Unit 10 - Approaches to Integrated Assessment Modeling: Cost Benefit Analysis

Question 1

What is the main goal of Cost-Benefit Analysis (CBA) in climate protection strategies?

Answer 1

Answer: To determine optimal climate protection strategies that minimize total costs (damage costs + mitigation costs) or maximize global welfare.

Question 2

Explain the Cobb-Douglas Production Function

Answer 2

• mathematical formula used in economics to model the relationship between production output and two input factors - typically labor and capital
• shows how these inputs combine to produce output, assuming that increasing either input will increase output but with diminishing returns (reduction in marginal productivity).

Question 3

Equation of Cobb-Douglas Production Function

Answer 3

Q’(t) = A(t) × K(t)^y × L(t)^(1-y)

Where:
Q(t) = global output
Q’(t) = global output withou taking into account damage cost & mitigation cost
A(t) = Total factor productivity/autonomous technical change
K(t) = Capital stock
L(t) = Labor force (proportional to population)
y = elasticity of output with respect to capital

Question 4

In the Cobb-Douglas Production Function used in DICE, what do K(t) and L(t) represent?

Answer 4

Answer: K(t) represents Capital stock, and L(t) represents Labor force (proportional to population).

Question 5

What are the two main variables that the DICE model tries to optimize?

Answer 5

• c(t): Per-capita consumption
• μ(t): Emissions control rate

Question 6

Why is discounting a crucial concept in climate change cost-benefit analysis?

Answer 6

Answer: Discounting determines how we value future climate damages compared to present costs. It can dramatically reduce the present value of future damages, which significantly impacts climate policy decisions.

Question 7

Name the key conceptual problems with Cost-Benefit Analysis in climate policy.

Answer 7

• Hidden value judgments in monetary valuations and aggregation
• Decision-making challenges (lack of single decision maker, incomplete information)
• Difficulties in dealing with long time horizons and uncertainties

Question 8

What is the emission function in DICE used to calculate?

Answer 8

Answer: The emission function calculates global CO2 emissions based on economic activity, carbon intensity of production, and emissions control rate.

Question 9

What is the Damage Cost Analysis?

Answer 9

Evaluates global climate damage as a function of global temperature change
damage = f(change in global temperature)

• Involves:
  
  • Determining sectoral and regional climate impacts
  • Monetary valuation of impacts
  • Aggregation across sectors and regions

Question 10

Explain the components of the damage cost curve equation D(t) = a₁ × T(t)^a₂.

Answer 10

• D(t) = Damage cost (fraction of economic output)
• a₁ = Damage coefficient
• a₂ = Damage exponent
• T(t) = Global mean temperature change relative to preindustrial level

Question 11

What is a limitation of the damage cost curve in DICE?

Answer 11

Answer: It does not take into account damages that depend on the rate of temperature change.

Question 12

How is per-capita consumption (c(t)) calculated in the DICE model?

Answer 12

Answer: Per-capita consumption is calculated by dividing total consumption C(t) by the labor force L(t): c(t) = C(t)/L(t)

Question 13

Explain the two ways to calculate global output

Answer 13

Q(t) (global output taking into account damage and mitigation costs):
Q(t) = [1 - D(t)] × [1 - V(t)] × Q’(t)

Where:
Q(t) = Global output (with damage and mitigation costs)
D(t) = Damage costs (as fraction of output)
V(t) = Mitigation costs (as fraction of output)
Q’(t) = Global output without climate damages and mitigation costs
= A(t) × K(t)^y × L(t)^(1-y) [from Cobb-Douglas production function]

or

Q(t) = I(t) + C(t)

Where:
Q(t) = Global output
I(t) = Gross investment
C(t) = Consumption

Question 14

what are the two ways output could be used?

Answer 14

• Output can be devoted to either gross investment l(t) or consumption C(t):
  
  • the benefit of investment is that you can get more output in the future (as you will have more capital stock) versus just consumption which will use up the output

Question 15

Explain capital accumulation

Answer 15

• refers to the process of increasing the stock of capital (like machinery, buildings, and equipment) over time through investment, accounting for depreciation.
• represented by the change in capital stock as a function of investment minus depreciation.

Question 16

What are the three key components that the DICE model combines in its dynamic optimization?

Answer 16

Answer:
1. Capital stock equations - tracking economic resources
2. CO2 concentration equations - calculating atmospheric CO2 levels from emissions
3. Temperature change equations - determining global temperature effects from CO2 levels

Question 17

What does the Intertemporal Optimization of Global Welfare aim to do?

Answer 17

Goal: determine the optimal emissions reduction path, which maximizes the present value of global welfare

considers discounting

Question 18

What is mitigation cost analysis?

Answer 18

• Examines costs associated with reducing emissions
• can be charted with present value gross world product (GWP) loss and stabilization level
  
  • GWP loss - measured in %
    
    • GWP - the total monetary value of all finished goods and services produced worldwide in a given year
• Optimal point occurs at minimal total cost

Question 19

What is the stabilization level?

Answer 19

• Stabilization level - measured in ppmv (parts per million by volume)
  - refers to the concentration of greenhouse gases (particularly CO2) in the atmosphere; represents the level at which we aim to stabilize atmospheric greenhouse gas concentrations to prevent dangerous climate change
  
  • can also be simplified as charting cost and emissions reduction

Question 20

What are the various Dynamic Cost-Benefit Analysis models?

Answer 20

• includes DICE Model (Dynamic Integrated model of Climate and the Economy)
  
  • Developed by Nordhaus (1989)
  • conceptual, global, intertemporal model for determining optimal climate protection strategy
    
    • model considers and analyzes effects across different time periods
  • involves simple damage and mitigation cost curves
  • won the Nobel prize for this
• RICE model (Regional dynamic integrated model of climate and the economy)
  
  • developed by Nordhaus and Yang (1996)
• MERGE (Model for Evaluating the Regional and Global Effects of GHG Reduction Policies)
  
  • developed by Manne and Richels (1990)

Question 21

Results of DICE

Answer 21

Showed that even if we reduce emissions (e.g to Kyoto protocol levels), there is still predicted high temperature increase → will not reduce the effects of global warming much

Question 22

What are some recommendations for climate policy in terms of cost-benefit analysis?

Answer 22

• Recognition that pure cost-benefit analysis may be insufficient → need for alternative approaches to global warming policies
• Importance of considering long-term objectives → need to take specific steps to override market decisions or conventional cost-benefit tests
• Value of international negotiation in decision-making → to make better decisions
• Recognition of limitations in quantitative decision models