4.Intragenerational equity in climate policy

Question 1

1. • Results of Stern Review
2. • WBGU Budget Approach, historical and future responsibilities
3. – ETS
4. • In case of horizontal MB , show how p can reach social optimal
5. • International issues in Compliance and Enforcement
6. • Process of Credit-based mechanism
7. • Show Germany’s target (that they’re ambitious), Germany’s climate action plan
8. • Flexibility of EU ETS, free allocation: how to calculate, carbon leakage: how do EU improve it

Question 2

Issues with ET?

Answer 2

• Combined with individual reduction targets Kyoto ET can also be viewed as a system of side-payments.
• Countries with lower interest in the treaty can be “bribed in” through the accordance of laxer targets and receive rents from selling certificates.
• Side-payment Mechanism less visible to the voter than direct transfers.
• But: Concessions to some countries were too large in 2012 in order to ensure a large coalition!

Question 3

What are the kyoto mechanisms?

Answer 3

Flexible mechanisms in the kyoto protocol

• Bubble Building (e.g. EU)
• Kyoto Emissions Trading
- between Annex I-Countries
• Joint Implementation
- Reduction projects between Annex I- countries
• Clean Development Mechanism
- Reduction projects in Developing Countries

Question 4

Condition for a coalition to be success, with mathematical formulas if possible

Answer 4

–> The coalition is internally stable if no individual wishes to leave to join the fringe; it is externally stable if no fringe member wants to join the coalition.

• Payoff of a member of coalition: πc (n)
• Payoff of fringe: πf(n)

A coalition of size n is potentially internally stable if πc (n) >= πf (n-1)

A coalition of size n is potentially externally stable if πf (n) >= πc(n+1)

Question 5

State an individual’s firm optimization problem in an ETS

Answer 5

• Assume that without regulation the firm emits e units
• The firm is allocated q units of emission rights for free
• The firm can reduce r units of emission at cost C(r)
• The permit price on the market is P.

min in r of C(r)+ P( e-r-q)

P( e-r-q) : net supply/demand of permits

Question 7

Describe The (First Best) Pigouvian Tax

Answer 7

• Create a price for greenhouse gases so that firms that pollute have to pay a tax, per unit of emissions.
• Generate opportunity cost that firms take into account and alters behaviour (internalising the externality)
• Tax is an economic instrument: uses market forces to change behaviour of polluters (instead of direct regulation)
• Tax has similar efficiency result to a tradable permit market
• Tax should be placed directly on emissions and not on other criteria such as products (petrol, plastics): distortions may occur
• Tax levied provides incentive to reduce emissions ⟹ in form of tax avoided
• All adjust their firm specific abatement levels
• If tax rate higher than MAC ⟹ incentive to reduce pollution
• If tax rate is lower than MAC ⟹ incentive to pay tax (not abate pollution)
• If tax rate is levied at t* efficient (and socially optimal) level of GHG pollution is attained without coercion or command and control regulation
• “Internalizes the externality”

Question 8

Compare TAX and Tradable permit market

Answer 8

• Carbon taxes establishes well defined price for emissions known to firms so they can calculate costs of emissions reductions
• •Can improve incentive to invest in R&D and long term capital

• In contrast, permit market:

• As supply is fixed and demand can vary considerably: price is volatile and uncertain
• Demand for permits changes for number of reasons: change in energy demand; fuel price changes
• May reduce incentive to invest in abatement R&D

However: TPM Allows quantity of emissions to change in face of prevailing economic conditions (e.g. recession/ boom)
• Fixed tax allows quantity of emissions to change which may make sense to allow for nation-wide emissions to vary due to prevailing economic conditions
• In contrast, markets as often claimed:
- Do not have inherent flexibility in market. So could be more costly to firms
- Makes only economic sense to have this if we are rapidly approaching the threshold of atmospheric greenhouse gas concentrations beyond which have dangerous impacts

• Existence of a “Hybrid schemes“
Tradable permit markets can be adapted to include:
- Price ceiling “safety valve” (to improve price stability): unlimited amount of permits that can be sold at the set “safety valve”
- Banking and borrowing of permits (to improve price stability)
- Reserve (to improve price stability): limited stock of permits that can be sold at a price ceiling
- Auctioning of permits (to obtain revenues for reduction in distortionary taxes)