environment 3. The field uses tools from economics to study climatic problems, or to study how climate change affects the economy Lecture 1B Climate change in economic models. (e.g., DICE, AIMs, Nordhaus/Stern) The Kaya identity: Economic growth, energy use, and climate change are intertwined. The Kaya identity decomposes the drivers of climate change: Any increase (decrease) in one of these components leads, everything else equal, to an increase (decrease) in total GhG emissions. The Kaya identity is a simple identity: useful for accounting purposes, but does not allow to isolate the effect of policies; not suited for prescriptive purposes. E.g. Would reducing the population by half cut emissions by two? → Which half? How would this affect GDP per capita? Etc. → To answer these questions, economists have developed a class of models, called Integrated Assessment Models (IAMs). The DICE model describes how the economy (i.e., production and consumption of goods and services) creates emissions that cause environmental damage - The environmental damages feedback by limiting the production of goods and services, thereby establishing this mutual casualty - The DICE model is therefore a set of (mathematical) equations that reduce the complex behaviours and natural processes to simple, tractable relationships - These equations can be calibrated to real-world numbers to (1) test the accuracy of the model and (2) make predictions for the future Objective of the DICE model: model climate change and how it interacts with the economy. The DICE model contains the following elements: 1. Households enjoy the consumption of a good; 2. The production of this good generates GhG emissions; 3. Emissions accumulate into carbon stocks; 4. GhG atmospheric concentration warms the planet; 5. Higher temperatures cause economic damages 1. Households enjoy the consumption of a good; a. 2. The production of this good generates GhG emissions;  b. 3. Emissions accumulate into carbon stocks; c. 4. GhG atmospheric concentration warms the planet;  d. 5. Higher temperatures cause economic damages  e. Graphical overview: Trade-off: Consuming more pollutes and leads to economic damages that reduce future consumption The most important output from IAMs like DICE: the Social Cost of Carbon (SCC) also called thee marginal social cost of carbon  Marginal social cost of carbon: means the cost imposed on society from emitting an additional unit of CO2 - It is a critical guide for action - ​Let’s assume Laura can choose to travel from Amsterdam to London by plane or by train. - Doing so by plane saves her the equivalent (in money, time, etc.) of e100, but emits an additional 1 ton of CO2. - Let’s assume there are no other costs or benefits for anyone else. - Should the person go by train or by plane? - If the SCC < e100/tCO2, then the plane is preferable from the society’s perspective. If it is above, then the train is preferable. - Policy relevance, policymakers must understand the relative harm and com- - pare it to other costs and benefits (i.e., opportunity costs). Positives and negatives to DICE: - Very influential model, a benchmark in the literature, inspiration for a field of study - Its simplicity makes it analytically tractable - Easily expandable - Climate model inconsistent with recent findings in climate science; - Damage function is more complex than assumed (beyond quadratic) - Risk and uncertainty are absent - No tail-end events, tipping-points, or radical behavioural changes - Highly dependent on the discount rate ρ (the pure rate of time preferences). Objections to IAMs 1. Deep uncertainty a. We don’t know much about climate dynamics, economic behaviour, and their interaction; b. Climate change may not be that bad; with some small probability, however, it will be cataclysmic; c. Climate change mitigation is not only about reducing smooth damages, it is about avoiding potential catastrophic events (see e.g. Weitzman, 2009; Pindyck, 2013). 2. Modelling ethics a. The optimal path of mitigation efforts depends on some preference parameters; b. such as the discount rate ρ, i.e. the weight given to the future relative to the present; c. Its value is fiercely debated → drastic implications. Climate economics: what is the trade-off between consumption by current and future generations? Discounting is about weighing future outcomes in present terms and matters in all inter-temporal economic decisions  How much should I put towards my pension? How much should I invest into savings? Should I buy financial instrument A or B? Should I eat that marshmallow? Discount rate ρ; the weight given to the future relative to the present (the pure rate of time preference) Alternatives to IAMs: The carbon budget approach Basic idea: - collectively determine a certain temperature target (e.g., maximum +2°C warming); - determine the total carbon emissions allowed without high chance of exceeding the target ; - find the most efficient path of consumption and abatement to attain it. Caveats (downsides): - What's the right target? How to inform that decision? Allocation of budget shares? - What if we exceed the target? Damages from +2ºC not the same as those from +4ºC, climate impacts are not binary Tutorial (SSPs, climate outcomes, and policy) 1) Multiple choice questions 1. What does the Keeling curve describe? a. The relationship between economic growth and carbon dioxide emissions b. The level of carbon dioxide in the atmosphere over time c. The relationship between temperature and the concentration of carbon dioxide in the atmosphere d. The expected path of atmospheric temperature if no climate policy is implemented 2. Which of the following elements is not considered a greenhouse gas? a. Particulate matter b. Methane c. Carbon dioxide  d. Water vapour 3. How did the share of the world population living in extreme poverty evolve between 1820 and 2015? a. It increased b. It remained stable c. It decreased d. It decreased and then increased 4. How many carbon reservoirs are there in the DICE model? a. 2 b. 3 i. Upper oceans ii. Deep oceans iii. Atmosphere c. 4 d. 5 5. In the Ramsey formula for time-discounting (rt ≈ ρ + ηgt−1), what does ρ represent? a. The social discount rate b. The aversion to inter-temporal inequalities c. The growth rate of the economy d. The pure rate of time preference 2) Document analysis This exercise is based on the following document: IPCC, 2021: Summary for Policymakers. In: Climate Change 2021: The Physical Science Basis. Contribution of Working Group I to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change (available here). 1. Explain what the IPCC is (what it stands for, what its goal is, and how it works). Intergovernmental Panel on Climate Change (IPCC) Created in 1988, it is “the United Nations body for assessing the science related to climate change” It’s goal is the following: “The IPCC was created to provide policymakers with regular scientific assessments on climate change, its implications and potential future risks, as well as to put forward adaptation and mitigation options” 2. The IPCC summary for policymakers depicts the current state of the climate. What are the main takeaways? It is unequivocal that human influence has warmed the atmosphere, ocean and land. Widespread and rapid changes in the atmosphere, ocean, cryosphere and biosphere have occurred. The scale of recent changes across the climate system as a whole – and the present state of many aspects of the climate system – are unprecedented over many centuries to many thousands of years. Human-induced climate change is already affecting many weather and climate extremes in every region across the globe. Evidence of observed changes in extremes such as heatwaves,  heavy precipitation, droughts, and tropical cyclones, and, in particular, their attribution to human influence, has strengthened since AR5. Improved knowledge of climate processes, paleoclimate evidence and the response of the climate system to increasing radiative forcing gives a best estimate of equilibrium climate sensitivity of 3°C, with a narrower range compared to AR5. 3. This report also discusses possible climate futures. What are the main takeaways? Global surface temperature will continue to increase until at least mid-century under all emissions scenarios considered. Global warming of 1.5°C and 2°C will be exceeded during the 21st century unless deep reductions in CO2 and other greenhouse gas emissions occur in the coming decades. Many changes in the climate system become larger in direct relation to increasing global warming. They include increases in the frequency and intensity of hot extremes, marine heatwaves, heavy precipitation, and, in some regions, agricultural and ecological droughts; an increase in the proportion of intense tropical cyclones; and reductions in Arctic sea ice, snow cover and permafrost. Continued global warming is projected to further intensify the global water cycle, including its variability, global monsoon precipitation and the severity of wet and dry events. Under scenarios with increasing CO2 emissions, the ocean and land carbon sinks are projected to be less effective at slowing the accumulation of CO2 in the atmosphere. Many changes due to past and future greenhouse gas emissions are irreversible for centuries to millennia, especially changes in the ocean, ice sheets and global sea level. 4. Explain what are the “Shared Socioeconomic Pathways” (SSPs) used in the sixth IPCC report. The "Shared Socioeconomic Pathways" (SSPs) are a set of scenarios that describe different trajectories of socioeconomic development and their implications for greenhouse gas emissions and climate change. In the context of the document, the SSPs are utilised to explore the climate response to a range of potential future developments in human activities, including factors such as population growth, economic development, and technological advancements. The document outlines five illustrative SSP scenarios, each characterised by varying levels of greenhouse gas emissions and associated climate impacts. These scenarios are referred to as: SSPx-y denotes the scenario x, with y the expected level of radiative forcing in the year 2100 SSP1-1.9 (1) SSP1-2.6 (2) SSP2-4.5 (3) SSP3-7.0 (4) SSP5-8.5 (5)  with each designation indicating the socioeconomic trends and the approximate level of radiative forcing (in watts per square metre) expected by the year 2100. The SSPs serve as a framework for assessing the potential climate outcomes based on different levels of mitigation efforts and emissions reductions. - SSP1-1.9 Sustainability - Taking the green road (Low challenges to mitigation and adaptation) - SSP1-2.6 Middle of the road (Medium challenges to mitigation and adaptation) - SSP2-4.5 Regional Rivalry - A Rocky Road (High challenges to mitigation and adaptation) - SSP3-7.0 Inequality - A Road Divided (Low Challenges to mitigation, high challenges to adaptation) - SSP5-8.5 Fossil-fueled Development - Taking the Highway (High challenges to mitigation, low challenges to adaptation) The SSPs are critical for understanding how different pathways can influence climate change and for informing policy decisions aimed at limiting global warming. They provide a basis for evaluating the effectiveness of various strategies to achieve climate goals, such as reaching net-zero emissions and adapting to the impacts of climate change. The document emphasises that the SSPs are neutral regarding the assumptions underlying the scenarios, allowing for a comprehensive analysis of potential future climate conditions. For further details, the SSPs are discussed in the document, particularly in the context of climate model projections and their implications for future climate scenarios (see from [page 12] to [page 14]). 5. Use Figure SPM.4 (panels a and b) to explain how SSPs project such varying climate outcomes. What do you believe policymakers should take away from this Figure? Key Takeaways for Policymakers: Emissions Reduction is Critical: The stark differences in projected emissions and temperature outcomes underscore the urgent need for strong and sustained reductions in greenhouse gas emissions to limit global warming. Policymakers should prioritise strategies that align with the lower emissions scenarios (SSP1-1.9 and SSP1-2.6) to mitigate climate change effectively. Socioeconomic Factors Matter: The SSPs illustrate that socioeconomic pathways significantly influence emissions trajectories  and climate outcomes. Policymakers should consider how economic development, technological advancements, and societal choices can shape future emissions and climate impacts. Long-term Planning: The figure highlights the importance of long-term planning and investment in sustainable practices. Policymakers should develop frameworks that not only address immediate emissions reductions but also promote sustainable development and resilience against climate impacts. Awareness of Risks: The varying outcomes depicted in the figure serve as a reminder of the risks associated with high emissions scenarios, including severe climate impacts. Policymakers should be aware of these risks when formulating climate policies and engaging with stakeholders. 6. Briefly explain the main takeaway from Figure SPM.8. How does Figure SPM.8 relate to Figure SPM.10 of the report?  Figure SPM.8 Figure SPM.10 Figure SPM.8 presents selected indicators of global climate change under five illustrative scenarios (SSP1-1.9, SSP1-2.6, SSP2-4.5, SSP3-7.0, and SSP5-8.5) and highlights the projected changes in global surface temperature, Arctic sea ice area, ocean acidity, and global mean sea level. The main takeaway from this figure is that human activities significantly impact all major components of the climate system, with varying degrees of change depending on the emissions scenario. For instance, higher emissions scenarios (SSP3-7.0 and SSP5-8.5) lead to more pronounced increases in temperature and sea level rise, as well as greater declines in Arctic sea ice and increases in ocean acidity. Figure SPM.10 complements this by illustrating the near-linear relationship between cumulative CO2 emissions and the increase in global surface temperature. It emphasises that the total amount of CO2 emitted directly influences the extent of warming experienced. The relationship shown in Figure SPM.10 reinforces the findings of Figure SPM.8 by indicating that the projected changes in climate indicators (such as temperature and sea level) are closely tied to the cumulative emissions outlined in the various SSP scenarios. Essentially, both figures underscore the critical link between human-induced emissions and the resulting climate impacts, highlighting the urgency of reducing emissions to mitigate future warming and its associated effects (see from [page 22] to [page 23] for Figure SPM.8 and from [page 28] to [page 29] for Figure SPM.10). B.1 Global surface temperature will continue to increase until at least mid-century under all emissions scenarios considered. Global warming of 1.5°C and 2°C will be exceeded during the 21st century unless deep reductions in CO2 and other greenhouse gas emissions occur in the coming decades. B.2 Many changes in the climate system become larger in direct relation to increasing global warming. They include increases in the frequency and intensity of hot extremes, marine heatwaves, heavy precipitation, and, in some regions, agricultural and ecological droughts; an increase in the proportion of intense tropical cyclones; and reductions in Arctic sea ice, snow cover and permafrost. B.3 Continued global warming is projected to further intensify the global water cycle, including its variability, global monsoon precipitation and the severity of wet and dry events. B.4 Under scenarios with increasing CO2 emissions, the ocean and land carbon sinks are projected to be less effective at slowing the accumulation of CO2 in the atmosphere. B.5 Many changes due to past and future greenhouse gas emissions are irreversible for centuries to millennia, especially changes in the ocean, ice sheets and global sea level. D.1 From a physical science perspective, limiting human-induced global warming to a specific level requires limiting cumulative CO2 emissions, reaching at least net zero CO2 emissions, along with strong reductions in other greenhouse gas emissions. Strong, rapid and sustained reductions in CH4 emissions would also limit the warming effect resulting from declining aerosol pollution and would improve air quality. D.2 Scenarios with very low or low GHG emissions (SSP1-1.9 and SSP1-2.6) lead within years to discernible effects on greenhouse gas and aerosol concentrations and air quality, relative to high and very high GHG emissions scenarios (SSP3-7.0 or SSP5-8.5). Under these contrasting scenarios, discernible differences in trends of global surface temperature would begin to emerge from natural variability within around 20 years, and over longer time periods for many other climatic impact-drivers (high confidence). Week 2: Instrument choice for climate policies How do we choose between these scenarios? What are the best policies to address climate change? Reading summary: 1) Tackling climate change is an urgent and fundamental challenge. 2) A well-designed carbon price is an indispensable part of a strategy for reducing emissions in an efficient way 3) Achieving the Paris objectives will require all countries to implement climate policy packages 4) The Commission explored multiple lines of evidence on the level of carbon pricing that would be consistent with achieving the temperature objective of the Paris Agreement, including technological roadmaps, analyses of national mitigation and development pathways, and global integrated assessment models, taking into account the strengths and limitations of these various information sources 5) Explicit carbon-pricing instruments can raise revenue efficiently because they help overcome a key market failure: the climate externality. 6) Carbon pricing by itself may not be sufficient to induce change at the pace and on the scale required for the Paris target to be met, and may need to be complemented by other well-designed policies tackling various market and government failures, as well as other imperfections 7) The explicit carbon-price level consistent with achieving the Paris temperature target is at least US$40–80/tCO2 by 2020 and US$50–100/tCO2 by 2030 8) Carbon pricing by itself may not be sufficient to induce change at the pace and on the scale required for the Paris target to be met, and may need to be complemented by other well-designed policies tackling various market and government failures, as well as other imperfections a) Decarbonizing electricity production i) Use of either renewable energy or other zero-carbon forms of energy b) Promoting electrification i) Increasing the use of carbon-free generated power c) Enhancing efficiency d) Optimizing landscape Lecture 2A Instrument choice: efficiency; (externalities, market-based, control) Focus on cost-effectiveness criterion 1) What policies are available? → Countless possibilities, but can be grouped in broad categories with common features. 2) What do they achieve? → Depends on the motives/criteria for intervention 3) Which policies are preferred? → There is no perfect or ideal policy, it depends partially on personal preferences such as fairness, justice, equality, and risk preference There are usually three aspects that policymakers need to assess to compare the merit of climate policies:  1. efficiency (i.e., “cost-effectiveness”); 2. equity (aka their distributional effects); 3. feasibility (i.e. their support/compliance by the public and/or stakeholders). Efficiency Can we make someone better off without making someone else worse off? Economics typically assumes that welfare is transmitted through market transactions making both parties better off. "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages." (Adam Smith, 1776, Wealth of Nations) - In a perfectly competitive market, considering only one’s self-gain leads to the best outcome for society (Invisible Hand) - However, welfare can also be transmitted outside of markets, which we call an externality Climate change as an externality A positive externality: When the production or consumption of goods and services makes a third party better off, e.g. Vaccines (consumption) technological spillovers (production) Education (consumption) Medicine (consumption) Installation of street lights (production) Building of green parks (production) A negative externality: When the production or consumption of goods and services makes a third party worse off, e.g. Individual consumption of gasoline -> particular matter emissions (consumption) Smoking (consumption) Palm oil (production) Deforestation (production) Traffic congestion (consumption) In the presence of an externality, markets do not deliver the best outcomes and regulations or (economic) incentives are needed to correct the market failure Consumer optimization, how do efficient markets work? - Economic agents choose the allocation of scarce resources such that it maximises their outcomes (e.g., utility, profits)  - Consumers have a limited budget that they spend on a wide variety of goods and services that generates utility: what allocation of limited income delivers the highest utility? (The optimization problem) - Let’s assume a consumer can buy two goods, beer costs $2 and grants 5 units of utility, and bread costs $1 granting 2 units of utility. What is the optimal allocation of a budget of $12? - Obviously, the entire budget is spent on beer. But can we generalise this outcome? - What matters is that the last dollar spent on beer delivers more utility than a dollar spent on an alternative good (bread). This is the marginal utility over the price Marginal Rate of Substitution (MRS): In reality, consumers do not spend all their income on just one good but purchase a basket of goods and services. This is due to diminishing marginal utility: each subsequent unit you consume delivers a lower utility than the last. A consumer cannot increase its utility by changing its consumption basket when the marginal utility per dollar spent is equal across all goods. Marginal rate of substitution showing how much of Good A one must consume less to consume one more of Good B and keep utility constant Producers maximize profits/minimize costs when they cannot substitute labor for capital or vice versa, which is the Marginal Rate of Technical Substitution In an efficient economy, the consumer and the producer maximize their utility and profits simultaneously, just like Adam Smith suggested The Pareto Efficiency: an allocation of resources such that any change will make at least one agent worse off. Perfect market Multiple Equilibria - In point a the slope of the indifference curves (M RS) are not equal, meaning we can potentially make A better off without hurting B (and vice versa) - In point b the slopes of indifference curves IB1 and IA are tangent/equal, meaning Pareto efficiency is achieved Product-mix efficiency Graphically, the slope of the indifference curve (M RS) and the slope of the isoquant (M RT S) are tangent → Pareto-optimal allocation of all resources Caveats of the perfect market: market failures The perfect economy described so far rests on extremely strong assumptions: 1) Markets are complete 2) Markets are perfectly competitive  3) Agents have perfect information 4) All resources are subject to private property rights 5) There are no externalities 6) There are no public goods (a uni lecture where anyone can just walk in without having extra cost) 7) Utility and production functions are “well-behaved” 8) Consumers maximise their utility, firms maximise their profits The stylized economy is a very strong result that sets a useful benchmark to understand markets’ properties. Two caveats are in order: 1. The previous assumptions are extremely strong: these assumptions depict an idealised economy. In reality, they are never fully met. Thus, we can hardly expect real markets to produce efficient allocations. 2. Efficiency is not optimality: under the previous assumptions, a competitive equilibrium will be efficient. This says nothing about its social desirability. When the assumptions are not met, we call this a market failure Market failure from externalities Externality illustrated by the MD curve Output (Q1) is set by the producer The graphical analysis is merely illustrative, because: The marginal damages may not be linear The marginal damages are uncertain Marginal damages are not static (change over time Instruments in theory (to regulate climate change as externality) 1) Command-and-control approach; set rules and regulations to ban behaviour a) Rules imposed on production methods e.g. i) Vehicle consumption standards ii) Only pesticides approved by the european commission b) Bans on certain products e.g. i) On the use of chlorofluorocarbons ii) On the use of leaded fuels iii) On constructions to protect some coastal areas c) Regulation of their use i) Banning polluting vehicles in certain city centers ii) Reglementation on when and where certain pesticides can be used in agriculture 2) Market-based approach; set prices or quantities to steer behaviour a) Taxes and charges i) Carbon tax Instrument 1: Taxing pollution or output Taxing output Taxing pollution Setting the Pigouvian tax (tau) equal to the marginal damages (at the social optimum) internalizes the externality in the decisions of the producer This means that every ton of CO2 emissions comes at a charge. Ideally, this is set equal to the (marginal) social cost of carbon SCC  The pollution fee (tax) means that those producers that can reduce emissions affordably (bart) reduce their emissions more than those who cannot (homer) Welfare effects: Government gains additional tax revenues Society gains from less damage Consumers lose consumer surplus Producers lose producer surplus Charge for household waste collection A carbon tax is regressive if the share of people’s income spent on the tax is decreasing with income People with low incomes, pay more for a higher share of their income on carbon tax Developed countries: energy consumption typically represents a higher share of poor households’ budget → carbon taxation is regressive. Developing countries: ambiguous pattern, poor households have significantly lower energy consumption (e.g. car ownership concentrated at the top of income distribution). A carbon tax lowers consumption because the higher price of carbon makes goods and services more expensive -> we consume less A carbon tax also introduces an inefficiency, lowering overall income i.e. GDP a) Subsidies i) Instead of punishing bad behaviours they reward good behaviours b) Instrument 2: subsidising pollution/output abatement  c) The government offers a subsidy when agents accept to reduce their emission below a certain threshold d) Assuming the subsidy is set optimally, producers have an economic incentive to produce less, thus curbing overproduction to the social optimum e) Environmental bonus on less polluting vehicles b) Property rights/tradable emission allowances f) Tradable permits (1) The government issues a fixed number of permits for x units of pollution to achieve the amount of pollution reduction reaching the social optimum (2) These permits/property rights may de traded freely among firms (3) (4) The EU emissions trading scheme (5) Tradable permits can be bought and is not very fair in equity ii) Property rights (1) Concessions of natural resources (a) E.g. they only gave local property owners the right to arrest or poach animals in africa (b) Fishing rights; you are allowed to fish x amount of tuna per year c) Or a combination of these g) Deposit-refund systems that combine a tax (deposit) and a subsidy (refund), such as for bottles or batteries h) Tradable emission allowances with a price floor, such as the UK carbon market Cost-effectiveness and the market-based approach In this simple economy, market-based instruments offer the most efficient response to the problem caused by pollution. Indeed, - by imposing a uniform price on the externality, equalization of the marginal abatement costs of all polluters; - the emission reductions undertaken will be all those (and only those) requiring an effort lower than the price of the externality (Baumol & Oates, 1971); - the environmental objective is attained at the lowest possible cost. Incentives without pollution pricing: 1. Invest in alternatives (e.g. public goods such as bike paths, public transport, so cheaper trains 2. Information provision policies and awareness campaigns 3. “Nudge” types of policies e.g. voting through your wastes Lecture 2B Instrument choice: equity. (carbon tax and dividend, etc.) Consider how costs care distributed across individuals, distribution among agents Policy prescription: design policies that correct market failures at the least possible cost (Pareto efficient); Social Welfare, In economics, we typically have a function that transforms all individuals’ well-being into a collective welfare (i.e., social welfare) Additive Social Welfare Function: we simply add up all individuals’ utilities/happiness to arrive at the social optimum Utilitarianism is the normative theory that we should strive for "the greatest happiness for the greatest number of people" Adding up everyone's happiness to arrive at the social optimum Benefit: Our happiness is weighed equally, everyone is included Downsides: Quantifying ‘utility/happiness’ possible? Maximin Welfare Function: We should strive to maximise the welfare of those who need it most Benefit: Greatly emphasises equality Downsides: What about the rest? Welfare measured in utility? Distributional effects in the near-perfect economy When the climate externality is the only market failure - Efficiency and equity are addressed separately; - Policymakers choose the most efficient climate policy, minimizing costs and maximizing total welfare (assuming Additive SWF) - The distributional effects from climate policies are irrelevant and can be addressed in a second stage; - Efficiency is about the size of the pie, equity is about sharing the pie Effects of command-and-control instruments - Offer little flexibility: pollution regulation mainly affects those who pollute more Effects of market-based instruments - They can raise public funds Taxes are regressive: not equal Carbon tax policy equity: Can we make it progressive instead of regressive? Solution: Carbon tax and Dividend - Poor households spend a larger share of their income in carbon taxes, not good - Poor person makes €10,000 a year and spends €60 on energy (0.6% of their income) - Rich person makes €50,000 per year and spends €100 on energy (0.2% of their income) - Solution: redistribute the revenue lump-sum to everyone - The total revenue of carbon tax for the government is 60(poor person) + 100(rich person) = 160€ - Each person receives half of the revenue 80€  - The net benefit of the policy is 20€ for the poor person and -20€ for the rich person Problem with this (Horizontal heterogeneity): - Households’ carbon emissions differ within income groups - Poor people have different levels of emissions but receive the same transfer - A poor person has no car and lives in a small apartment: pays €20 for the tax, receives a €80 dividend: net benefit of €60. - Another poor person with a car and lives in a poorly insulated house in the countryside: pays €100 for the tax, receives a €80 dividend: net cost of €20. How can we avoid so many losers among the poor? Make it even more equal - Option 1: Make transfer even more progressive - Heavier burden on the middle class? Or concentrate everything on the richest? - Option 2: Make more targeted transfers, e.g. depending on location, house, household - We cannot target polluters without removing the incentive to pollute less - Option 3: Offer complementary policies to help reduce energy dependence - Programs with subsidies for home insulation Consumption vs income channel Are subsidies less regressive (more equal) than tax? Depends on which specific behaviours are targeted - To consume less dirty products - To consume more clean products - Subsidise cleaner goods relative to dirtier ones Cleaner goods are usually more expensive -> subsidies tend to favour rich households e.g. subsidy electric cars or solar panels Solution: A global carbon tax, it would be progressive (high income=higher tax) - At the global level, low- and middle-income households are affected the most - The least affected are households at the top of this distribution Low-income houses are most hurt by climate change and would benefit most from mitigation On average, poorer countries have higher temperatures. Also suggests that they will probably be more sensitive to temperature increases - Poor people live on warmer places experience higher temperature increases - Less combat measures and tools for prevention (air conditioning, water access etc.) - Fewer resources available for adaptation - Low-income jobs/work is more sensitive to extreme weather events - Poor countries are much more reliant on agriculture - Poor countries have less resources to adapt to climate change Summary - In developed economies: poor households spend a larger share of their income on carbon-intensive goods (energy) → they are hurt more by climate policies.  - Taxes, subsidies, and norms are usually regressive. However, taxes and transfers offer the possibility to redistribute the revenue progressively. - Horizontal heterogeneity describes the infeasibility of compensating all low-income losers. - Across countries, global low- and middle-income households are hurt most without transfers. - Mitigation policies are likely to benefit the poorest people in the poorest countries, as they are the most exposed to climate change. → Prioritizing efficiency over equity could very well lead to a more unequal world, do you find that acceptable? Tutorial (Efficiency and equity of carbon taxes) 1) Multiple choice questions 1. Why is a carbon tax and dividend progressive in developed countries? a. Poor households spend more in energy goods, and more as a share of their income. b. Poor households spend less in energy goods, but more as a share of their income. c. Poor households spend less in energy goods, and less as a share of their income. d. Poor households spend more in energy goods, but less as a share of their income. 2. According to Dell et al (2012)’s findings, higher temperatures: a. negatively affect the growth rate of both poor and rich countries, with larger effect in rich countries; b. negatively affect the growth rate of both poor and rich countries, with larger effect in poor countries; c. negatively affect the growth rate of rich countries and have no to little effect in poor coun- tries; d. negatively affect the growth rate of poor countries and have no to little effect in rich countries. 3. In a simple economy where many polluters have heterogeneous abatement costs, which of the following statements is correct? a. Taxes and subsidies have the same efficiency and the same equity effects. b. Taxes and tradable permits have the same efficiency, but not the same equity effects. c. Tradable and non-tradable permits have the same efficiency, but not the same equity effects. d. Subsidies and non-tradable permits have the same efficiency, but not the same equity effects. 4. Which of the following statements is true? a. To be optimal, an allocation must also be efficient. b. To be efficient, an allocation must also be optimal. c. To be sustainable, an allocation must also be optimal.  d. To be sustainable, an allocation must also be efficient. 2) Document analysis 1. Explain the idea behind the "Synthetic Control Method", used for example by Andersson (2019) and Leroutier (2022). The Synthetic Control Method (SCM) is a statistical technique used to evaluate the impact of an intervention or treatment in situations where a randomised control trial (RCT) is not possible. By comparing what the emissions would have been absent the reform Built new roads in the donor pool countries, only a prediction? Climate change, these countries are in geographically different areas Contamination, swedes driving into denmark because the fuel prices are cheaper 2. In 1990, Sweden reformed the taxation of transport fuels: the VAT was increased, and a carbon tax was introduced. Figure 2.1 below comes from Andersson (2019). The author compares the emissions per capita from transport in Sweden, to what it would have been absent the reform. This counterfactual is represented by the "Synthetic Sweden". Describe the graph and comment on the effect of the reform. Figure 2.1: Per capita CO2 emissions from transport during 1960-2005: Sweden versus Synthetic Sweden (from Andersson, 2019). The graph in Figure 2.1 compares the per capita CO₂ emissions from transport in Sweden with a counterfactual scenario, called "Synthetic Sweden," from 1960 to 2005. "Synthetic Sweden" represents the estimated emissions that would have occurred in Sweden without the 1990 taxation reform, which included an increase in the value-added tax (VAT) on transport fuels and the introduction of a carbon tax. Description of the Graph: - Timeline: The graph covers the period from 1960 to 2005, with a focus on the effect of the 1990 reform.  - Two Trends: - The Sweden line shows the actual CO₂ emissions per capita from transport during this period. - The Synthetic Sweden line shows the counterfactual projection, representing what emissions would have been without the reform. - Pre-1990 (Before Reform): Before the reform, the two lines (Sweden and Synthetic Sweden) follow a relatively similar trajectory, indicating that Sweden's emissions were in line with what could have been expected without intervention. - Post-1990 (After Reform): After the 1990 tax reforms, the Sweden line shows a noticeable decline in emissions per capita, diverging significantly from the Synthetic Sweden line, which continues to rise. This suggests that the taxation measures significantly reduced emissions in comparison to the counterfactual scenario. Commentary on the Effect of the Reform: - The introduction of the carbon tax and the increase in VAT had a clear and immediate impact on reducing transport-related CO₂ emissions in Sweden. - Without the reform, the "Synthetic Sweden" scenario implies that emissions would have continued to rise in line with historical trends, suggesting a growing reliance on transport fuels without additional regulatory pressure. - The divergence between the actual emissions and the counterfactual after 1990 illustrates the effectiveness of carbon pricing mechanisms in curbing CO₂ emissions. - Overall, the graph suggests that the 1990 reform contributed significantly to reducing Sweden’s carbon footprint in the transport sector, making it a successful policy intervention for climate mitigation. - The reform appears to be a decisive factor in changing the trajectory of Sweden's transport emissions and demonstrates the potential of economic instruments like taxes to influence environmental outcomes. 3. In 2013, a carbon tax was introduced in the U.K. power sector. Figure 2.2 below comes from Leroutier (2022). It follows the same methodology as Andersson (2019) to compare emissions per capita from the power sector in the U.K., to what it would have been absent the policy. This counterfactual is represented by the "Synthetic UK". Describe the graph and comment on the effect of the policy. (Note: you can ignore the third curve representing the "Naive counterfac-tual").  Figure 2.2: U.K. and synthetic U.K. per capita emissions (from Leroutier, 2022). Figure 2.2 compares per capita CO₂ emissions from the U.K. power sector with a counterfactual "Synthetic U.K." from 2005 to a few years after 2017, when the carbon tax was introduced. The methodology used is similar to that of Andersson (2019), where the counterfactual "Synthetic U.K." represents what emissions would have been without the carbon tax. Description of the Graph: - Timeline: The graph covers the period around 2005 to a few years after 2017, with a focus on the period following the introduction of the carbon tax in the power sector. - Two Trends: - The U.K. line shows the actual per capita CO₂ emissions from the power sector over time. - The Synthetic U.K. line represents the counterfactual scenario where no carbon tax was introduced. - Pre-2013 (Before the Carbon Tax): Before the carbon tax was introduced, the actual emissions in the U.K. and the Synthetic U.K. follow similar trajectories, meaning that emissions were aligned with what could be expected without policy intervention. - Post-2013 (After the Carbon Tax): After the introduction of the carbon tax, the U.K.'s actual emissions start to fall significantly, diverging from the Synthetic U.K. line, which shows what emissions would have been in the absence of the tax. The Synthetic U.K. line remains relatively stable or declines much more slowly than actual emissions in the U.K., indicating that without the policy, emissions would have been substantially higher. Commentary on the Effect of the Policy: The introduction of the carbon tax in the U.K. power sector had a significant impact on reducing per capita CO₂ emissions, as demonstrated by the sharp divergence between the actual U.K. emissions and the Synthetic U.K. counterfactual after 2013. Without the carbon tax, emissions would have stayed much higher, as represented by the Synthetic U.K. line. The gap between the two lines indicates the substantial effect of the tax in cutting emissions. The rapid decline in actual emissions suggests that the carbon tax likely incentivized a shift toward cleaner energy sources (e.g., renewable energy or natural gas) and disincentivized the use of high-emission fuels like coal. This demonstrates the effectiveness of carbon pricing as a policy tool for reducing emissions in the power sector. By making it more expensive to emit CO₂, the tax encouraged power producers to reduce their carbon footprint. Overall, the carbon tax in the U.K. power sector appears to have been highly effective, leading to a steep reduction in emissions that would not have occurred without the policy intervention. The significant gap between the actual U.K. emissions and the counterfactual shows the strong role of this policy in accelerating the decarbonization of the power sector. 4. Explain what the EU-ETS is (what it stands for, what its goal is, and how it works). The EU-ETS stands for the European Union Emissions Trading System. It is a key policy tool aimed at reducing greenhouse gas emissions across the European Union and is the largest carbon market in the world. Launched in 2005, its primary goal is to combat climate change by providing economic incentives for industries to reduce their carbon emissions. Applies to about 11,000 installations covering around 40% of the EUs GhG emissions How it Works: The EU-ETS operates on a "cap-and-trade" principle: a) Cap: A limit, or "cap," is set on the total amount of certain greenhouse gases that can be emitted by installations covered by the system (e.g., power plants, industrial facilities, and airline companies within the EU). The cap is reduced over time to ensure that overall emissions decrease. b) Allowances: Companies receive or buy emission allowances, which give them the right to emit a certain amount of CO₂ (one allowance equals one ton of CO₂). These allowances can be traded in the carbon market. c) Trade: If a company emits less CO₂ than its allocated allowances, it can sell its surplus allowances to other companies that are exceeding their cap. This trading creates a financial incentive for companies to reduce their emissions since selling excess allowances generates revenue. d) Compliance: At the end of each year, companies must ensure they have enough allowances to cover their total emissions. If they exceed their emissions without enough allowances, they face significant fines. Sectors Covered: The EU-ETS covers large carbon-emitting sectors like: a) Power generation and heat production b) Energy-intensive industries (steel, cement, chemicals) c) Aviation (flights within the European Economic Area) 5. Not all installations (factories, power plants, etc.) in the EU are subject to the EU-ETS. The ETS applies only to installations bigger than a certain threshold. If one wants to measure the effectiveness of the EU-ETS at changing firms’ environmental outcome, what could be the problem of comparing the EU-ETS firms (whose installations are subject to the ETS) and the non-EU-ETS firms (whose installations are not subject to the ETS)? Comparing EU-ETS firms (whose installations are subject to the EU Emissions Trading System) with non-EU-ETS firms (whose installations fall below the size threshold and are not subject to the ETS) to measure the effectiveness of the ETS at changing environmental outcomes can present several problems. These issues largely stem from differences in the characteristics of the firms and their installations, which could bias the comparison: 1. Selection Bias: Size and Emission Levels: The EU-ETS applies only to larger installations that emit above a certain threshold. These firms are likely to have different emission profiles compared to smaller firms not subject to the ETS. Larger firms might already have more emissions-intensive production processes, different resource usage, or a higher capacity to invest in abatement technologies, regardless of the ETS. Comparing them directly to smaller firms could lead to misleading conclusions about the ETS's effectiveness. Different Production Processes: The non-ETS firms may use different technologies, production processes, or inputs, which naturally result in lower emissions. Thus, any difference in emissions between ETS and non-ETS firms could be due to pre-existing differences rather than the impact of the policy. 2. Regulatory Differences: Other Environmental Regulations: Non-ETS firms might still be subject to other types of national or regional environmental regulations that influence their emissions.  These regulations could affect the firms' environmental outcomes, making it difficult to isolate the effect of the EU-ETS. Comparing the two groups without accounting for other policies could misattribute changes in emissions to the ETS when they might be driven by different regulatory frameworks. 3. Different Market Dynamics: Market Size and Influence: Larger ETS firms might operate in different markets or have greater economic power than non-ETS firms. Larger firms may be more integrated into international supply chains or more exposed to public and investor scrutiny regarding their environmental performance. These external pressures can influence their environmental outcomes, making it hard to attribute changes purely to the ETS. Investment Capacity: ETS firms might also have more financial resources to invest in cleaner technologies or energy efficiency measures, independent of the ETS. Smaller, non-ETS firms may have less capacity to make these investments, which could create differences in environmental performance that are unrelated to the ETS itself. 4. Strategic Behavior Around the Threshold: Avoidance of Regulation: Firms with installations near the ETS size threshold might engage in strategic behavior to avoid regulation, such as dividing operations into smaller units or maintaining emissions just below the cap. This behavior can distort the comparison, as some firms may actively reduce emissions to avoid regulation rather than due to the ETS. Differences in Compliance Costs: ETS firms face direct costs associated with purchasing allowances, while non-ETS firms do not. This cost difference could affect firms' production choices, investment in abatement technologies, or output levels, complicating comparisons between the two groups. 5. Potential Spillover Effects: Indirect Effects on Non-ETS Firms: The EU-ETS can have indirect effects on non-ETS firms through changes in the broader economy. For example, the price of electricity might rise due to the ETS, which could impact non-ETS firms’ energy costs and lead to emissions reductions. Thus, changes in environmental outcomes among non-ETS firms could still be partly influenced by the ETS, making it hard to draw clean comparisons between the two groups. 6. In order to assess the impact of the EU-ETS on firms’ green innovation, Calel and Dechezlepre- tre (2016) select only a sub-sample of EU-ETS and non-EU-ETS firms. They describe their method as follows: "In order to control administrative costs, the EU ETS was designed to cover only large installations. Firms operating smaller installations are not covered by EU ETS regulations, although the firms them- selves might be just as large as those affected by the regulations. Because innovation takes place at the firm level, we can exploit these installation-level inclusion criteria to compare firms with similar resources available for research and similar patenting histories, but which have fallen under different regulatory regimes since 2005." Explain how their method can address the issue raised in question 5. Calel and Dechezleprêtre (2016) address the issue of bias in comparing EU-ETS and non-EU-ETS firms by carefully selecting a sub-sample of firms that are similar in key characteristics but differ only in their exposure to the EU Emissions Trading System. Specifically, they exploit the installation-level inclusion criteria to ensure that the firms being compared are as similar as possible in terms of size, resources, and innovation capabilities, while differing only in whether or not they are subject to the EU-ETS regulations. Here's how this method helps overcome the problems identified in the previous question: 1. Controlling for Firm Size and Resources: - By selecting large firms that operate both EU-ETS and non-EU-ETS installations, they ensure that the firms in both groups have similar financial and technological resources available for green innovation, such as investing in research and development (R&D) or filing patents. - This controls for size-related factors that could otherwise bias the comparison, since large firms generally have more capacity to innovate than smaller firms. Thus, any difference in innovation between ETS and non-ETS firms would be more likely to result from the ETS policy itself, rather than differences in firm size or resources. 2. Comparing Firms with Similar Innovation Histories: - The authors compare firms with similar patenting histories, meaning they select firms that had similar levels of innovation activity before the introduction of the EU-ETS in 2005. This helps to control for pre-existing differences in innovation capacity or focus on green technology. - By ensuring that both ETS and non-ETS firms were similarly active in innovation before the policy was introduced, the study can more accurately measure the impact of the EU-ETS on subsequent green innovation, isolating the effect of the policy from other factors that may have driven firms' patenting activity. 3. Reducing Selection Bias: - The key issue in comparing EU-ETS and non-EU-ETS firms is selection bias, particularly because the EU-ETS only applies to firms with larger installations. Firms with smaller installations might not have the same emissions intensity or environmental pressures as firms with larger installations, leading to biased comparisons. - By selecting firms that are equally large but have installations that either do or do not fall under the EU-ETS due to the regulatory threshold, the study reduces this selection bias. This approach allows the researchers to compare firms that are more similar in terms of production processes, market presence, and compliance capabilities, making the differences in innovation outcomes more likely to be due to the policy itself. 4. Exploiting Installation-Level Criteria: - The installation-level inclusion criteria of the EU-ETS mean that some large firms are subject to the ETS for part of their operations, while others are not, even though the firms themselves may be similar in other respects. By focusing on these installation-level rules, the study takes advantage of a kind of natural experiment, where firms are subject to different regulations not because of fundamental differences in their characteristics, but due to the structure of the policy. - This method helps to isolate the causal effect of the EU-ETS by ensuring that the differences in green innovation between firms are attributable to the policy, rather than to pre-existing differences between firms in size, capacity, or industry. 7. Figure 2.3 below comes from Calel and Dechezlepretre (2016). From this figure, what do you conclude about the effect of the EU-ETS on low-carbon innovations? Figure 2.3: Low-Carbon Patents by EU-ETS and Non–EU-ETS Firms (from Calel and Dechezlepretre, 2016). Observations: 1) Pre-EU-ETS Period (Before 2005): a) Both EU-ETS and non-EU-ETS firms have similar levels of low-carbon patenting activity before 2005, when the EU-ETS was introduced. This suggests that, prior to the implementation of the ETS, there was no significant difference in low-carbon innovation between the two groups. 2) Post-EU-ETS Period (After 2005): a) After the introduction of the EU-ETS in 2005, there is a clear increase in low-carbon patenting by EU-ETS firms relative to non-EU-ETS firms. b) The number of low-carbon patents filed by EU-ETS firms rises significantly, while non-EU-ETS firms show only a modest or relatively flat increase in low-carbon patenting activity. 3) Divergence Between EU-ETS and Non-EU-ETS Firms: a) Over time, the gap between EU-ETS and non-EU-ETS firms in terms of low-carbon innovation widens, indicating that the firms subject to the EU-ETS are generating more low-carbon patents than those not covered by the system. b) This divergence suggests that the EU-ETS had a positive impact on stimulating low-carbon innovations among firms subject to the policy. Week 3: Climate policies beyond Homo Economicus Lecture 3A Behavioural climate economics: instruments (social norms, etc.) Economic models generally assume that individuals behave as self-interested rational utility maximizers. However we are boundedly rational, it is equally important to relax this assumption Example: - Ambiguity aversion  - Present bias/recency bias - Loss aversion/endowment effect - Misperception of probabilities Implications for climate policies - Irrational behaviour limits the effectiveness of policies - People hold inaccurate perceptions of policies, hurting public support - Sometimes market-based instruments such as the Carbon Tax and Dividend have unintended consequences such as - Horizontal heterogeneity - Lack of public support - Lack of political support Conformism and descriptive norms - Descriptive norms (descriptive): positive neutral way, what people generally do, description of what it is - Households update their beliefs on the social norm upward and change their behaviour - Injunctive norms (Prescriptive): what people approve or disapprove, a description of what should be Nudge: an intervention which alters behaviour without reducing the choice options or changing economic incentives. Behavioural nudges can be a cost-effective, efficacious, non-limiting method to promote green behaviour e.g. Calorie Labelling on Menus, Default Options for Green Energy, Placing Healthy Foods at Eye Level, putting a emissionztzf sticker on a fridge Psychological costs - Annoyed people have to endure colder temperatures during winter - Annoyed people have to remember to turn off the light everytime - Or annoyed people make their fridge warmer Present bias describes the tendency to overvalue the present compared to the future, it presupposes that an individual has a true time preference (discount rate ρ) Inter-temporal decision-making: making decisions in the present that affect the future When purchasing appliances and such, individuals’ energy consumption often results from two-stage decision process - Which energy-consuming appliance do I choose? - How much do I use this appliance? Rational self-interested individuals choose the option that delivers the highest intertemporal utility Present-biassed consumer assigns a disproportionately high weight to current utility Correcting present-biassed selves - Generate salient information on cost savings (i.e. nudges) - Use of colours and Letters to indicate energy efficiency of a fridge or oven - Tax/subsidise dirty/clean durable goods (market based approach)  - Impose a bonus/malus to cars depending on their energy efficiency - Ban on less efficient technologies (command-and-control approach) - Outlaw the least efficient light bulbs Motivated reasoning: rationally trying to explain behaviours that does not align with our preferences - We want to help the climate, but we also want to go on holiday to thailand - We want to travel by plane which takes us far fast, but has enormous emissions - Heating our home to 22ºC in winter is comfortable, but causes more climate change than wearing an extra sweater How do we reconcile our self-interest with our moral concerns? The meat paradox - Many people enjoy eating meat - But, they also care about animal welfare - How do they process the moral cost of their meat consumption Individuals have two ‘moment of selves’: Solf-0 comes first, followed by Self-1 Self-deception: Deceiving and lying to ourselves about the suffering of something is less than it actually is in the future (lying to yourself) - People with higher preference stand more to gain from eating meat and, therefor, are more prone to self-deception - An increase in meat price -> lower benefits of meat consumption after subtraction price ->decreases self-deception - But, campaigns that make people more morally aware (i.e., increasing how much someone cares about animals) - increases the threshold of necessary meat consumption (eat less meat!) but also - increases the benefit of self-deception (eat more meat). → Information campaigns have an ambiguous effect (according to the theoretical model) Summary - Aside from feasibility and equity the efficiency of climate instruments is constrained by our limited capacity to act rationally we call bounded rationality. - People have predictable but imperfect biases in their decision-making than results in behavior against their own self-interest - Policies that aim to steer behavioral without limiting freedom or changing prices are called nudges. - Non-market policies, such as information provision, can play an important role, but - They are insufficient to address the climate externality. Sometimes complementary to other policies such as taxes. Lecture 3B Behavioural climate economics: public support (beliefs, carbon tax) People may not fully grasp the importance of climate change People may not fully understand the effects of climate policies Rational inattention: we choose not to constantly think about it Availability Bias - After a KLM plane crash people tend to be more scared for flying - The KLM airline stock will plummet - The probability of another plane crash is unchanged Several characteristics make major environmental problems difficult to grasp: - Long term trends: - People barely witness the climate changing, at best the recieve pieces of noisy information (e.g. weather fluctuations, floods) that they process imperfectly - Drivers of climate change are diffuse and uncertain: who is the victim and who is the villain - Who is causing it? - Are you scared of causing it/contributing rather than thinking about the consequences - Requires deep understanding of global causation chain Why do our beliefs clash with scientific evidence in the first place? - Incorrectly processing new information - People are more likely to think that climate change is happening on warmer days instead of colder days - Bayesian errors (its still warm outside, and theres still snow so climate change is a hoax) - Motivated reasoning - An avid air-traveler may want to underestimate her emissions and lie to herself to take an aeroplane and not feel bad about it - Imperfect social learning - Bubbles, rabbit hole, algorithms benefit from pushing you deeper into trenches - Social media algorithms push you further into your beliefs - Misinformation and biased supply - Media has an incentive to confirm your beliefs and you seek media that confirm your beliefs - Social image concern - Present bias - People don't weigh the future benefits with their present costs - Scenario: A government introduces a new policy that puts a high tax on fuel cars to reduce carbon emissions and provides subsidies to make electric vehicles (EVs) cheaper and more accessible. The goal is to encourage people to switch to EVs, which offer long-term benefits like lower operational costs, reduced environmental impact, and future savings. - Present Bias Effect: Many consumers may still prefer to stick with their existing fuel cars despite the tax and subsidies. This is because they prioritize the short-term cost  and convenience of continuing to use a car they already own, even though the long-term benefits of switching to an electric vehicle (like saving on fuel and reduced environmental impact) are more significant. - Short-term Cost (Immediate Focus): Buying an electric car involves an upfront cost, even with subsidies, and learning to use new charging infrastructure. Consumers focus on the hassle and expense today. - Long-term Gain (Devalued): The lower fuel and maintenance costs of an EV, the future tax savings, and the environmental benefits are perceived as far-off, so they feel less urgent. As a result, many people continue using fuel cars to avoid immediate expenses or changes. - Lack of attention - Motivated reasoning How do seemingly erroneous beliefs limit the efficacy of climate policies? Economists: Carbon tax is the most efficient tool to deal with climate change However, carbon taxes create winners and losers People hold pessimistic beliefs about carbon tax and dividend - 75.8% calculated to win from the carbon tax and dividend, but only 14% thought they would - They underestimated the progressivity and effectiveness These beliefs are endogenous to people's political views - The more people initially dislike the policy, the less they are willing to accept objective information that supports it; - observations consistent with motivated reasoning: people discard arguments that go against their prior beliefs. Rejection of the tax comes from biased beliefs - When people were told that they would actually benefit, support increases by 50 p.p.; - If all winners knew they would win, and everyone believes in the policy’s effectiveness and progressivity: expected support above 90% Huge pessimistic beliefs about self gains from climate policies People are more inclined to update beliefs towards losses than toward wins (pessimism [86%] > optimism [25%]) People who think they will lose are very unlikely to be persuaded by information, even if that information is likely to be true It is incredibly difficult to garner support for policies and much easier to garner opposition to policies. Support for other climate policies 1) What do people actually know about climate change around the world? a) Citizens do not have a very good knowledge of the drivers of climate change b) Still, they are aware and concerned about climate change c) Citizens want something to be done about climate change: they don't seem to agree on what to do or how to do it. 2) Which policies do people tend to support?  a) Citizens support more climate policies in middle-income countries b) People prefer subsidies over taxes i) People tend to want to be rewarded than punished ii) Subsidies have hidden costs (who pays for the tax?) c) Bans are preferred over taxes i) Its easier to be banned than to tax ii) Environmental outcomes are more clearly visible d) The carbon tax receives positive support from citizens when revenues finance green spending i) Carbon tax is only green when revenue are used to green 3) What are the political or socio-demographic determinants of people’s support? a) Political leaning strongly correlates with support i) Left-leaning people are overall more supportive of climate policies ii) Do green parties actually deliver? Do they actually deliver policies and do their job Summary Many citizens aware and concerned about climate change, but disagree about how to proceed. Economists focused mostly on creating effective and "fair" instruments However, policymakers face the challenge of how the public perceives these instruments. ○ If beliefs over the cause/culprit of environmental problems and the solutions are biased designing efficient and fair policies will be insufficient for a successful transition. How to overcome this obstacle?  Remain critical about our own assessment of equity and efficiency. Improving communication about climate change and climate policies. Accept compromises in terms of efficiency and equity EXAM: - 10 multiple choice (30 points) - 50% about the first three weeks (C. van Krevel lectures) - 50% about the last three weeks - 2-3 open-ended questions (70 points) - 1 question about the first three weeks (35 points) - 5 subquestions - 1 or 2 questions about the last three weeks (35 points) - All lectures will be represented equally - Basically just study the slides and study tutorial slides - Not focused on details, maths, or minor things, dont get quizzed on the small stuff - Only the major, main ideas, if you know the - Writing in bold and blue is important Tutorial (Bayesian updating: Case-study floods in U.S.) 1) Multiple choice questions 1. According to the work of D’Haultfoeuille et al (2014), did the French 2008 bonus-malus policy reduced emissions in the short run? a. No, because it did not significantly affect consumers’ purchase of polluting vehicles. b. No, because people bought more vehicles as a result. c. Yes, because people bought cleaner vehicles. d. Yes, because people bought less vehicles. 2. According to Allcott (2011), which households reduced their electricity consumption the most after receiving the reports from the OPOWER program? a. Households consuming more electricity reduced it more. b. Households already consuming less electricity reduced it more. c. Households in the middle of the electricity consumption distribution reduced it more. d. Households did not reduce their electricity consumption. 3. According to Douenne and Fabre (2022), which of the following statements is not correct? a. People who oppose the carbon tax are more likely to overestimate how the tax affects their purchasing power. b. On average, people overestimate the impact of the carbon tax on their budget. c. People have biassed beliefs about the impact of the tax on their budget, but correct beliefs about its progressivity. d. When people learn that they gain from the carbon tax and dividend policy, their support significantly increases.  4. According to the survey by Dechezleprêtre et al (2022), do people consider climate change to be an important problem? a. In developing countries yes, but in developed countries no. b. In developing countries no, but in developed countries yes. c. In both developed and developing countries yes. d. In both developed and developing countries no. 3) Document Analysis 1. Based on the above sections of the paper on pages 206-212 and pages 214-217, briefly summarise the main research question and method of the paper. In Figure 2 from the paper, Justin Gallagher shows that the demand for flood insurance jumps in communities in the U.S. immediately after they are hit by a PDD (Presidential Disaster Dec- laration) flood. However, insurance demand returns to baseline after about 10 to 20 years. How do households learn about the arrival rate of the rare stochastic event of flooding? Sub Questions: (i) Is observed learning by households after a flood event consistent with rational belief formation?; (ii) If not, which model of learning behaviour is consistent with observed learning by households? The paper uses simple regression equations, effectively following a difference-in-difference approach but with some controls. For example, ‘state by year fixed effects’ are used in the main estimating equation so that the results are not influenced by differential trends in U.S. states in the uptake of flood insurance. Gallagher studies the change in demand for insurance just after a flood event in the flooded community, others that are not flooded, not flooded but nearby, not flooded but in the same media market, and not flooded but nearby and in the same media market. This allows him to make inferences about homeowners’ changed perceptions of the probability of flooding in each of these categories 2. Gallagher argues that the spike he uncovers in demand for flood insurance after a flood event is inconsistent with rational, fully informed behaviour by homeowners. Why? accurate flood risk maps are available that inform homeowners about the risk of flooding. Therefore, homeowners’ beliefs should not change substantially after a flood event, since they have access to the relevant information already. See top of page 208: ‘A new flood provides very little new statistical information given the history of past floods.’ 3. What explanation does Gallagher offer for the pattern of flood insurance demand displayed above? People forget about the risk of floods. Availability bias’, which means that people attach excessive weight in their decision-making to what they recall spontaneously. Therefore, homeowners attach too much weight on recent experience of flooding, and too little weight on experience in the more distant past. 4. We know floods will occur more and more frequently in the future. According to your answer to Question 3, why would this lead to inefficiency in the housing market? Can you give examples of how this inefficiency can hurt individuals (directly) and the economy (indirectly)? Directly: suppose people underestimate flood risk, because they rely on past experience only and underweight more distant events. Then, they will be willing to pay too much for coastal property. The most optimistic individuals will sort into the most risky property, and coastal property will be overvalued. When a flood event happens, beliefs are corrected, and the price of coastal property falls. This causes individuals in high-risk property to suffer a hit to their financial wealth, on top of any direct flood damages. Indirectly: if many people underestimate flood risk and are willing to purchase highly exposed property, then too much housing construction will take place in locations vulnerable to rising flood risk. This causes damages from flood events to increase in the aggregate. 5. Suppose you were an economist advising policy-makers in a coastal country seeking to adapt to the effects of climate change. What suggestions would you have to offer to remedy the inefficiency from Question 4? Enforce mandatory flood insurance, with the premium at the expected loss plus insurance costs. Even if homeowners underestimate flood risk, higher premiums in more exposed properties will ensure flood risk is at least partly incorporated in the house price. (Private firms might not have the financial capacity to offer such insurance, some form of public insurance and/or re-insurance on international markets may be required.) Prohibit building in the most exposed locations. This is especially important if actuarially fair insurance, see point above, cannot be enforced for political economy reasons. Making highly detailed information on flood risk publicly accessible, and require relevant information to be communicated to buyers of new homes. Require banks to hold more liquid capital as a proportion of their lending to homeowners in exposed locations, to reduce the risk of a financial crisis. Week 5: Disasters, Impacts & Valuation ECC - Compulsory readings week 5 (Valuation).pdf Lecture 5A Disasters & Impacts The expected impact of climate change and extreme events on different outcomes. Impacts of climate change Extreme events Infrastructure Biodiversity loss Food insecurity Productivity Extreme events: 1. Extreme heat a. More frequent b. More intense 2. Droughts a. Increase in some regions  3. Heavy rain a. More frequent b. More intense 4. Glaciers a. Retreat 5. Wildfires a. More frequent 6. Storms a. Less frequent overall b. Very intense storms more frequent Types of disasters: 1. Geophysical a. Earthquake, mass movement (dry), volcanic activity 2. Hydrological a. Flood, landslide, wave action 3. Meteorological - conditions which take hours or a day, shorter time-frame, e.g. water conditions we have today a. Storm, extreme temperature, fog 4. Climatological - about the average weather over a longer period of time (long-lived) a. Drought, glacial lake outburst, wildfire 5. Biological a. Animal accident, epidemic, insect infestation 6. Extra-terrestrial a. Impact, space weather, meteor Richer countries have better accounting of economic losses, for instance because more things are insured in richer countries DO NOT jump to the conclusion that richer countries are more economically impacted by disasters Storm disasters account for the biggest economic loss, next is flood. What a country looks at in case of an extreme event - Number of disasters - # of Deaths - Damage in $ Impacts of disasters on climate A. (cyclone disaster) Infrastructure a. Damage to road and railway assets b. 27% of assets are exposed to at least one hazard c. Calculations of Global Expected Annual Damages (EAD) d. 73% is caused by surface and river flooding e. Cost-benefit analysis of flood protection B. Biodiversity loss a. FRS = fraction of remaining species b. FRA = fraction of remaining are with suitable climate for each species  C. (temperature disaster) Agriculture - Food insecurity a. Global wheat production may decrease by 6% with each degree of warming b. Global corn production may decrease c. Fisheries may move poleward Climate change and inequality Climate change will impact both within-country and across-countries inequality Productivity by temperature Multi-model study using micro-survey data and impact models to estimate the effect of climate change (increased temperature) on number of hours worked and productivity of workers. Lecture 5B Environmental Valuation Ways to assess the value of things where the value doesn't give a price To express a welfare loss in equivalent income loss A Pigouvian tax is a tax imposed on activities that generate negative externalities, which are costs or harms that affect third parties who are not directly involved in the economic transaction. The purpose of the tax is to correct these market inefficiencies by aligning the private costs of the activity with its true social costs. Why do we need valuation? Setting priorities! Cost-benefit analysis Calculating the right Pigouvian tax Pay for preservation Compensation Adjust economic growth in national accounts (GDP) Types of value - Use value (if we directly or indirectly use it somehow) - Direct (acai, things we get directly from e.g. the amazon) e.g. timber, fuelwood, nuts - Indirect (the function the amazon serves within the climate) e.g. carbon storage. Or Soil - Non-use values (passive use) - Others’ use (value the amazon for the sake of the future generation)(enjoyment by others or next generation or bequest value) - Pure existence (even if there were no future generations, even if i wasn't taking any direct or indirect use, i am giving value for the amazon per se, for ethical and/or moral reasons) (ethics, rights of other species) - Option values (related to uncertainties one might have in the future, the amazon might help some uncertainty one might have about the future)(there’s so much for us to learn from the Amazon!) Two main methods: Revealed preferences (Methods that try to infer people’s value for some environmental resource by looking at their actions in real life) only good for use-values, not good to estimate non-use values A. Travel cost a. The use value someone gets from natural resources for recreational purposes b. E.g. trying to find the value for a natural park i. Travel costs that people are paying to visit a park or forest c. Time + travel cost expenses to visit the site = price/value d. Value of a site/park/forest can be estimated by the number of trips that they make at different travel costs B. Hedonic pricing a. Using the market for a related good (house prices) to estimate the demand curve for a non-market good (emissions) b. Try to assess the copana beach, compare two houses completely identical, just one is at copana beach and one is not, see the difference in price  c. House in quiet area is more expensive than identical house in noisy area, or house near wind turbines is cheaper than identical house far away from wind turbines d. Comparing house prices nearby wind turbines with house prices further away e. C. Defensive expenditures a. Compensating for the lack of something in the environment b. Double glazing windows vs. noise i. The price of double glaze windows can determine value of the noise pollution c. Bike helmet vs. safe roads i. The price of buying helmets reflects the value of the safety of the roads d. Bottled water vs. clean tap water e. Limitations: i. Often incomplete ii. Hard to identify all defensive behaviours iii. Joint products (double glazing also saves energy) Stated preferences (Methods that involves simply asking people) (better to assume non-use values or option values) A. Contingent valuation a. Interview or survey b. Simply ask willingness to pay (WTP) directly, e.g. how much would you pay to preserve this? c. Limitations (disadvantages) i. Its simply a hypothetical scenario (no budget constraint) ii. Depends on the way the question is framed/asked iii. People might answer strategically (if your survey might lead to an increase in taxes, people will answer to favour them and keep taxes low) iv. Do people really know their WTP? (unfamiliarity)(If you have never even thought about the amazon, how reasonable is it if i can ask you a question about the amazon) B. (Contingent) (Discreet) Choice experiments (modelling) a. Not asking what they are willing to pay directly, but asking which of these situations/scenarios you would prefer b. respondents are given sets of alternatives with different attributes and asked to choose their preferred option. Each alternative represents a different scenario or  policy option, and the attributes describe various aspects of the environmental good (e.g., better air quality, biodiversity, or less flood protection). The key idea is to assess how people trade off different attributes. c. Example: If a policymaker is considering flood risk management options, a DCE might ask respondents to choose between different flood management strategies, each varying in cost and the level of risk reduction they offer. Helping people to imagine disasters, to see the change in willingness to pay for prevention methods People are willing to pay more once they experienced it in VR Be able to measure the value by seeing the change in the WTP before and after the VR experience Tutorial (Exploring Disaster Data) 1) Multiple choice questions 1. Risk is the combination of… a. Disaster, hazard & vulnerability b. Hazard, exposure & vulnerability c. Disaster: the interaction between the hazardous climate events and the effects on humans d. Hazard: Type of eventThe natural or man-made event that could cause harm (e.g., flood, drought, or wildfire, or chemical spill). e. Exposure: Whether humans are effected. The people, property, systems, or other elements present in hazard zones that are thereby subject to potential losses. f. Vulnerability: How resilient we are (do we have mechanisms to evacuate/protect people? Are houses strong enough) The susceptibility of the exposed elements to damage or harm. g. Hazard, exposure & damage h. Disaster, exposure & damage 2. Wildfire could be classified by the WMO as… a. Disaster group: natural & Disaster subgroup: meteorological b. Disaster group: natural & Disaster subgroup: climatological c. Wildfires are linked to climatic factors such as drought, heatwaves, or other environmental conditions d. Disaster group: technological & Disaster subgroup: geophysical e. Disaster group: technological & Disaster subgroup: meteorological 3. Soil conservation would be an example of… a. A quasi-option value b. Non-use value of pure existence c. A direct use value d. An indirect use value e. Soil conservation provides ecosystem services that benefit humans indirectly.  4. In the travel cost method, you interpret the time and money spent on traveling as an entrance fee and thus as… a. The minimum willingness to pay b. it reflects the effort they are already willing to make to visit the site. c. The maximum willingness to pay d. The minimum willingness to accept compensation e. The maximum willingness to accept compensation 5. Imagine you are approached by a policy maker who is confronted with an increased risk of flooding due to climate change. The policy maker has several possible management options, and would like to examine which one yields the highest overall net benefits. Which valuation method would you recommend? a. Travel cost method b. Hedonic pricing c. Contingent valuation d. Choice experiments e. It allows the policymaker to understand preferences for different policy outcomes and calculate the net benefits of various choices based on people's preferences. f. E.g. In the exam, will we get data and get asked to calculate the WTP? Or just discuss and recommend certain valuation methods 2) Document Analysis This exercise is based on the following database: Ritchie, H. & Roser, M. (2014) - Natural Disasters. Published online at OurWorldInData.org. Re- trieved from: https://ourworldindata.org/natural-disasters 1. Which type of natural hazard led to the most fatal disaster in the past? (i)Droughts and (ii)floods However THE most fatal disaster was the China floods (3.7 million deaths) 2. Which type of natural hazard leads to the highest death toll in recent years? (i)Extreme temperatures and (ii) Earthquakes 3. Which type of natural hazard is most fatal in your country of origin? Netherlands In the past: Floods In recent years: Extreme temperatures 4. Discuss the trend of global death tolls from disasters. What do you expect to happen to this trend under climate change? The global death toll from natural disasters has significantly decreased over the last century. This decline is largely attributed to improved early warning systems, better infrastructure, disaster preparedness, and response mechanisms. However, I believe the death tolls from  disasters will increase, under climate change the frequency and intensity of disasters like floods, storms, and heatwaves are expected to rise. This could potentially reverse the declining death toll trend, particularly in vulnerable regions with less adaptive capacity. Thus, climate change poses a serious risk to future disaster-related mortality, especi