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MPE 781 Economics for Managers: Global Climate Change

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Questions:

 Assignment Overview: This assignment is based on an article pub-lished in The Economists’ Voice titled ‘Global Climate Change: A Challenge to Policy’, by a Nobel laureate Kenneth J . Arrow , in 2011.

Task:

Answer all questions.

  1. Motivate the reader to read the article by summarising the key assumptions and main points.
  1. According to Arrow, We are much better to act to reduce CO2emis-sion substantially than to su er and risk the consequences of failing to meet this challenge." { in light of the article and based on your own research, please explain why he suggests so. Speci cally, what sources of market failure are present? Apply the abstract possible solutions to this problem of global warming.
  1. In this article, the consumption discount rate, denoted by , is de ned as = + g . What do the terms and g  represent? Explain the intuition behind this equation. One critique says that any kind of uncertainty regarding g may lower the value of . Do you agree or disagree with the critique? What are the implications to the economy of having a lower value of , when human-induced global warming is occurring? Explain.
  1. Adam Morton, in his article titled Energy crisis: Wholesale power prices have doubled since the carbon tax was axed" published in the Sydney Morning Herald (dated the 9th March, 2017), has argued that the dramatic increase has been largely blamed on soaring gas prices and investment uncertainty over what power plants to build as age-ing coal generators shut down. If so then what are the implications regarding the value of for Australia? Explain.
  1. In the equation = + g , assume that is determined by an action of a social planner. Consider the event when U.S. President Donald Trump withdrew the U.S. from the Paris Climate Accord on June 1st, 2017. What are the implications regarding the value of for the world? Explain.

Answers:

Introduction: 

Over the last few decades one of the most bothering and disturbing issues in a global level have been the drastic climatic changes and the phenomenon of global warming. Global warming in simple words means an increase in the overall average temperature of the earth, at a pace, which is faster than normal. This phenomenon, though not accepted by a few, is mostly perceived to be occurring in the recent times and has been a cause of immense concern among the global leaders and environmentalists across the globe, due to the short term and long term threats it poses. The long term threats include huge changes in the global temperature, which in turn may result in an overall change in the environment as well as demography, endangering the lives of plants, animals and human beings (Fankhauser, 2013). Global warming, as suggested by many, has been caused due to many reasons, one of the primary ones being the human activities over the years. The most harming of these activities has been the huge and uncontrolled emissions of greenhouse gases like carbon dioxide, methane and others, which aggravated to a major extent since the last century. The concerned report gives a detailed account of this issue and tries to analyze and seek answers to several important questions, based on Kenneth J. Arrow’s article on Global Climate Change (Arrow, 2007). 

1: 

In the article, by Kenneth J. Arrow, the effects on the earth, positive and negative, due to the occurrence of global warming and a rise in the overall level of temperature as a byproduct, has been discussed and critically evaluated. The article discusses about the potential costs that are expected to be borne by not only humankind but also other life forms existing on earth, due to the aggravated pace of the global warming. There have been significant debates and confusions regarding the extent of this cost and at what time this cost has to be borne by human beings. The author however, tries to suggest the presence of global warming in reality with the help of empirical evidences present. He also tries to discuss about the necessity to reduce the emission of carbon dioxide by huge levels in order to prevent the future catastrophic situations that are highly expected to arise if the emissions go on at the existing levels (Arrow, 2007).

The article attributes the phenomenon of global temperature increase, to a big extent, to the trace gases, which are present in the earth’s atmosphere. These trace gases are primarily composed of carbon dioxide, methane and water vapor and have the inherent property of absorbing radiations at low frequency, thereby getting heated up. The proportion of CO2 has been consistently increasing, even at a greater pace post Industrial Revolution, which along with increasing the mean temperature worldwide, is also having significant impacts (mostly adverse) on sea-levels, crops, vegetations, climate and life forms. The cost and benefit approach has been used in this article to calculate the effects of taking restrictive measures on CO2 emissions in near future (Trenberth et al., 2014). 

2: 

The author, in this article advocates for the immediate need for taking restrictive measures on the uncontrolled emissions of the greenhouse gases, mostly carbon di0xide as s being currently done by human beings all over the world, especially in the industrially developed countries. These measures, according to the author are mandatorily required to avoid the huge negative consequences from the global warming, which is being substantially caused by the uncontrolled emission of these greenhouse gases. The implications, as suggested by Arrow, can be short term as well as long term. The reasons, as put forward by the author, in support of his suggestions, are elaborately discussed in the following section:

Scientists, environmentalists and global leaders across the world has overtime unanimously agreed to the fact that one of the dominating factors causing this global warming has been the natural as well as man-caused emissions of greenhouse gases, especially carbon dioxide, from the beginning of existence of life forms on earth. These greenhouse gases, being one of the comprising elements of the trace gases, have added bulks to the amount of trace gases present in the atmosphere of the earth (Seinfeld & Pandis, 2016). The trace gases, having the unique tendency of absorbing radiations when emitted at low frequencies, have caused the heating up of the earth overtime. One of the major sources of the emission of carbon dioxide has been the activities of the human beings, who, especially from the last few centuries, have been contributing significantly to the share of emission of carbon dioxide in the earth’s atmosphere. The levels have drastically risen from the time of initiation of the Industrial Revolution. Post Industrial Revolution, these levels have significantly gone up with time (Lau, Lee & Mohamed, 2012).

The following graph shows the dynamics in the emission of carbon dioxide overtime:

Figure 1: Emission of Carbon Dioxide Globally

(Source: Scienceblogs.com, 2017)

The above figure supports the fact that the emissions have significantly from the Industrial Revolution period, as can be seen that the emissions significantly rose from 1851, with the pace getting increased post 1951. The emissions of carbon dioxide reached a threatening level of 8000 million metric tons by the next century (Bondyrev, Davitashvili & Singh, 2015). This massive increase in the CO2 levels has in its turn contributed to the abnormal increase in the global temperature in the last few centuries, thereby creating a greenhouse like effect on the environment of the earth (O'Neill et al., 2012). The direct relationship between the increase in the levels of CO2 in the atmosphere and the increase in the global temperature can be seen from the following figure:

Figure 2: Relation between levels of CO2 and Temperature overtime

(Source: Scienceblogs.com, 2017)

It is evident from the above figure that both the variables have a positive and direct correlation thereby giving robust support to the theories of the author. The concern as showed by Arrow, in his article, gets relevance from this data, thereby making the need to take appropriate actions against this an absolute priority (Friedlingstein et al., 2013).

Substantial research has been carried out in this aspect and shocking results have been received which shows that the levels of CO2 emissions drastically got hiked from 280 ppm (parts per million) from the periods prior to the Industrial Revolution to 430 ppm since the initiation of the revolution. Reports also predict the expected levels of these emissions to reach up to 550 ppm (2035), if the current activities and pace continue. This projected emission levels are scarily twice of that of the levels existing before the industrial activities gained impetus. The levels, if received, will be first of that extent in the last few of millions of years. These threatening statistics pose a serious threat to the overall existence of humanity in the future, provided no measures are taken to control and reduce it (Cook et al., 2014).

The article, along with substantial support from other research and scholarly works, suggests that there are direct and substantial implications of these continuously increasing levels of emission of carbon dioxide on the average levels of temperature in the world. The projected rise in the levels of these emissions is expected to increase the average global temperature by a minimum of 2oC in very near future. This emission pattern, if maintained, poses a threat of a five degree increase in the global temperature by fifty percent probability, by the beginning of 2100, if no corrective measures are under taken (Peters et al., 2013).

One of the many negative consequences that the emission of greenhouse gases and global warming as a result, has on the global environment is the melting of the glaciers, thereby leading to an overall rise in the sea levels as can be seen from the following graph:

Figure 3: Changes in the sea levels overtime

(Source: Climatecentral.org, 2017)

The alarming rise in the sea levels are observed especially between the fifteenth and the twentieth century and is expected to rise faster and to a greater extent if the current trends of global warming and melting of glaciers tend to continue. This, in its turn, poses a credible threat of wiping out many of the populous landmasses, including huge land areas of low sea level countries like Bangladesh. Cities like Manhattan and others also face threat of complete extinction from the geographical map of the world forever. Two major glaciers of Greenland and West America also faces the threats of melting, which if occurs, can create even bigger catastrophe, causing significant loss to human life and properties (Hansen, 2016).

Another direct impact of global warming is the changes that the global climatic patterns are expected to undergo with the increase in the average levels of temperature. The current pace of global warming is expected to change the currently pleasant climatic conditions of Europe and similar countries to the type of climate, which prevails in Greenland. The tropical storms are also expected to intensify in magnitude and frequencies overtime, causing problems for humankind. The decrease in the reserves of glaciers, with rapid melting of the huge ones, can lead to a worldwide shortage of drinkable water supplies in near future (Bondyrev, Davitashvili & Singh, 2015).

All these consequences, collectively, poses threats to even the existence of life forms in future on earth. These projections have led to creation of immense concern and tensions among people all over the world and the projections are expected to be having enough potential for causing catastrophe. Therefore, appropriate design and implementations of adaptive and corrective measures, on a global level, has become a matter of immense priority and necessity, as is discussed by the author, in this article (Pachauri et al., 2014).

Source of Failure in the Market:

Market failure, in terms of economics, is described as a phenomenon where the welfare of the overall society is not maximized in a particular market structure. In this case, this issue has relevance. The rate of emissions of carbon dioxide has significantly increased post the initiation of the Industrial Revolution, as can be seen from the data and statistics provided by various research and studies conducted worldwide. However, the positive gains of the industrial revolution, as known by all, have been achieved by the few contemporary highly developed countries, which were on the growing trajectory during the revolution period (Rezai, Foley & Taylor, 2016).

The Industrial Revolution fuelled the growth and economic welfare and the overall development of these countries significantly and embarked them on the path of sustainable growth, as can be seen from their current performances. However, this growth in the economy of these countries came at the cost of uncontrolled emission of carbon dioxide, due to the absence of adequate awareness of the negative consequences and absence of appropriate restrictions (Emanuel, 2012).

The burden of these activities is borne by the succeeding generations. The developed countries grew and prospered at the cost of the underdevelopment of the developing countries, which faced the restrictions and anti-growth policies to reduce emissions of greenhouse gases. These caused a significant blow to their economic prosperity, keeping them poor and less developed. Therefore, it can be see that the costs of economic growth of the developed countries were not mostly borne by them but were in fact borne by the less developed ones as they are mainly facing the tradeoff between growth and global well-being. This can be portrayed as a source of market failure in this aspect in the global scenario (Rezai, Foley & Taylor, 2016). 

Solutions to combat Global Warming:

To reduce the pace of global warming or to at least confine them to the existing level, several measures can be adapted which can possibly help in reducing the levels of carbon emissions. Some of these are as follows:

  1. a) The replacement of the traditional high-carbon-emitting energy resources like coals and other fossil fuels with those of natural gases can reduce the levels of carbon emission massively (Emanuel, 2012).
  2. b) One of the primary factors contributing to global warming is the huge deforestations that has taken place over the years, mainly by men. Trees help in reducing CO2 levels and therefore should be planted all over the world in huge quantities to combat global warming (Pachauri et al., 2014).
  3. c) Energy consumption reducing production techniques and innovations are an absolute necessity and they should also be used worldwide to reduce the overall energy consumption levels. Both developed and the recent developing countries should take this innovation and implementations seriously (Seinfeld & Pandis, 2016).
  4. d) The developed countries have enjoyed fruits of Industrial Revolution substantially. Therefore, it becomes a responsibility on their part to take the proper initiatives to control and reduce carbon emissions such that they can inspire others to follow their footsteps (Lau, Lee & Mohamed, 2012).

3: 

The article uses the following equations to see the inter-temporal preferences of consumption in general:

δ = ρ+gη

The term δ in this equation, shows the discount rate in consumption. This shows the rate of discounting losses by an individual that is expected to occur in the future consumption if the individual prefers to consume in the present period. This is an overall picture of the preference pattern of an individual of current over future. Higher values of this term indicate that the particular individual prefers to consume more in current period to future period (Sen, 2013).

The term ρ, in this equation is the rate of time preference. Higher values imply more preference of an individual of current welfare over his or her welfare in the future. The term g shows the expected growth rate of average consumption and the term η indicates the elasticity of social weight as a result of a change in consumption levels. This is nothing but the economic concept of marginal utility as there is an increase in the level of consumption (Goulder & WILLIAMS III, 2012).

Figure 4: Social Cost of Carbon and Global Discount Rate (2010)

(Source: Source: Americanprogress.org, 2017)

Economic Intuition:

The equation implies that there are two factors contributing to the consumption discount rate. The rate has a positive relation with the time preference variable as with higher time preference, people value present consumption more than that of future consumption. Again, gη is the change in the value of δ, due to an increase in the mean rates of consumption, keeping in mind that increases in g decreases η (Sen, 2013). 

The critique argues that uncertainty in the values of g leads to a fall in the value of the consumption discount rate. This, however, may not be correct as with high uncertainty in the growth rate of consumption, current consumption tends to be of more importance than that of future consumptions. Therefore, the relation as suggested by the critique might not be true in a generalized framework (Cropper et al., 2014).

In the given scenario, a country having a low value of the consumption discount rate implies that the country in general prefers future consumption significantly and has a low current preference rate. This implies that future consumption is also of importance to the residents of the country. This economy, given the threat of aggravated global warming and its potential negative effects, is expected to take pro-active measures to reduce emission of CO2 to safeguard their future welfare. They can be expected to pave the path of sustainable development and can inspire other countries to sacrifice their current welfare to some extent for future betterment (Cropper et al., 2014). 

 4: 

The article by Adam Morton, argues that the prices of power in Australia has gone up drastically and has almost doubled after the axing of taxes on carbon. Their findings are backed by many evidences, which suggest the same phenomenon. The cost of consumption of electricity in the country, as a result, has also grown up due to this hike. Much of this is attributed to the continually rising gas prices and also the investment uncertainty in the power sector. This is arising due to the speculations and doubts among the investors regarding the future of the power plants. Though these plants are the future replacements to the coal factories, their prospects and credibility are matters of concern among the investors (Smh.com.au, 2017).

The article shows that though the country acknowledges the need to reduce the emission of carbon dioxide for future welfare, but with the current crisis in the power sector, it has backed off from pursuing the ambitious target of decreasing the uses of the non-renewable energy resources to only fifty percent. This indirectly implies that in the face of the huge rise in the prices of the electricity consumption, the consumption discount rate of the people in Australia is expected to see an increase. The immediate implication of this dynamics is that with a soar in the prices of gas, the residents will not agree in sacrificing their current welfare for the future benefit, which is highly uncertain. If the present price trends continue, there can be an increase in the demand for traditional non-renewable sources (Meng, Siriwardana & McNeill, 2013).

Figure 5: Changes in price of electricity in Australia

(Source: Smh.com.au, 2017) 

The trend, as discussed above, can be interpreted in terms of general behavioral patterns of human beings, who by nature, value current welfare that future well being because there are more uncertainties regarding future consumption and welfare than current welfare and consumption levels. People are risk averse by nature, barring few exceptions. This implies that this kind of behavioral trend may be seen in this case. The uncertainties in the investment in the power sector, as can be seen from the article, may be due to the unsure prospects and profit abilities of these plants. Taken together, these can influence people to resort back to the usages of non-renewable carbon emitting energy sources, even at the cost of future welfare (Smh.com.au, 2017). 

5: 

In the article, the term ρ, that is the time preference variable, denotes the tradeoff between current and future preferences of the individuals. Higher the values of this variable, greater are the preference of current consumption of an individual to future consumption. This means that a high value of time preference for a country will cause an increase in the discount rate of consumption for that country, which indicates that the country is more concerned with the present welfare and bothers less about the welfare of the succeeding generations (Friedman, 2016).

The current instance of withdrawal of the United States of America from the Paris Climate Accord can be related with the above discussion and is expected to create significant impacts on the global environmental conditions (Bodansky, 2016).

Table 1: Average Discount Rate over the years

(Source: Americanprogress.org, 2017)

The USA has been and is still one of the highest emitters of carbon dioxide at the global level. It contributes almost a quarter of the total emissions of carbon dioxide emission in the world, which indirectly indicates that, the strategies and behavior of the country significantly determines the fate of the world in terms of carbon emissions and global warming. Given this context, the withdrawal of the country from the Climate Accord may imply that there will be less impositions of restrictive policies and limitations on the country regarding carbon emission (Friedman, 2016). This can increase the value of ρ, as the residents, inherently, will choose current welfare over future welfare. This may increase the consumption discount rate of the country and directly affect the global value of the rate by creating an upward pressure. The global value of δ, if increases under the influence of that of the USA, can increase the threats of global warming even more in the near future (Raupach et al, 2014).

References 

Americanprogress.org. (2017). Hidden Costs: President Trump’s Campaign to Erase the Social Cost of Carbon - Center for American Progress. Center for American Progress. Retrieved 5 September 2017, from https://www.americanprogress.org/issues/green/reports/2017/04/19/430591/hidden-costs-president-trumps-campaign-erase-social-cost-carbon/

Arrow, K. J. (2007). Global climate change: A challenge to policy. The Economists' Voice, 4(3).

Bodansky, D. (2016). The Paris climate change agreement: a new hope?. American Journal of International Law, 110(2), 288-319.

Bondyrev, I. V., Davitashvili, Z. V., & Singh, V. P. (2015). Global Warming and Climate Change. In The Geography of Georgia (pp. 205-218). Springer International Publishing.

Climatecentral.org, J. (2017). Study Reveals Stunning Acceleration of Sea Level Rise. Climatecentral.org. Retrieved 23 August 2017, from https://www.climatecentral.org/news/study-reveals-acceleration-of-sea-level-rise-20055

Cook, B. I., Smerdon, J. E., Seager, R., & Coats, S. (2014). Global warming and 21st century drying. Climate Dynamics, 43(9-10), 2607-2627.

Cropper, M. L., Freeman, M. C., Groom, B., & Pizer, W. A. (2014). Declining discount rates. The American Economic Review, 104(5), 538-543.

Emanuel, K. (2012). What we know about climate change. MIT Press.

Fankhauser, S. (2013). Valuing climate change: the economics of the greenhouse. Routledge.

Friedlingstein, P., Andrew, R. M., Rogelj, J., Peters, G. P., Canadell, J. G., Knutti, R., ... & Le Quéré, C. (2014). Persistent growth of CO2 emissions and implications for reaching climate targets. Nature geoscience, 7(10), 709.

Friedman, M. (2016). A theory of the consumption function. Pickle Partners Publishing.

Goulder, L. H., & WILLIAMS III, R. C. (2012). The choice of discount rate for climate change policy evaluation. Climate Change Economics, 3(04), 1250024.

Hansen, J., Sato, M., Hearty, P., Ruedy, R., Kelley, M., Masson-Delmotte, V., ... & Velicogna, I. (2016). Ice melt, sea level rise and superstorms: evidence from paleoclimate data, climate modeling, and modern observations that 2 C global warming could be dangerous. Atmospheric Chemistry and Physics, 16(6), 3761-3812.

Lau, L. C., Lee, K. T., & Mohamed, A. R. (2012). Global warming mitigation and renewable energy policy development from the Kyoto Protocol to the Copenhagen Accord—A comment. Renewable and Sustainable Energy Reviews, 16(7), 5280-5284.

Meng, S., Siriwardana, M., & McNeill, J. (2013). The environmental and economic impact of the carbon tax in Australia. Environmental and Resource Economics, 1-20.

O'Neill, B. C., Liddle, B., Jiang, L., Smith, K. R., Pachauri, S., Dalton, M., & Fuchs, R. (2012). Demographic change and carbon dioxide emissions. The Lancet, 380(9837), 157-164.

Pachauri, R. K., Allen, M. R., Barros, V. R., Broome, J., Cramer, W., Christ, R., ... & Dubash, N. K. (2014). Climate change 2014: synthesis report. Contribution of Working Groups I, II and III to the fifth assessment report of the Intergovernmental Panel on Climate Change (p. 151). IPCC.

Peters, G. P., Andrew, R. M., Boden, T., Canadell, J. G., Ciais, P., Le Quéré, C., ... & Wilson, C. (2013). The challenge to keep global warming below 2? C. Nature Climate Change, 3(1), 4.

Raupach, M. R., Davis, S. J., Peters, G. P., Andrew, R. M., Canadell, J. G., Ciais, P., ... & Le Quere, C. (2014). Sharing a quota on cumulative carbon emissions. Nature Climate Change, 4(10), 873.

Rezai, A., Foley, D. K., & Taylor, L. (2016). Global warming and economic externalities. In The Economics of the Global Environment (pp. 447-470). Springer International Publishing.

Scienceblogs.com. (2017). Denying Climate Science in Multiple Dimensions. Greg Laden's Blog. Retrieved 23 August 2017, from https://scienceblogs.com/gregladen/2014/02/27/denying-climate-science-in-multiple-dimensions/

Seinfeld, J. H., & Pandis, S. N. (2016). Atmospheric chemistry and physics: from air pollution to climate change. John Wiley & Sons.

Sen, A. K. (2013). Approaches to, the Choice of Discount Rates for Social Bene?t—Cost Analysis. Discounting for Time and Risk in Energi'Policy, 325-53.

Smh.com.au, A. (2017). Wholesale power prices have doubled since the carbon tax was axed. The Sydney Morning Herald. Retrieved 23 August 2017, from https://www.smh.com.au/federal-politics/political-news/energy-crisis-wholesale-power-prices-have-doubled-since-the-carbon-tax-was-axed-20170308-gutf8t.html

Trenberth, K. E., Dai, A., Van Der Schrier, G., Jones, P. D., Barichivich, J., Briffa, K. R., & Sheffield, J. (2014). Global warming and changes in drought. Nature Climate Change, 4(1), 17-22.

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