5 ie454 l1_ sustainability & externalities
TRANSCRIPT
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Environmental and energy economics
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Lecture Moderate A. Sustainability 1 21.09
What is "sustainability"? Externatilites. Hanley Ch.2, Tietenberg Ch 2
2 29.09
Market failure Tietenberg Ch 2
3 05.10
Global warming Tietenberg Ch 16
4 12.10
First-best optimal instruments Second-best instruments (subsidies)
Tietenberg Ch 14 Cramton
5 19.10
Optimal extraction of exhaustible sources: the basic model & extensions
Tietenberg, Ch.5
B. Fossil fuels: Oil, Gas & Coal 6 26.10
Oil. Security of supply. Shale oil, oil shale (kerogen), tar sands (bitumen). Peak oil, Huber curves and reserves
BP BP 2013 Edwards p.68-92, 126-157 IER Smil: Memories of peak oil Smil 2010: power density primer
7 02.11
Gas. Security of supply: short-term & long-term. The crucial difference between oil and gas. Bilateral monopoly. "pipe wars".
Shively-GAS, Chap 1, 2, 10 Ratner Shively-GAS Stern
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C. Electricity markets 8 09.11
Fundamentals of electricity: The system Shively-E Ch.1, 2, 4, 5, 6, 7. Biggar Ch. 2
9 16.11
Fundamentals of electricity: Generation Shively-E Ch. 4. Edwards p.93-112 +117 (California)
10 23.11
Generation: Trading simulation 1a & 1b Edwards p.259-271 Stoft p.33-45, 123-129
11 30.11
Generation: optimal investment, screen curves, load duration curve, missing money & capacity payments and subsidies
Stoft p.33-45, 123-129
D. Climate policy
12 07.12
Renewable energy sources: - costs & benefits - the costs of intermittency - LCOE and its drawbacks - the utility dead-spiral
Borenstein 2012 Marcantonini Taylor Boehringen Hirth Smil 2010 Smil 2014 Reader
13 14.12
E. Enviromental survival: Past and future
- The Green paradox - Disasters, myths and miracles
Tietenberg, Ch.5 Morris Wilson
17.12 Exam for exchange students (not for "domestic" ones)
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• SUSTAINABILITY
• Hanley, Chap. 2
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• What is sustainability?
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• What is sustainability?– Utilitarian approach: look at the discounted
sum of well-being of all people over time.– Kantian approach: Future generations have
moral rights to a level of well-being no less than our own.
– Should we use a discount factor or not?
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– Should we use a discount factor or not?- Value of goods is not less because it is later in
time+ Assets saved now grow with the real interest rate
in time and are thus worth more in the future
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• What defines a sustainable path?1. Outcome oriented
• Utility calculations
2. Capital oriented• Capital stock calculations
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• What defines a sustainabile path?1. Outcome oriented
• Utility calculations– Representative agent
[ ]U t
[ ] 0dU tdt
• Utility not decreasing
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• Ramsey (or Solow) model?– Remember macroeconomics
– Are the outcomes sustainable?
[ ] dtMaxU C t e
(1 ) ( )t t t tsuchthat K K Y C
tY
[ ]C t
t
Yes
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• Ramsey (or Solow) model?– Remember macroeconomics
– Are the outcomes sustainable?
[ ] dtMaxU C t e
(1 ) ( )t t t tsuchthat K K Y C
tY
[ ]C t
t
No
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• Ramsey (or Solow) model?tY
[ ]C t
t
Sustainable
• What is drawback of this approach?• We only talk about utility -> human satisfaction is the
focal center.• No mention of natural stocks.
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• What defines a sustainable path?1. Outcome oriented
• Utility calculations
2. Capital oriented• Capital stock calculations• What is capital?
– Man-made capital Km– Human capital Kh– Natural captital Kn– Social capital Ks
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• Weak sustainability
• Different sorts of capital are substitutable.
M H Nt t t tK K K K 0tdK
dt
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• John Hartwick (1977, AER) “Intergenerational equity and the investing of rents from exhaustible resources”
• Rules for “Weak sustainability
• Does the consumption of non-renewable assets imply a decrease in consumption?– Oil, gas, coal extracted and burned– Forests, pristine nature replaced by cities
• If the capital stock is kept constant, consumption may not decrease.
M H Nt t t tK K K K 0tdK
dt
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• What should Saudi-Arabia do to be weakly sustainable?– Extracting oil– Invest the rents in human and man-made
capital– Do they do this?
• Not really
• What oil and gas country is weakly sustainable?– Norway– Rents are invested in the “oil fund”.
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• What is the drawback of this definition of sustainability?
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• We may want to keep a stock of pristine nature
• Problem with weak sustainability– Assumes perfect substitution between
different forms of capital
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• Weak sustainability
• Different sorts of capital are substitutable.
M H Nt t t tK K K K 0tdK
dt
• Strong sustainability
0NtdK
dt 0
NN N tt
dKK K anddt
or
No reduction in natural assets!
• A subset of the natural assets is deemed essential
• May not be degraded!
Examples:• The ozon layer• Amazon forest• Global temperature
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0N
N N tt
dKK K anddt
• A subset of the natural assets is deemed essential
• May not be degraded!
• What is this the essential subset of the natural assets?• Possible answers:
1. Existing level2. “Level consistent with the critical level”3. (Something in between)
• Possible answers:
• Suppose we have an answer to this (we set some level)– For global temperature– For fish stocks– For pristine forest
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• How do we measure such a level?– Should they be measured in physical or
monetary units?• Physical: Aggregation problem
– How to aggregate the different elements of KN?» oak tree + a blue whale?
– Category woodlands:» Is a sitka pruce as valuable as native Scots pine or
an ancient oak?
• Monetary:– How much is a human’s life and how much that of a
whale, a tree or fresh air?
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• “Mother ship earth”• environment - economic system is a closed
system.
• first law of thermodynamics– energy and matter can neither be created nor
destroyed• second law of thermodynamics (entropy
law)– entropy increases– Entropy is a measure of disorder
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• How to diminsh pollution– In an as efficient as possible way?
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• Applied on carbon emissions by the electricity sector in the EU:–How to create a framework that
leads to cleaner electricity?
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2mT 4mT 5mT
A B C
Emissions:
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2mT 4mT 5mT
A B C
Emissions:
4$/T 5$/T 20$/TAbatement cost:
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2mT
A B C
4$/T 5$/T 20$/TAbatement cost:Abatement-investment
7$/T
5mT4mT1mT
1$/T
Emissions:
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A B C
Abatement cost:Abatement-investment ?Emissions:
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A B C
Abatement cost:Abatement-investment
Emissions:
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A B C
EMISSION PERMIT MARKET
Competition for
permits
Solution 1:EU Emission Trading Scheme (EU-ETS)
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• 2005- end 2007: Phase 1 (test phase)
• 2007- end 2012: Phase 2 (6.5% below 2005 level)
• 2012- end 2020: Phase 3 (linear 1.74% reduction/year)Kyoto Protocol
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Reduction of 21%
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• Qm is the chosen quantity of production
• A+B+D= profit• B+D+C= external
costs.
• Q* is the optimal level of production– Implying an
optimal level of pollution
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• How to improve this outcome?– Tax– Set property
rights and leave to bargaining
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• Lecture 1 finish
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• Coase Theorem
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• Coase (1960): Set property rights and leave to bargaining
1. Polluter has property rights
– Victim suffers cost B+D+C at Qm
– Victim offers bϵ[D,C+D] to produce at Q*
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• Coase (1960): Set property rights and leave to bargaining
2. Victim has property rights
– Polluter produces 0
– Polluter offers bϵ[B,A+B] to victim to produce at Q*
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• What are the assumptions of the Coase Theorem (1960)?– No transaction costs!
• Cost of the effort of contracting• Free riding problems• Not a general equilibrium approach -> Wealth
effects may affect preferences.
Debreu & Arrow, 1954. Existence of an Equilibrium for a Competitive Economy, Econometrica.
• Coase theorem is a special case of a general equilibrium.
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• Examples
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1. Does an externality exist? Positive or negative?
2. Does the Coase theorem apply? 3. If Coase theorem does not apply which
government tools are best 1. quantity regulation2. taxes/subsidies3. tradeable
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1. British Petroleum drills for oil in the gulf coast2. Carbon emissions from vehicles3. Your upstairs neighbors throwing an awesome,
but loud party4. Buying a car with added safety features that
prevent the drivers/passengers deaths in the event of an accident
5. Bringing crying babies on a plane
1. Does an externality exist? Positive or negative?2. Does the Coase theorem apply? 3. If Coase theorem does not apply which government
tools are best 1. quantity regulation2. taxes/subsidies3. tradeable
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• An natural gas company in San Francisco owns many pipelines running underneath what is now populated areas.
• The company can invest $u in the maintenance of the pipes. Maintenance affects two things:– less gas lost. Value of lost gas = 1/u– less damage to land above the pipes. Value
of damage = 3/u
• Externality?• What is the social optimum?
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• The social optimum minimizes total costs:
–Value of lost gas = 1/u–Value of damage = 3/u
The social optimum?
• Optimal maintenance is u*=2• The value of lost gas is ½ • Value of nature damage is 3/2.• Total costs are: 2 + ½ + 3/2 = 4
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• The gas company will solve:
–Value of lost gas = 1/u–Value of damage = 3/u
No owner of the land?
• Private maintenance is uP=1• The value of lost gas is 1 • Value of land damage is 3.• Total costs are: 1 + 1 + 3 = 5
• In the social optimum, the social costs were 4.• Thus, there is a deadweight loss: 5-4= 1.
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• Suppose now that the gas company owns the land above the pipes.
• What level of u will they choose now? • Is this optimal?
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• The gas company will solve:
–Value of lost gas = 1/u–Value of damage = 3/u
Joint ownership of gas and land
• This is optimal• Thus, there is no deadweight loss
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• Suppose now that Jimmy Fallon, an ordinary private citizen, owns the property above the plant and can costlessly sue the natural gas company for the losses to his property.
• What level of u will be chosen by the natural gas company?
• How much will be paid from the gas company to Jimmy Fallon?
• The lawsuit imposes a cost on the gas company• How large?
– P(u)= 3/u
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• The gas company will solve:
–Value of lost gas = 1/u–Value of damage = 3/u
Costless enforcement of property right by land
owner
• This is optimal• Thus, there is no deadweight loss• The company pays 3/2 to Jimmy
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• No dealing • What level of u is chosen by the gas company
when no one owns the land above the pipes?• Now what is the value of lost gas? What is the
value of land damage? • The gas company will solve:
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• What if the courts are imperfect?• For every $1 in actual damage, only 50%
of the damage can be recouped in court.• So, if the true damage to Jimmy is L, the
gas company will only pay L/2
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• The gas company will solve:
–Value of lost gas = 1/u–Value of damage = 3/u
Only half of property right can be enforced by
land owner
• The social costs are now
• DWL =
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• Suppose the gas company owns the property. What level of u will be chosen? Is this efficient?
• Why does ownership make a difference here? Coase theorem says it shouldn’t make a difference
• No perfect property rights (can only be enforced for only 50% )
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• Extra exercises
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• Two power plants provide power to all of Cambridge: an MIT plant and a Harvard plant. Both power plants burn coal to produce electricity, and consequently produce smog as a by-product.
• The MIT power plant could reduce its smog by xM at a total cost of:
• The Harvard power plant could reduce its smog by xH at a total cost of:
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• The Cambridge government hires a team of environmentalists who calculate that the total benefit of smog abatement to the city of Cambridge is
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Costs:
Benefit:
What is the socially optimal level of abatement?
Social optimum
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• The Cambridge government considers imposing a tax on power production.
• What tax should it impose to reach the socially optimal abatement?
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Socially optimal level of abatement:
What tax reaches the socially optimal abatement?• What is the marginal damage?• -100 -> Set tax=100 per unit of production
Costs:
Benefit:
Taxing
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• Suppose that instead of taxation, the Cambridge government tries to regulate quantities.
• However, the city of Cambridge cannot write a law for each firm, so it simply declares that all Cambridge power plants must cut down on smog by xC= 1 units each year.
• How suboptimal is this?
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Socially optimal level of abatement:
Compare marginal costs of reduction:• M: MC=10 x 1 = 10• H: MC= 14 x 1 +10 = 24
Costs:
Benefit:
Reduce each by 1 unit
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• Suddenly, an economist is voted in as Mayor of Cambridge.
• She declares that each Cambridge power plants must cut down on smog by 5 units.
• However, she declares that firms will be able to competitively 5 trade permits that will allow them NOT to abate.
• She grants MIT 5 permits and Harvard 0 permits.
• As a result, Harvard is expected to abate by 5 units, and MIT nothing.
• Assume that MIT and Harvard act as perfectly competitive permit traders
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Socially optimal level of abatement:
Costs:
Benefit:
Reduce by 5 units in total,
trade 5 permits
2: (5 ) 5(5 )M MM Max p y y 2: 7(5 ) 10(5 )
Hy H H HH Min y y p y
Let: be the amount of permits M holds be the amount of permits H holds
M
H
yy
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2: (5 ) 5(5 )My M MM Max p y y
10(5 ) 050 10
10 50
510
M
M
M
M
p yp y
y ppy
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2: 7(5 ) 10(5 )Hy H H HH Min y y p y
14(5 ) 10 070 14 10 80 14
8014
H
H H
H
y pp y y
py
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510Mpy
8014H
py 5 M Hy y
800 10024 3
805 510 14
8010 1414 800 1024 800
33.3
p p
p p
p pp
p
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Costs:
Benefit:
Reduce by 5 units in total,
trade 5 permits
33.335 1.6710My
80 33.3314Hy
MMC 33.33
HMC 14 1.67 10 23.33 10
33.3346.67 3.33
14
Is this optimal?
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