Assignment: The Economics of Global Warming

Please see the attachment first!!! And please make sure that you could finish it!!!

Econ 2216 (2013) Assignment 3
Emissions Reduction Trajectories & Technical Change

Ruth Forsdyke

Due: Wednesday March 20th

Question 1: Dire Predictions

a) Look at the graph on pg. 99. What is the range of sea level rise predicted for the year 2100?
Noting that there is evidence of past sea level rises of 4 – 5 meters for a couple of centuries during
transition from the last ice age to the current interglacial period, Hansen considers these numbers
to be conservative. Indeed, even higher numbers are possible as the current climate shock is
unusual because GHGs are usually lag not lead variables. Discuss some recent observations (pg.
98) that are not modeled in the “state of the art” models.

b) Based on page 102, why might investment in water storage systems be a good way to adapt to
climate change?

c) What is the estimated effect of an increase in Earth’s average surface temperature of 40C
relative to preindustrial on i) coral reefs, ii) species extinctions, iii) global coastal wetlands and iv)
global food production of 30C on tropical rainforests? (pg. 109) How confident are scientists
regarding species extinction rates? (pg. 119).

d) If both the Greenland and West Antarctic Ice Sheet melted, sea levels would rise by more than
10 meters. If the sea level rises by 10 meters, how many people would have to move globally? In
Bangladesh (world population = 7 billion, Bangladesh population = 150 million). What would
happen to New York and Boston?

e) In addition to damaging impacts due to sea level rise, coastal areas will experience impacts due
to more intense storms. List some impacts due to more intense storms. What are estimates of
global warming damages in coastal areas due to a 1 meter sea level rise, a 10 meter sea level rise?
Note that as sea level rise depends on GHG concentration, which in turn depends on emissions,
estimates such as these can be made for various levels of emissions giving us the MD from sea
level rise equations. We then add the MD from all damage categories to get the aggregate MD
equation.

f) Conserving wetlands will help to slow global warming since they are excellent carbon sinks.
List some other reasons why humans need wetlands (pg. 113).

g) As global warming occurs, ecosystems are expected to slowly migrate polewards. Will this
necessarily prevent their destruction? How might humans help the ecosystems migrate and hence
adapt or partially adapt (meaning they will be less biodiverse) to climate change? (pg. 113)

h) Explain how global warming may have already have contributed to the extinction of the golden
toad and harlequin frog? (pg. 118).

i) What is happening to some rivers in the Amazon and how might this affect hydro electricity
generation rates? (pg. 123)

j) Climate change unchecked is predicted to cause the creation of hundreds of millions of
environmental refugees. How many environmental refugees are there estimated to be already? (pg.

128). In what locations are these environmental refugees being created? Why can this lead to
wars?

k) Crop and livestock yields are predicted to increase globally for moderate warming (1 – 30C)
with winners and losers. Identify some winning and losing countries. What is the global
prediction for food crop yields for warming greater than 30C? (pg. 131)

l) By how much has forest fire area extent increased in the US over the past 2 decades? (pg. 135)

m) How fast is the Arctic warming relative to the world as a whole?

Question 2: Actual Electricity GHG footprint Calculation for a Consumer

In this question, we will calculate an electricity footprint. If you have an electricity bill, you are
encouraged to use your own bill so that you can calculate your own carbon footprint.

Date kWh/day
Jan-Feb 29.6
March – April 33.05
May – June 18.1
July to August 9.05
Sept – Oct 8.45
Nov – Dec 11.15

a) Calculate:
i) average electricity usage/day
ii) yearly total
b) Assume, the person lives in Nova Scotia and gets their electricity from Nova Scotia Power, the
GHG intensity of electricity production is 0.850 kg/kWh1, find this person’s electricity GHG
emissions/yr (Ei2009) .
c) Calculate the total GHG electricity externality for this person per year under the following three
2009 marginal damage estimates.
i) $50/ tonne, $100/tonne, $200/tonne, $400/tonne.
d) How much tax would this person pay under the 4 possible carbon taxes?
e) Do you think this tax will have big effect on behaviour? You will need to consider different
income classes.
f) If the person is perfectly compensated for the income loss due to income tax reductions and
lump sum rebates of equal size made to all households, will the person still have increased
incentives to decrease their electricity bill.
g) Now assume the person lives in Quebec. Here the GHG intensity of electricity is much lower
at 0.002 kg/kWh. How much carbon tax would the Quebecer pay at a carbon price of $200/tonne.
h) Quebec has a much lower GHG intensity of electricity due to having rich hydro reserves while
Ontario’s GHG intensity is .1000 kg/kWh due to getting a large share of electricity from nuclear
power while also having hydro and growing wind power. Based on page 123, why can hydro
electricity be a risky strategy given global warming?

1 For GHG Intensity Data for Canada, please visit:
http://www.ec.gc.ca/ges-ghg/default.asp?lang=En&n=EAF0E96A-1#footnote3

Question 3: Incentives to adopt renewable energies in Nova Scotia’s Electricity Sector.
The short run MAC refers to the short run in which technology is held constant. Suppose that
Nova Scotia Power’s short term MAC for 2010 was as follows:
MACNSP(ENSP) = 875 – 90ENSP.2 {y-axis units are $/ tonne CO2e and x=axis units are megatonnes
(Mt)/y}

a) In 2010, the Government of Nova Scotia imposed emissions standards on NSP as part of its
policy package to fight climate change.3 The emissions standards are increased in stages towards
an emissions cap of 7.5 Mt/y by 2020 (the Copenhagen target deadline). Plot the MAC and the
emissions standard on a graph 1.

b) Label and calculate NSPs:

i) total abatement costs (TAC)
ii) total private costs of compliance (TCCPrivate) (all costs due to complying to

policy).
c) Now suppose that NSP adopts renewable energy (for simplicity, we will ignore the independent
renewable energy providers under the FIT program). This shifts NSP’s MAC inwards to:

MACNSP = 720 – 90ENSP
On graph 2, replot your old MAC and the new MAC. For the new MAC label and calculate
NSPs:

i) total abatement costs (TAC)
ii) total private costs of compliance (TCCPrivate) (all costs due to complying to
policy).

d) How much TCCPrivate will NSP save per year by adopting the renewable energy?
e) Suppose that other than reducing electricity output (moving along short run MAC), the only way
to abate emissions is to purchase wind turbines to replace 3000 GWh of fossil fuel generated
electricity/y. A back of the envelope estimate provides an estimate that it will cost $359 million/yr
to install the wind turbines (I have divided the total cost of $7.1 billion by the 20 year life of the
turbines to get an average number to use for the yearly comparison and have ignored discounting4).
Just focusing on the one year, will it be profitable for NSP to purchase the wind turbines in order
to shift its MAC? Explain and show work.
f) Now instead suppose that NSP is regulated by a carbon tax. What carbon tax would provide
incentives to abate to 7.5 Mt/y by 2020 under the old MAC?
g) Redraw the two MACs and draw the carbon tax on graph 3. Calculate the total tax, TAC and
TCCPrivate with and without the MAC shift. How much TCCPrivate will NSP save by adopting the
wind turbines? (be sure to notice that once the MAC shifts, NSP’s abatement incentives will
change).

2 This MAC is a very rough back of the envelope version. In 2010, NSP’s GHG emissions were 9.6 megatonnes/yr.
NSP is to reduce emissions under a staged emissions standard (cap that is not tradeable) to 7.5 Mt/yr by 2020 (the
Copenhagen target year). I used Mark Jaccard’s MAC estimate for Canada as a whole to assign a carbon price of
$200/tonne to meet the Copenhagen target and this is apparently near to that estimated by a consulting company. I
then drew a line through the BAU point and the target point and use the equation y = mx+b to get my MAC. Hence it
is rough but probably reasonable.
http://www.nspower.ca/en/home/environment/initiatives/air/default.aspx
3 The plan “Toward a Greener Future” is found here: http://climatechange.gov.ns.ca/doc/ccap
4 I assumed a price of $3.5 mill per 2MW turbine and that they get 1 MW, which may be conservative. I have ignored
other costs. That the fixed costs of installing the turbines fall in year 1 while NSP’s TCCP savings fall over a 20 year
time horizon, means that the latter are discounted such that using the average cost of installing the turbines over a 20
year time frame will lead to an underestimate of costs relative to the Net Present Value of the TCCP savings. My Econ
3350 cost benefit analysis students are working this out for their 3rd assignment.

h) Again focusing on the year 2020, will it be profitable for NSP to purchase the turbines in order
to shift the MAC?
i) Compare your answers for the emissions standard and emissions tax. Under which of the two
policies does NSP have a higher incentive to adopt the wind turbines to shift its MAC?
j) Although the tax is coming out ahead in terms of its effect on low GHG energy production
incentives, NSP is left with a crippling tax bill, which reduces its financing possibilities. As a
solution, the Government could provide lump sum subsidies to help finance the renewable energy.
Since NSP gets the money back, does this mean that it has no incentive to abate?

L9a_Aggregating MACs & MDs
(c) Ruth Forsdyke, 2013

1- Introduction

– Here, we take a brief look at how to aggregate MAC
and MD curves.

– Note that our development of the MAC so far has
assumed that the only way to reduce GHGs is to reduce
output. This only holds in the very short run due to
being unable to substitute low GHG technologies in
production.

– Abatement costs fall privately on the consumers
and producers. To aggregate MACs (for either
consumers alone, producers alone or private parties as
a whole), add subgroup MACs up horizontally (as is
the case with regular demand and supply curves).

– If we have a consumer MAC and a producer
MAC for a given set of emissions, since the
private abatement costs are shared between
consumers and producers, we must add them
together such that they are added vertically.

– Net damage reductions (D) are the net
benefits of abatement. Since these net benefits
are shared by many third parties existing in
future time periods, they are public goods.
MD curves are aggregating vertically as with
regular public goods.

2 – Aggregating

Consumer
MACs

M
A

C
L

isa

6000 M
A

C
B
art

GHGs tonnes CO2e/y

M
A

C
A

?0 0 0

PGHG
($/
tonne
CO2e)

3000

2.5

10 ?

PGHG ELisa EBart EAgg

6000

3000
0 (BAU)

ELisa

EBart

EAggEBart

Consumer
MACs

M
A
C
L
isa
5
6000 M
A
C
B
art
GHGs tonnes CO2e/y

M
A
C
A
gg

250 0 0

PGHG
($/
tonne
CO2e)
3000
0
2.5

10 12.5

PGHG ELisa EBart EAgg
6000 0 0 0
3000 2.5 10 12.5
0 (BAU) 5 20 25

ELisa
EBart
EAggEBart

6000

GHGs Gt CO2e/y

MAC
Agg Consumer

PGHG
($/
tonne
CO2e)
0

EEarth2013

To get global consumer MAC for the year
2013, add up > 7 billion MACs horizontally.

3 – Aggregating Producer
MACs

M
A

C
F

irm
1

8000 M
A

C
Firm

GHGs mega tonnes CO2e/y

20
M
A
C
A
gg
?0 0 0
PGHG
($/
tonne
CO2e)

4000

0
5
10 ?

PGHG EFirm1 EFirm2 EAgg
8000 0 0 0
4000 5 10 15
0 (BAU) 10 20 30

ENS Power

EBart

EAggETransAlta #1

Producer MACs

8000

GHGs Gt CO2e/y

MAC
Agg Producer

53
PGHG
($/
tonne
CO2e)

0
?

EEarth2013

To get global producer MAC for the year
2013, add up all the producer MACs horizontally.

4 – Aggregating MDs

8000
GHGs Gt CO2e/y

MAC
Agg

PGHG
($/tonne
CO2e)

0 EEarth

To get global MAC for the year 2013, vertically
sum the consumer MAC and producer MAC.

14000

MACCons

6000

MACProd

– These #’s are far too high as I aggregated “back of the envelope
very short term MACs” for people in early industrialized
countries with MACs in low income countries being much lower.
– These are very short term MACs in which it is assumed that the
only way to reduce emissions is to reduce output.
– With a y-intercept of 263 $/tonne, the area under the entire
MAC would equal the World GDP of ~ $ 70 trillion.
– $263/tonne would hence give a minimum y-intercept estimate if
the MAC was linear. However, the MAC is likely to be convex to
the origin and the y-intercept could be considerably higher.

Aggregating Damages:

– complicated since damages from a given year fall primarily in
future.
– add up damages from a given emission in year 2013 upon all
party’s damages in each future year while that GHG remains
in the atmosphere.
– damages from each emission are shared by many and must
hence be added up.

MDPerson 1
MDPerson 2 = 2

E2013

10 -8 $/tonne
CO2e

MDAgg = 3

GHGs Gt CO2e/y
53

– money will have different
values in the future when
damages occur and so we
need to weight with
“discount factors” (which
could be negative). This
will be discussed later.

Aggregating Damages:
MDPerson 1
MDPerson 2 = 2
E2013

$/tonne
CO2e MDAgg

= ?

GHGs Gt CO2e/y
53

TextAdd up over
many people

Not to
scale

100

5 -Summary

Damage Aggregation
– use vertical aggregation (damages shared by 3rd parties
= public bads)

MACs
– use horizontal aggregation (for consumer MACs,
producer MACs or private MACs)
– except vertically aggregate consumer and producer
component of MAC for a given set of emissions.

– Notice that abatement costs “privately fall” on
the polluters, such that abatement costs are
aggregated horizontally as with regular demand
and supply curves.

L9 Changes in GHG Emissions over time:

Past, Present and Future

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* Draft version only. All copyright permissions not attained but used under Dalhousie Copyright Agreement, hence the document is not for
widespread distribution. No copyright claim on public domain graphics or copyrighted items.

Topics List:

1.Introduction
2. Shifts of MAC
3. Shifts of the M

4. Relate Shifts of MAC and MD to hypothetical
Socially Efficient Price and Emissions
Trajectories.
5. Predictions of BAU Emissions
6. Shifts MAC MD under Future Emissions
Reduction Scenarios.
7. Summary and Conclusions

1-Introduction with recap:

Residual
Byproducts

inputs services goods

Ex. banking, hair
cuts, activist
services, CO2
removal by
trees

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ru
d
e

– crude oil, trees
for paper and
wood, includes
technologies

– transport
– trees as an
end product GHGs

Recall, we have switched our policy focus from GHG
intensive goods, services and inputs to the GHG
residual byproducts.

– it is important to note that regulations on residual byproducts (whether via carbon taxes, emissions standards, or cap and trade systems) will
raise the price of GHGs. In the case of emissions standards (which are quotas on emissions), the effect on prices is indirect due to a reduction
in the supply of GHGs which drive up their price to eliminate excess demand.
– this will increase the price of GHG intensive goods, services or inputs relative to the price of less GHG intensive varieties due to increasing the
producerʼs costs by putting a price on the GHG externalities.
– note that the term “carbon tax” refers to a tax on carbon dioxide equivalents (CO2e) such that it includes taxes on all GHGs (including
methane, nitrous oxides and F-gases).

$/ tonne
CO2e

net GHG
Emissions

gT
CO2e/year

$ MD =

= 80 – 2E

BAU

PSE= 50

In the previous two lectures, we developed the
monetary MAC MD framework from the Pigouvian
market framework.

Money Social Efficiency

Business as Usual(market)

40
$/ tonne
CO2e

= 15
net GHG
Emissions gT
CO2e/year
0
80
$ MD = 50
0

M
PS

EBAU

= 40

PSE= 50

The MAC is also the MPS of emissions with area A
being the maximum total social surplus gained from
increasing E from 0 to ESE =15 gT.

Monetary Social EfficiencyA

– Recall that the total private surplus of the 15 gigatonnes of GHG in CO2e (total consumer surplus + total producer surplus form the goods and
services which produced the GHG residual byproducts) is equal to A + B while the total external costs to the 3rd parties is equal to area B. The
difference (A) is the total social surplus of 15 gTs and this is maximized at Ese. If you have forgotten this, re-look at the MAC MD worksheet.
– MAC = net marginal abatement costs (equivalent to the marginal private surplus (MPS) of the GHGs.
– Recall that the interpretation of the MAC depends on whether we are decreasing emissions from BAU (net abatement costs), or increasing
emissions (in which we get a marginal private surplus from each emission).

40
$/ tonne
CO2e
ESE
= 15
net GHG
Emissions gT
CO2e/year
0
80
$ MD = 50
0

M
A

EBAU
= 40
PSE= 50

From the perspective of starting at BAU, D is the gain in total
social surplus gain due to abating emissions to the SE level
corresponding to the deadweight loss of the unregulated market

Monetary Social EfficiencyA

B C

Question: What do the following areas represent

i) D+ C, ii) C, iii) D

D + C = total net benefits to third parties due to abatement from 40 to 15 gt (total external costs saved)
C = net total abatement costs (TAC) to private parties (this is the total consumer + producer surplus, i.e. total private surplus that is given up
by abating.
D = Gain total social surplus = D = total external costs saved by third parties (D+C) – total abatement costs incurred by private parties
(C) = D (its the deadweight loss of the market).

40
$/ tonne
CO2e
ESE
= 15
net GHG
Emissions gT
CO2e/year
0
80
$ MD = 50
0
M
A
C

EBAU
= 40
PSE= 50

We then looked at policies to achieve money social
efficiency including emissions standards (quotas), cap and
trade and floors on carbon sinks)…

Emissions Standards
A

B C
D

– includes emissions standards and floors on natural sink areas. Recall, these are quantity mechanisms.
Question:
a) Which Canadian Province has this policy?
b) What area on graph represents the private cost of compliance?
c) How is the emissions quota enforced?
Answers:
a) Nova Scotia has an emissions standard with the focus on electricity. This is in addition to other policies including a
renewable energy quota and floors on natural areas and feed in tariffs.
b) The only compliance costs are the total abatement costs (TAC) equal to area C.
c) Firms are monitored and punished if in non-compliance. For example, if Nova Scotia Power exceeds its emissions
standard, it receives a fine of $500,000/ day by law. As long as NSP believes that the law will be enforced, it has an
incentive to comply.

40
$/ tonne
CO2e
ESE
= 15
net GHG
Emissions gT
CO2e/year
0
80
$ MD = 50
0
M
A
C

EBAU
= 40
PSE= 50

… and price mechanisms including carbon taxes,
subsidies to abate emissions and cap and trade.

Carbon tax = $50/ tonne
A

B C
D

– recall that cap and trade is both a quantity mechanism and a price mechanism.
Question: i) Find the total tax collected under the policy (also equals permit rent under cap and trade policy) ii) Find the total abatement
costs (TAC) of the private parties and iii) find the total private cost of compliance = TAC + tax paid. vi) Explain why private parties are
expected to abate to 15 gT under the tax.
Answer:
i) B is the total tax collected = 15 billion tonnes/ year * $50/tonne = $750 billion/ year
ii) C is the net total abatement costs (TAC) of the private parties from EBAU to ESE is area C (the total private surplus given up) = (40 – 15) * 50/2
= $ 625 billion.
iii) B + C = Total private costs of compliance = TAC + Total tax = $1375 billion/year.
– Private parties abate all tonnes above 15 because they will save more tax than abatement costs at the margin thereby gaining either a
producer or consumer marginal surplus. For example, for E > 15, the tax saved by abating an additional unit is $50/ unit, while it costs the height
of the blue MAC to abate the unit. Since the cost of abating the unit is less than the tax saved, the private surplus will increase by abating. This
holds until E = 15 gT per year after which, abating an additional unit will cost more than any tax saved and so it wonʼt pay to abate.

We investigated a one period framework (of
short duration, like a year) in which the MAC and
MD curves did not shift about.

In reality, the MAC & MD curves shift about over
longer periods of time and hence the monetary
socially efficient carbon prices and output
levels change over time.

40
$/ tonne
CO2e
0
80
0

MAC

2010

EBAU

We can think of the MAC as the demand for
emissions (since its equal to the marginal private
surplus of emissions). It is the maximum that the
private parties will collectively be willing to pay
(WTP) to emit an additional tonne of emissions at a
given level of Q.

Dem

and

net GHG
Emissions Gt
CO2e/year

– i.e., the private parties (consumers & producers) are collectively WTP the amount of consumer plus producer surplus they will gain from
polluting.

For example, if Q = 0, producers and consumers are jointly WTP $80/unit.
If Q = 20 Gt, producers and consumers are jointly WTP $40 to pollute an additional tonne or alternatively would be WTA compensation of $40 to
reduce emissions by one tonne.

40
$/ tonne
CO2e

ESE
Emissions

201

0
0

$ MD2010 = 50
= min WTA

0
EBAU

PSE= 50

We can think of the MD as the social supply for
emissions (since it is the minimum that the
damaged “third parties” would be willing to
accept (WTA) to be compensated for the damages.

Supply

* This will only be the supply curve if the third parties have the right to charge the polluters to pollute, as would occur under perfect regulation.
Under no regulation, polluters donʼt have to pay and so the supply is just a horizontal line at 0.
– The supply curve for emissions is expected to slope upward over the longer term as later emissions wreak more damages than earlier ones
(see later slides). Hence, over the long term (say a century), the MD curve will look like a regular supply curve.
– It is also the maximum marginal WTP of third parties for a clean environment (if they do not have the right to a clean environment).

As the MACs and MDs shift about, the socially
efficient carbon prices and net emissions levels
will change over time.

– The above graph is the output of William Nordhausʼs climate economy model. The objective of the models is to choose the emissions
trajectory to maximize the happiness of the greatest number of people over time. This occurs when MACs and MDs (measured in hypothetical
utility units, not money) are equal. The MD shifts up over time which is why the carbon price is rising over time. This will become clearer in this
and the succeeding lecture.
– The reason for two different trajectories is that Nordhaus changed parameters for different model runs. The trajectory of higher carbon prices
puts more weight on future happiness (as in Sternʼs model).

Note that prices are in $/ tonne of carbon and hence need to be adjusted to get them into CO2e.
Since carbon weighs 12 atomic mass units while CO2 weighs (12 + 2*16) = 44 amu, a given mass of carbon will have a higher price than a given
mass of carbon dioxide.
– Ex. Pcarbon = $100/ tonne
PCO2e= ( $100/ tonne ) * 12/ 44 = $27.2/ tonne.
– If we changed the y-axis into carbon prices in CO2e, we will need to divide by 3.67 (i.e. 44/12)
Source: William Nordhaus, “A Question of Balance” (pg. 88).
* Note that these are NOT Sternʼs estimates but are Nordhausʼs model run with Nordhausʼs interpretation of Sternʼs assumptions.

It will be necessary to understand factors that
cause the MD and MACs to shift in order to
understand the emissions reduction trajectories
and carbon prices recommended by economists
like Nicholas Stern and William Nordhaus.

In this lecture, we first investigate reasons for shifts
in the MAC and use the MAC MD framework to
illustrate how the money socially efficient price and
quantity of emissions is affected. Next, we repeat
the exercise for the MD framework.

– For descriptions and graphs of emissions scenarios for fossil fuels, see pg. 86 – 87 DP.

After this, we use the model MAC MD to illustrate
how the socially efficient level of GHG
emissions and carbon price is predicted to change
over time conditional on feasible shifts in MACs and
MDs.

Next, we revisit the Kaya Equation and discuss how
it relates to emissions levels and their trajectories.

We then discuss how the model predicts past shifts.

As future shifts in the MACs and MDs will depend upon
what events happen, we then investigate scientist’s
predictions of possible emissions trajectories based
upon a series of feasible emissions scenarios.

– For descriptions and graphs of emissions scenarios for fossil fuels, see pg. 86 – 87 DP.

2-Shifts of MACs

MACs and MD curves are not static. They
shift about like regular demand and supply
curves. In this section, we examine some shifts.

The shifts of the MACs and MDs will be used to
determine socially efficient carbon
emissions reduction trajectories and carbon
prices.

For simplicity, we will shift one curve at a time
starting with the MAC.

Shifts MAC:
Supply Side: Demand Side:

1) Adoption
of low GHG
technologies

2) Increased
efficiency of
GHGs (get
more value
from each
GHG)

3)Population
Change

4) Behavioural
Attitudes

2.1) Adopt Low GHG Technologies

Consider a large
electricity generating
company (Acme Co.)
which currently
generates 40
Megatonnes (Mt) of
power from coal.

– It is considering
whether to purchase
low GHG technology
such as wind turbines.

– 40 Mt is equal to 40 million tonnes (40,000,000 tonnes).
– For simplicity, we will ignore consumer surplus here and use the producer MAC, the area under which represents the producer surplus.
– We will assume that the MD of a CO2e is $50/tonne in this period (this is a bit higher than Nordhausʼs estimate for the first decade of the 21st
century but is lower than Sternʼs estimate).

$/ tonne

ESE
0

80
$ MD = 50
0

M
A
C O

EBAU

net GHG
Emissions (Mt
CO2e

/year)

A
B C
D

If Acme Co purchases the wind turbines, will the
MAC shift? Will the MD shift? If so, how?

Think about before looking at next slide.
– What will happen to the BAU level of emissions if less coal is being combusted due to the wind turbines?

$/
tonne

ESE
(old)

0
80
$ MD = 50
0
M
A

C O
ld

EBAU
(new)

The MAC shifts inward and down as there are fewer
GHGs under BAU and the value of each will be equal to
or lower than its previous value.

M
A

C
N

EBAU
(old)

ESE
(new)

net GHG
Emissions (Mt
CO2e/year)

-The BAU emissions level falls because less coal is being combusted.
– What happens to the y-intercept is not so obvious as marginal costs of wind will be a bit higher decreasing the producer surplus for each unit of
electricity. Also, the amount of GHGs per unit of electricity will be lower. Here I have assumed the y-intercept has fallen.
– Notice that the socially efficient level of emissions has fallen due to the firm getting less private surplus from each emission.

40
$/
tonne
ESE
(old)
0
80
$ MD = 50
0
M
A
C O
ld
EBAU
(new)

We can use the framework to investigate the monetary
incentives private parties have to adopt or invent low
GHG technology under policies like a carbon tax.

M
A
C
N
ew
EBAU
(old)
ESE
(new)

C
F

net GHG
Emissions (Mt
CO2e/year)

carbon tax
= $50/tonne

-We will use areas under the graph to compare the firmʼs total private cost of compliance (TCCPrivate) before it adopts the new technology with
after it adopts the new technology. This will tell us how much the firm expects to save by adopting the new technology.
– The TCCPrivate includes all costs to the firm due to the policy. Under a carbon tax, there will be two costs. These are:
1) The total abatement costs.
2) The total tax paid.
Before moving to the next slide, use the letters to identify the TCCPrivate before the MAC shifts (i.e. before the firm purchases the wind turbines
from the pollution abatement industry).
– For simplicity (albeit unrealistically, we will assume that the world only lasts for one year and then ends.

40
$/
tonne
ESE
(old)
0
80
$ MD = 50
0
M
A
C O
ld
EBAU
(new)

Old total private cost compliance
= total tax + TAC = (C + D + F) + (G + H)

EBAU
(old)
AB
C
F
D
G
H
I
carbon tax
= $50/tonne
net GHG
Emissions (Mt
CO2e/year)

– Now look back at previous slide and identify the TCCPrivate after the firm purchases the wind turbines. Check your answer on the next slide.

40
$/
tonne
0
80
$ MD = 50
0
M
A
C O
ld

New total private cost compliance
= total tax + TAC = (C) + (F + G)

AB
C
F
D
G
H
I
carbon tax
= $50/tonne
EBAU
(new)
M
A
C
N
ew
ESE
(new)
net GHG
Emissions (Mt
CO2e/year)

– We can see that the TCCPrivate fell such that the firm can save money by adopting the wind turbines. Before moving to the next slide, identify
the total savings in TCCPrivate (using letters to indicate the area).

40
$/
tonne
ESE
(old)
0
80
$ MD = 50
0
M
A
C O
ld
EBAU
(new)

Savings in total private cost of compliance by inventing
and or adopting low GHG technology is [(C + D + F) +
(G + H)]- [(C) + (F + G)] = D + H.

M
A
C
N
ew
EBAU
(old)
ESE
(new)
AB
C
F
D
G
H
I
net GHG
Emissions (Mt
CO2e/year)

– Now suppose that we have calculated the blue area of TCCPrivate savings to be area D+H and suppose this area is $700 million. Suppose the
wind turbines cost $100 million. Should the firm purchase the wind turbines. Answer: Yes because the savings in TCCPrivate is less than the cost
of the wind turbines.

– For simplicity, we assumed that the world only lasted for one year. In reality, the wind turbines have a life time of about 20 years. Hence, there
would be a benefit of D+H for 20 years with a cost of adopting the wind turbines in year 1 and some maintenance and operating costs in the
subsequent years. When costs are measured in money and fall in different time periods, they need to be adjusted via a process called
“discounting”. This takes into account inflation and the opportunity cost of tying up money in the turbines when it could have been invested
elsewhere. We will be considering this in subsequent lectures. Hence, wind turbines would be worthwhile even if their costs were considerably
higher than D+H.

– Later, we will show that the incentive to adopt the turbines is higher under a carbon tax than an emissions standard and identical to that of a
cap and trade system. The standard does however leave the firm with more money to finance the wind turbine purchase unless the government
returns some tax as a lump sum payment or reduces corporate taxes.

As low GHG energy alternatives are adopted, their costs
are expected to fall due to factors such as scale
economies, increased competition, and learning by doing.

Cumulative Installation

N
ew

T
echnology

marg.
cost
per

kWh
Established
Technology

“ Historical experience of both fossil-fuel and low-carbon technologies shows that as scale increases, costs tend to fall.
Economists have fitted ‘learning curves’ to costs data to estimate the size of this effect. An illustrative curve is shown above for
a new electricity-generation technology; the technology is initially much more expensive than the established alternative, but as its
scale increases, the costs fall, and beyond Point A it becomes cheaper. Work by the International Energy Agency and others
shows that such relationships hold for a range of different energy technologies.
A number of factors explain this, including the effects of learning and economies of scale. But the relationship is more complex
than the figure suggests. Step-change improvements in a technology might accelerate progress, while constraints such as the
availability of land or materials could result in increasing marginal costs.” Stern Review Summary for Policy Makers, pg. xx.
– The figure is adapted from figure 5, on pg. xx.
Link here: http://webarchive.nationalarchives.gov.uk/+/http://www.hm-treasury.gov.uk/media/4/3/Executive_Summary

As renewables are intermittent, there is a
problem of storage. Problem with renewables at 30%
of grid. Demand batteries rises ==> price up ==>
profits to inventing better batteries up ==> Supply
batteries up ==> Price batteries down when firms
invent better batteries and enter market.

$/
battery

D1 S1 S2

Q1 Q2

1
2

1- Start out in the fossil fuel energy world
2- Add renewables as is occurring in Nova Scotia to about 30% of electricity grid. Demand for batteries shifts up and out creating excess
demand for batteries. The price of batteries rises. Firmʼs profits go up. Firms now have incentives to invent better batteries.
3. New firms enter the battery market with their new inventions and the supply of batteries rises (supply curve moves from S1 to S2). There is
now excess supply and the price falls.
=========
Batteries not limited to chemical but also include other types like water gravity batteries which work as follows. When it is windy, water is
pumped uphill into a reservoir. When the wind stops blowing, water is let out of the reservoir and allowed to flow over hydro turbines to generate
electricity! Water batteries are in action in Wales and in the Fiordʼs or Norway. Other types of batteries include hydrogen batteries in which
electricity is used to split water to make hydrogen which is stored. The hydrogen is then used to power a fuel cell. Unfortunately, the technology
is expensive. Also see high density direct current supergrids which pool electricity from many sources helping to reduce the intermittency of
the renewable energy.
– Ex. underwater air compression balloon battery http://www.treehugger.com/renewable-energy/how-to-store-wind-power-pump-it-into-a-big

–

underwater-balloon.html

$/
spun wool

D2
D1 S1 S2

Q1 Q2
1
2
Q3
3

A similar thing happened in the 18th century with the
flying shuttle which sped up weaving so there was an
excess demand for spun wool leading to the spinoff
technology, the spinning jenny which sped up
spinning.

1. prior to invention of flying shuttle, demand at D1.
2. Early C18 ==> flying shuttle invented by John Kay a watchmaker increases rate of weaving wool into cloth. demand for spun wool shifts up to
D2==> price spun wool up ==> profitable to spin wool providing incentives to invent wool spinning machines.
3. Later in the century, James Hargreaves invents the spinning Jenny which increases the rate of spinning wool. The supply of spun wool rises
(shift of supply from S1 to S2) and the price falls.

Flying shuttle photo: http://en.wikipedia.org/wiki/Flying_shuttle
Spinning Jenny: http://en.wikipedia.org/wiki/Spinning_jenny

– The adoption of low GHG technologies (ex. solar,
geothermal, tidal, wind and nuclear) is needed both to slow and
halt global warming. As low GHG energy sources are
increasingly adopted, spinoffs like better batteries are predicted
to develop and costs to fall.

– As such, policies which merely aim to use fossil fuels
more efficiently are insufficient and such a focus risks
getting us stuck into a nasty trap in the future where it becomes
expensive to move to carbon neutrality because we did not get
started early enough.

– Policies like renewable energy quotas (as in Nova Scotia)
help us to develop carbon neutral technologies today
putting us on a trajectory towards a carbon neutral future.
Nuclear energy may help us transition although it too is a finite
resource and must be carefully regulated.

– carbon neutrality refers to a situation in which human net GHG emissions are 0, our ultimate goal.
– Note that even if we did not have a global warming problem, as fossil fuels are a finite resource, we would
eventually run out and would hence need to develop alternative energy sources. Also, fossil fuels have other valuable
uses such as plastics and we are currently squandering a great deal on many unnecessary items like the plastic
laundry scoops discussed earlier as a no brainer example of a product which could be banned with no cost benefit
analysis required.
– There is estimated to be about 900 years of coal left if we were to combust it at the current rate. Doing so would be
foolish and dangerous unless the CO2 can be captured (unproven on large scale).

Note: In 2011, the UN IPCC released a Special Report on Renewable Energies available here:
http://srren.ipcc-wg3.de/

2.2) More Efficient Use of Fossil Fuels

Stanley Jevons
(1835-1882)

– Here, following on from the last slide, we will investigate why, although on their own improvements of energy efficiency are a good thing,
exclusive dependence on energy efficiency in the short run can get us stuck in a situation in which it is efficient to increase GHG emissions.
– The main message is that we need to be using policies to provide incentives to adopt alternative energy sources to the fossil fuels even if they
are expensive in the short run. For example, the feed in tariff for some classes of solar energy in Ontario is about 80 cents per kWh, far more
expensive than wind or hydro. However, it is reasonable for the government to encourage this technology in hopes that this will lead to
innovations which greatly reduce the cost of solar.

– make steam engines more efficient.
– cogeneration plant with heat from gas or coal turbines
being used to power a second turbine (ex. Tuft’s Cove plant).
– heat from turbines can also be used to heat buildings.
– insulate buildings.
– more efficient public transit (higher use means used closer to
capacity with fewer GHGs per passenger mile).
– increased fuel efficiency in transport vehicles.
– sustainable forestry.
– not putting bananas and other fruit in bags–they already have
skins!
– looking after goods, building them to last and repairing them
when broken.

– One of the cheapest and important ways to reduce
emissions is to use fossil fuels more efficiently so that
we get more private surplus from each emission. Examples
include:

Footnote: (this is a digression)
– Currently, we tolerate planned obsolescence (goods which are purposefully designed to break) so people will buy more goods. How
remarkably inefficient!!! For example, phones break within a year or so whereas my parents have phones they purchased in the 1970s which
they still use!
– Perceived obsolescence is similar but firms market goods as being out of style before they wear out so people replace them. Ugghh– my
shoes have flat toes,help I must go buy some pointy ones!
– Why do we tolerate this? Likely because it creates jobs which distributes income which means people demand goods which creates jobs and
so on (the consumption multiplier). Remarkably, given the industrial technology, we could all work less–however, then how would we pay the
people who are not working or how would we agree to share the work? Is capitalism failing? When machines are cheaper than labour, there will
be no market, capitalism would fail. Karl Marx predicted this–is this happening? Fascinated by this question which I was introduced to in a book
called “21st Century Capitalism” by Robert Heilbroner, in the mid 1990s, I decided to return to school to study economics. Interestingly, this
question was not addressed in a single class that I took.

40
$/ tonne
ESE
0
80
$ MD = 50
0

MAC Old

EBAU
net GHG
Emissions gT
CO2e/year

If Acme Co purchases invests in increased
efficiency of its coal or gas fired generators, will the
MAC shift? Will the MD shift? If so, how?

Think about this before moving on to the next slide.

Hints:
1) What will happen to BAU emissions if you get more energy from each GHG produced?
2) If each GHG produces more energy, what has happened to the private surplus derived from each GHG residual byproduct?

$/tonne

0
80

The increase in efficiency in
use of GHGs shifts the
EBAU left (you need less
emissions to make as much as
before) but each emission
provides more private
surplus (twists up).

0
M
A
C
N

e
w

MAC Old
EBAU

160

EBAU
net GHG
Emissions gT
CO2e/year

Note: The MD will not shift because the relationship between damages and emissions has not changed. We just move along the MD in
response to emissions levels that year. However, energy efficiency affects the cumulative emissions and so can change the rate at which the
MD shifts in later periods (to be explained under MD shifts).

– Here imagine you get two times as much surplus from each GHG. This means that to generate a given amount of private surplus, you produce
half as many emissions (here 20 gT). However, each emission now gives twice as much money value as before so the MAC curve is twice as
high. So, the MAC twists inward and upward.
– I have oversimplified a bit–for example, the more energy efficient turbines may have a higher marginal private cost which should reduce the
private surplus of emissions offsetting the above effect somewhat.

40
$/tonne
ESE
0
80

$ MD = E

Case 1: If the MD is low, the SE level of
emissions falls.

0
M
A
C
N
e
w
MAC Old
EBAU
160
ESE
net GHG
Emissions gT
CO2e/year

– For example, if you have a more fuel efficient car and you now need to use half as much gasoline and are travelling a similar distance as
before, you will use less gasoline and therefore create fewer emissions for each unit of consumer surplus generated.

40
$/tonne
ESE
0

80
$ MD

0
M
A
C
N
e
w
MAC Old
EBAU

160
ESE

Case 2: If the MD is high, the SE level of
emissions rises. This appears to be a paradox!

net GHG
Emissions gT
CO2e/year

– The Key thing to note here is that that the SE emissions level are in the region of the x-axis for which the new MAC (with the increased
efficiency) gives a higher marginal private surplus than the old MAC. This means that we get more value from each emission! This is the
Jevonʼs paradox.

Stanley Jevons: 1835 – 18

Jevons’
Paradox

– The above paradox was to my knowledge first investigated by Stanley
Jevons, an economist whose lifetime over-lapped with a massive
increase in the use of coal to provide energy.

Source Stanley Jevons Picture and interesting profile of available
at
http://homepage.newschool.edu/~het/profiles/jevons.htm

Imagine it is the 19th Century
England… the age of coal is in full swing.
People are worried that coal will run out.

– Through out the Late Middle Ages, as England became deforested coal was increasingly used to heat homes although considered inferior to
trees (source Adam Smith–1776,WON Book 1).
– By the beginning of the 18th century, coal-fired steam engines were being used to pump coal out of mines.
– By the end of the 18th century, the steam engine was light enough to be used for transport enabling it to be used to power trains and steam
boats. This greatly increased the size of markets enabling economies of scale, importantly due to specialization as discussed by Adam Smith.
– Engineers worked (including James Watt) worked on improving the steam engine such that by the second half of the 19th century, it replaced
the water wheel as the mechanical force in factories. Innovations in making steel (the Bessemer converter) enabled machines to withstand the
powerful force of the coal driven steam engine. The Second or Late Industrial Revolution was now in full swing.

The question of the day is: Will making the
steam engine more efficient help to conserve coal ?

Source Steam Engine Picture: http://en.wikipedia.org/wiki/
Steam_engine (this is animated at the website)

Some people argued that more efficient steam
engines will help to conserve coal so it
won’t run out as fast.

To contrast, Jevons argued that the coal may
run out even faster due to more efficient steam
engines.

Why? The price of energy will fall and this will
increase its demand making coal run out even
faster.

Innovations
in steam
engine

less coal
inputs
needed to
make each
good

demand
coal

–

– Price of goods
using
coal
input

Demand
Goods

+
+

Jevon’s
Paradox Case + > –

– This systems diagram illustrates Jevonʼs argument..
– Jevons mathematically illustrated the possibility using the general equilibrium economics models (these include multiple goods and contain
models of consumers who choose goods to maximize their happiness (utility) given their budgets and firms which choose output levels given
prices of the goods they sell and the costs of factor inputs like labour and capital. Our models, to contrast, are called “partial equilibrium” only
containing one good.

Corporate Average Fuel Efficiency Standards
Cars:
1978 = 13.1 Litres per 100 km
1986 = 9 Litres per 100 km
2011 = 7.8 Litres/100km

Light Trucks:
1979 = 13.8 L/ 100 km
1990 = 11.8 L/ 100 km
2010 = 10 L/100 km

2020 target (all vehicles on road) = 6.72
L/100 km.

– One way to reduce GHG and other emissions (like SO2) from transport are fuel efficiency standards, an example of a “performance
standard”.
– Canadaʼs standards are called CAFC and just follow the US policy since automobile production is completely integrated.

Cars
become
more fuel
efficient

less
gasoline
needed to
drive a mile

demand
gasoline

–

–
Price
driving a
km

Demand
for
driving

+
+
+

Jevon’s Paradox
Case + > –

– Fuel efficiency standards insufficient/ gasoline taxes
also needed

– In the case of cars, it is easy to appreciate Jevonʼs paradox. If you have a more fuel efficient car, it now costs less to drive a mile, i.e. the
price of driving a mile falls. When the price of goods and services fall, demand often goes up. It is possible that the increased demand for
driving offsets the fact that you need less gasoline to drive a mile resulting in an increase in the demand for gasoline.
– note that this has effects on the urban structure because it becomes relatively cheap to live in the suburbs in comparison to the downtown
core. Many North American cities are spread out with urban sprawl.

http://en.wikipedia.org/wiki/Gas_pump#Nozzles

Corporate Average Fuel Efficiency
Standards = Policy Failure

– different standards on cars vs “light trucks” (to
help business)
– Auto companies respond by marketing the SUV
and Minivan such that gasoline use rises in US
and Canada

– today, due to environmental concerns and the high price of gasoline, SUVs have become less fashionable…indeed after the prices rose in the
summer of 2008, the price of a second hand SUV dropped massively–people wanted to get rid of them but there were no buyers.
– interestingly, SUV sized cars are being marketed today (see the right picture). This may be a sort of greenwash as the car seems greener than
the SUV. Cars marketed as hatchbacks are also much bigger than 1980s and 1990s versions. They are however, more energy efficient.

Chicken Tariff
– In the 1960s, Europe banned US frozen chickens
– US responded with tariff on light trucks
– US light truck industry protected relative to US
car industry also encourages US Auto to market
and advertise SUVs.

– Volkswagon minivans have long been popular.
– Although some people have jeeps in the 1980s, use is not widespread. SUVs and minivans became popular in the 1990s due to massive
advertising including product placements in TV shows. Environmentalists were astounded–cars got bigger even though scientists were
warning that greenhouse gases needed to be reduced rapidly.
– Source: Linda McQuaig “ Its the Crude Dude: War, Big Oil, and the Fight for the Planet.” This book gives a history of the oil industry-
highly recommended.
http://www.amazon.ca/Its-Crude-Dude-Fight-Planet/dp/0385660103

Canada’s GHG Emissions

– GHG intensity targets have been the main
policies in the USA and Canada–They don’t work!

Can. Kyoto Target = 556

a) b) c)

Can.
Copenhagen
Target = 607

– Canada and US Policies have emphasized increasing energy efficiency with GHG intensity targets meaning that the objective is to make each
unit of GDP with fewer GHGS such that the GHG intensity of the GDP falls. While this is fine as a goal, as the Jevonʼs paradox shows, there is
no guarantee that we hit our targets; Firm GHG targets are needed–GHG intensity targets are not enough.
– Notice that our national Copenhagen target is laxer than the Kyoto Target.
– green dashed line is the Kyoto target date for which commitments need to be met.
a) George W. Bush Junior (US President 2000 – 2008, Texas Oil Man, son of George Bush Senior, US President and oil company owner).
b) Dick Cheney (US Vice President 2000 to 2008). Was CEO of Halliburton Corp., an oil services firm before becoming VP.
c) Stephen Harper (Current Canadian Prime Minister). Photo Sources: wikipedia
Note: Although it looks like we are making progress, and this is happening in some provinces, the downturn in GHG emissions in 2009 is due to
the collapse of the US economy with the USA being Canadaʼs biggest trading partner. Tar (oil) sands expansion will make it very difficult to
make our Copenhagen target. Meanwhile, countries are being urged to set tighter targets or the 2015 Doha target date.
Regulatory Capture: refers to a situation in which corporations use techniques like election finance to prevent themselves from being regulated.

More real
GDP per
GHG

less GHGs

demand
GHGs

–

–
Shadow
price
GHG
falls

Consume
more stuff

+
+
+
Jevon’s Paradox
Case + > –

– Greenhouse Gas intensity standards are insufficient
to solve our problem–tight caps are also needed.

GDP

– note that this result holds in a regulated market.

$ MCPrivate

$ MBPrivate

$/kWh

What happens to $SE price when half as
much GHGs are used/ kWh of electricity?

$ MCExternal(old)

$ MCSocial

PSE(old)

QSE Quantity
Electricity

To understand Jevonʼs Paradox consider the underlying Pigou framework for electricity. How will an increase in energy efficiency affect this
framework?

$ MCPrivate
$ MBPrivate
$ MCExternal(old)
$ MCSocial
PSE(old)

QSE

$ MCExternal(new)

As there are half as many GHGs per kWh, the marginal
external cost is half as much and hence shifts downward
by 1/2.

$/kWh

Quantity
Electricity

(kWh)

What happens to the marginal social cost curve, $SE price and quantities of electricity?

Note: MCPrivate may rise if the low GHG technology is privately more expensive. This is ignored for graphical simplicity.

$ MCPrivate
$ MBPrivate

The Social supply curve (MCSocial) shifts down due to teh
smaller externality and the $SE price falls & quantity
rises.

$ MCExternal(old)

$
M

C
So

ci
al (o

ld
)

PSE(old)
QSE
$ MCExternal(new)
$
M
C
So

ci
al (n

ew
)

$/kWh
Quantity
Electricity

(kWh)

$ MCPrivate
$ MBPrivate
$ MCExternal(old)
$
M
C
So
ci
al (o
ld
)

PSE

QSE
$ MCExternal(new)
$
M
C
So
ci
al (n
ew
)

The Social supply curve (MCSocial) shifts down due to the
smaller externality and the $SE price falls & quantity
rises.

$/kWh
Quantity
Electricity
(kWh)

– It is now efficient to produce more electricity. This in itself creates more GHGs however, there are now half as many GHGs per unit of
electricity working in the opposite direction.
– We can see, however, that if the first effect dominates, the quantity of GHGs would increase for an increase in energy efficiency and this is our
Jevonʼs paradox.

– We can see here that although increasing energy
efficiency and more generally the efficiency of use of
GHGs is an important part of the solution, efficiency
cannot be relied on as our sole policy. This is because it
does not guarantee hitting the cap on GHGs and there
are limits to efficiency.

– Energy efficiency only takes us part of our way
to our target and there is a risk that we get trapped in
a situation in which we focus on energy efficiency at the
exclusion of developing carbon neutral
technologies making it very expensive to switch out
of GHGs which will ultimately be required to move to
carbon neutrality. Jevon’s paradox provides us
with a warning.

Chapter 17 of Stern Review provides some examples of achievements in energy efficiency (see box 17.2)
http://webarchive.nationalarchives.gov.uk/+/http://www.hm-treasury.gov.uk/media/0/F/Chapter_17_Beyond_Carbon_Markets_and_Technology

“ China first introduced appliance standards in 1989 and expanded their application rapidly during the 1990’s to include,
for example: refrigerators, fluorescent ballasts and lamps, and room air-conditioners. By 2010, energy savings are
estimated to reach 33.5 TWh, or about 9% of China’s residential electricity. This is equivalent to a CO2 emission
reduction of 11.3Mt C02. A more recent study highlighted the potential for significant energy savings in the longer term
from more stringent performance standards on three major residential end uses: household refrigeration, air-
conditioning, and water heating.” (from box 17.2)
* Stern notes that design standards (although inflexible) can help to create scale economies for new technologies.
He also discusses the importance of design and land-use planning regulations to facilitate “a less energy intensive
society, while balancing a range of wider economic and social objectives.

2012

1988

2-iii) MAC shifts due to Population Change

Recall that GHGs = population * GHGs per capita.

40
$/ tonne
ESE
0
80
$ MD = 50
0
M
A
C O
ld
EBAU
net GHG
Emissions gT
CO2e/year
A

B
C

Lets suppose the world population increases from 7
billion to 9 billion people by 2050 (28.6%). How do
you think the MAC and or MD will shift?

My BAU emissions levels are not
realistic here. 40 Gt is the 2000 level
and we are already at 53 gT/year.

– For simplicity, we will hold everything else equal (“ceteris paribus”) which is not very realistic and just assume that 28.6% more emissions
are produced under BAU with the Oth emission for the new population giving a marginal private surplus of $80/ tonne and the last giving a
marginal value of $30 per tonne. Another way to put this is that on average, we assumed each consumer and producer gets the same private
surplus from emissions today as in 2050.
Question: Explain why the ceteris paribus assumption may be very unrealistic here.
Answer: One answer is limits to growth (land is getting used up and oil and food will be more expensive).
Another reason is that the private surplus of emissions need not be shared equally.
Changes in behavioural attitudes towards post materialistic attitudes (see next section) may occur so each person would emit fewer GHGs
helping to offset the effect of the population growth.
– Also note that with a higher population, at any given point in the future, cumulative emissions should be higher such that marginal damages
would be expected to be higher. We will just focus on the MAC shift here.

$/ tonne

ESE
(2012)

= 18

0
80
$ MD = 50
0

MAC

2050

EBAU
(2012)

=40

net GHG
Emissions
gT CO2e/
year

All else equal, BAU emissions rise and
socially efficient emissions rise.

M
A

C 2012

EBAU
(2050)

= 51.4

ESE
(2050)

= 19.2

– For simplicity, we will hold everything else equal which is not very realistic and just assume that 30% more emissions are produced under BAU
with the Oth emission for the new population giving a marginal private surplus of $80/ tonne and the last giving a marginal value of $30 per
tonne.
Question (Extra for interested students): What is the new MAC?
Answer:
y-intercept = $80/tonne.
slope = b = rise / run = – (80 $/tonne)/51.4 billion tonnes per year.= – 1.56
MAC (E2050) = 80 – 1.56 E2050
Find the SE emissions level in 2050 assuming no shift of MD.
Set MAC (E2050) = MD
80 – 1.56 E2050 = 50
E2050 = 19.2 gT/ year (increase)

2-iv) MAC shifts due to changes in
behavioural attitudes.

– see ch. 13 of Sternʼs review.

In the 20th century, the Early Industrialized countries
have enjoyed material standards of living far in excess of
any prior period.

D
em

and

Sup
ply

– Madonna sings a song called “material girl” source wikipedia
– Ferris Buellerʼs Day Off (1986). Funny part with a “very boring economics teacher”.

Signs that the environment was being harmed caused
increase in post materialistic attitudes

– Post materialistic attitudes refers to concerns about the environment such that people attempt to decrease their impacts by reducing the
quantity of environmentally damaging consumption goods and the nature of the goods consumed. For example, environmentalists use public
transit, bring cloth bags to stores and refill their containers making efforts to buy less packaged goods and reduce meat consumption.
– Although environmentalism dates back much earlier than the 1960s (ex. Romantic movements of the 19th century), the modern environmental
movement is often dated with the publication of Rachel Carsonʼs 1962 book, Silent Spring, a study of pesticides. The book opens with a
hypothetical description of a spring in which a dust of pesticides has killed all birds such that there is no song–the spring is silent. Her work
roused the public attentions leading to environmental acts like bans on pesticides like DDT which weakens bird eggs among other things such as
the passing of clean air and water acts. Unfortunately, widespread use of pesticides still harms nature and also human health.

Look a mother
nature on the run

in the 1970s

Can you tell a
green field from a

cold steel rail

The powerlines
have floaters so the
airplanes won’t get

snagged.

Musicians and writers helped to spread the
message of post materialism.

Hey farmer farmer, put away
your DDT. I don’t care about

the spots on my apples, leave me
the birds and the bees–please

Exercise: Think of environmental lyrics in more recent songs.
– Neil Young: http://en.wikipedia.org/wiki/Neil_young
– Joni Mitchell: http://en.wikipedia.org/wiki/File:Joni_mitchell_1974
– Michael Stipe: (R.E.M.): http://en.wikipedia.org/wiki/Michael_Stipe
– Roger Waters: http://en.wikipedia.org/wiki/File:Roger_waters_leeds_1970
– Three waves of peak environmental awareness.
1962 to 1970s (Hippie movement)
1992 to end of 1990s (after Rio Earth Summit)
2007 (Goreʼs Movie “An Inconvenient Truth” with increasing evidence of changes in the weather easily observable throughout the world making
people more concerned.)
– The 1980s was a low point.

– Some Grossbeaks near Lockport Nova Scotia.

– Ad Busters is an NGO which tries to make people aware of the effects of advertising.
http://www.adbusters.org/

http://jonathanlevinegallery.com/?method=Blog.PressReleasesDetail&entryID=F00AA5CC-BE7A-F688-F83E1E594F2C4A36

Culture Jammers modify ads like this one to send
the opposite message…Started by Calle Lasn who
founded Adbusters.

Kalle Lasn used to work in advertising and realized that it made use of psychological manipulation techniques to sell people often
unnecessary goods and services which were harming the environment. He founded Adbusters to draw awareness to impacts and dangers of
advertizing. “ In his first book Culture Jam, he argues that consumerism is the fundamental evil of the modern era. He calls for a “meme
war”: a battle of ideas to shift Western society away from consumer capitalism. His second book, Design Anarchy, calls on graphic
designers, illustrators and others to turn from working in service to corporate and political pollution of both the planet and “the mental
environment”, and embrace a radical new aesthetic devoted to social and environmental responsibility.[citation needed] His third book,
Occupy Econ 101 (Seven Stories Press, Fall 2012), will include contributions from Nobel Prize winner Joseph Stiglitz, Paul Samuelson,
George Akerlof, Lourdes Benería, Julie Matthaei, Manfred Max-Neef, David Orrell, Paul Gilding, Mathis Wackernagel and the father of
ecological economics Herman Daly, among others.[2]” (Wikipedia entry on Kalle Lasn”) http://en.wikipedia.org/wiki/Kalle_Lasn
Source: http://en.wikipedia.org/wiki/Culture_jamming

$/ tonne

ESE
(2008)

= 18
0
80
$ MD = 50
0
MAC 2050

EBAU
(2008)

=40

net GHG
Emissions
Tonnes
CO2e/
year

M
A
C 2012

Suppose Material Girl’s MAC is as follows where x-axis
is in tonnes per year. She then goes to see the movie…

– note that correctly, the total private surplus of Madonna will include her consumer private surplus and her producer surplus (like plane trips to
concerts). Lets just pretend that the area under her MAC is her total consumer surplus under BAU. Note her BAU emissions is in tonnes (not
Megatonnes as with our electricity plant or Gigatonnes as with our planetary MACs).
– recall that the average Canadian has a BAU footprint of 20 tonnes per capita based on production emissions divided by the population. The
number will be somewhat different than this due to imports and exports. Also, foreigners own some of our production such that this producer
surplus should be counted as foreign footprints and vice versa when Canadians own foreign assets.

and…

– Watch the trailer here:

– The picture book is on reserve in the library (a great read and fast way to get
overview of the science and economics).
– Rent the full firm — fastest way to get an overview of this course.

See trailer here:
http://www.youtube.com/watch?v=AB7VF980cEA

$/
tonne
ESE
(2012)

= 1.9

0
80
$ MD = 50
0
MAC 2050
EBAU
(2008)
=40
net GHG
Emissions
Tonnes
CO2e/
year
M
A
C 2012

She realizes she is a big part of the problem and makes
lifestyle changes. She experiences a private surplus loss from
emissions due to feelings of guilt shame and a warm glow
from helping others.

EBAU
(2008)

– note that the MAC may also shift down if she experiences guilt costs and warm glow benefits for each and every emission.
Question: What is the new MAC?
Answer:
MAC (E2012) = 80 – 16E
Find the SE emissions level in 2012 assuming no shift of MD.
Set MAC (E2012) = MD
80 – 16 E2012 = 50
E2012 = 1.87 Tonnes CO2e/ year (increase)

People derive utility from status goods like top
hats, large homes, fancy cars and the latest fashions.

These conspicuous consumption items
(positional goods) serve to provide people with
social status. These goods often have large
footprints and could be substituted for low GHG
versions.

Ads target people by making them feel inferior if
they don’t have these goods.

For example, a small eco friendly home could serve
as a display of wealth. Income caps also put
limits on the conspicuous consumption arms races
enabling people to rank themselves without the
footprints. This is an abatement “win win” as
discussed by Stern.

– This is the “keep up with the Joneʼs phenomena”. When Jones buys a bigger house, his neighbours feel inferior and now they work harder
at their jobs to earn more money to buy a bigger house too. Everyone may end out far worse off than had they agreed to work less and live in
smaller houses. They are money rich but time poor and are caught up in the rat race! http://shootingthestars.files.wordpress.com/2011/04/rat-
race-wheel.gif This is an example of a prisonerʼs dilemma.
– Jones imposes a negative externality on the other households when he buys the bigger house. This is called a “user externality”. Much of
the decisions going on here are subconscious driven by our fast emotional brains such that we are unaware of the psychological motivations.
Studying psychology can help us to understand ourselves such that we do not get caught up in positional goods arms races.

Summary of MAC Shifts:
In the above section, we discussed reasons for MAC shifts
including supply side shifts due to inventing and adopting low
GHG technologies and increases in energy efficiency. The
importance of adopting low GHG technologies now to get
us on an efficient long run path, thereby avoiding Jevon’s
paradox was emphasized.

The MAC may shift due to demand side factors including
population growth (shift out) and a change in materialist
attitudes (shift in).

The affect on advertising and its promotion of materialistic
attitudes by psychological methods was discussed as were
the problem of status arms races in positional goods.

3 – Shifts of MD

“ The scientific evidence
points to increasing risks of
serious, irreversible impacts
from climate change
associated with business-as-
usual (BAU) paths for
emissions”.

Stern Review, Executive Summary pg. iii

http://www.hm-treasury.gov.uk/d/Executive_Summary

“ Even if the annual flow of emissions did not increase
beyond today’s rate, the stock of greenhouse gases in
the atmosphere would reach double

pre-industrial

levels by 2050 – that is 550ppm CO2e – and would
continue growing thereafter. But the annual flow of
emissions is accelerating, as fast-growing economies
invest in high- carbon infrastructure and as demand for
energy and transport increases around the world. The
level of 550ppm CO2e could be reached as early as
2035. At this level there is at least a 77% chance – and
perhaps up to a 99% chance, depending on the climate
model used – of a global average temperature rise
exceeding 2°C”. (Stern, Executive Summary)

If, the CO2 concentration reaches, 675 ppm, there
would be a 50% chance of exceeding 4 0 C. Is it
possible that it could get this hot by 2099?

– Figure 2 from Stern Executive summary.
– Image of Artistʼs Depictions of the Predictions of Climate Change Models.
Source: Vince, Gaia (Feb. 25th, 2009) How to Survive the Coming Century, “The New Scientist”, Issue 2697.
http://www.newscientist.com/article/mg20126971.700-how-to-survive-the-coming-century.html

Alas the answer is yes, under the A1F1 SRES scenario, of rapid
fossil fuel intensive energy growth, population peaking by mid
century, global income convergence and high rates of
technological innovation with improved efficiency, the average
estimate for average global surface warming is 4 0 C.

40C

The Stern Review, Executive Summary, Pg. v http://www.hm-treasury.gov.uk/d/Executive_Summary

Wind SolarGeothermal

Land lost (sea
level rise)
(assumes 2
m)

Potential for
Reforestation

Food Growing
Zones/
compact high
rise cities

Uninhabitable
due to
floods,
drought, or
extreme
weather

Uninhabitable
dessert

– Note: This is an artistʼs depiction based on scientific studies and its from a popular science journal, not a peer reviewed science journal.
Nevertheless, it allows us to think about possibilities.
– There is uncertainty. For example, although basic climate change models predict that the Southern USA will become increasingly dryer,
effects of climate change on El Ninos can work the other way. Also, some models predict a possible greening of the Sahel region due to
complicated weather patterns..
– The map also indicates possible future siting of renewable energies with large solar farms covering the equatorial desserts and large offshore
wind farms and geothermal in Mexico, Central Asia, Europe, East Africa, the Middle East and Australia.
– I find the use of brown to illustrate the areas that are “uninhabitable due to floods, drought or extreme weather” misleading because yellow was
used for desserts, so brown suggests it is really dry while some of these areas are expected to experience heavy flooding (which is the opposite
of dry).

Source: Vince, Gaia (Feb. 25th, 2009) How to Survive the
Coming Century, “The New Scientist”, Issue 2697. http://
www.newscientist.com/article/mg20126971.700-how-to-
survive-the-coming-century.html

76Source: Nordhaus, W. 2005

Models Estimate Higher Carbon Prices as time progresses.
Scientists predict the marginal damages will rise over time.

– Note that the marginal damage at each point in time is equal to the carbon price.
– Note these carbon prices are in $ per tonne carbon –to get into prices in carbon dioxide equivalents, we
divide by 44/12.

MD and Carbon Price Shifting Upwards Over Time
based on Nordhaus model run with Stern Assumptions

$/tonne
C

650

MD(2015)

GHG emissions
(gigatonnes CO2-

eq per year)

0
0

MD(2055)

MD(2095)950

100

These marginal damages are taken from the previous graph using the
Stern numbers. The basic idea is that the damages of each additional
emission added within a one year period are similar although increasing
very gradually (unless some tipping point were to be reached within that
year).
– Hence, marginal damages within a given year are depicted as
horizontal lines. Over the century, they are however increasing as the
GHGs build up. This corresponds to upward shifts in the MDs over time
causing $SE carbon prices to rise.

MD and Carbon Price Shifting Upwards Over Time
based on Nordhaus model run with Stern Assumptions
$/tonne
C
650
MD(2015)

GHG emissions
(gigatonnes CO2-
eq per century)

0
0
MD(2055)

MD(2095)
950

100

5000

– The long run MAC is upward sloping as shown above. Notice the x-
axis is now in units of GHGs per centuries. The short run MACs are still
the horizontal straight lines, imagine the old x-axis for these lines.

Why would marginal damages, that is
the damages to the third parties from
each additional tonne of carbon dioxide
equivalents to the atmosphere, be
rising over time?

* this means that total damages plotted against cumulative emissions over the
century are increasing exponentially. (for math students, note MD is derivative of
total damage curve with respect to emissions).

Concentration
GHGs in
atmosphere

Surface
Temp

Size of
Impacts

Time

$ Damages
per additional
GHG = MD

+
+
+
+

Cumulative
Emissions +

Econo
mists

scientists

– the first basic reason that the marginal damages are increasing in
emissions is because emissions accumulate in the atmosphere. As
they build up, they cause bigger temperature changes and bigger
impacts to climate and bigger impacts to the human systems.
Cumulative pollutants tend to have flat short term marginal damage
curves and upward sloping long run marginal damage curves. This
contrasts with non-accumulative pollutants like SO2 and NOx, which
have upwards sloping MDs in the short run, but disappear (ex. are
broken down by natural systems) over the longer run.

Ex. Damage costs increase disproportionately for
small increases in peak wind speed.

– illustrated in Stern Review, Chapter 3

Here we see that as the wind speed (a climate change impact which is
positively related to total emissions over century) rises, the monetary
total damage estimates increase exponentially. This is one impact that
causes the MD to slope upward over the longer term.

– For another example, consider that as temperature rises from 1 to 20C above
preindustrial, the millions at risk from storm surges does not increase much.
However, if we go over 20C, the number of people at risk begins to rise rapidly.
These numbers are higher with higher populations. The letters A2, B2, and A1/B1
refer to various climate change scenarios, a component of which is population
growth. We will be discussing these scenarios which are part of the United
Nations IPPC reports.
– Many damage categories start to rise rapidly after the average surface
temperature warms by 20C which is why our global Copenhagen target is to
prevent a 20C rise in the average surface temperature.

Malaria incidence expected to increase as follows…

– increase of 2 degrees C –> additional 40 – 60 mill
exposed
– increase of 3-4 degrees C –> additional 70 – 80 mill
people exposed.

-Again, the increase in total damages is exponential which means the
marginal damage is increasing in the cumulative emissions.
Source photos: wikipedia, see malaria.

Temp
Change
relative to
Preindustrial
(0C)
1 – at least 10% of land species extinct

(one estimate)
2 – 15 – 40% species face extinction

– high risk polar bear, caribou extinction

3 – 20 – 50% (one estimate) (mammals,
25 – 60%, birds, 30 – 40%, butterflies in
South Africa, 15 – 70%)
– collapse Amazon rain forest (some
models)

4 – loss of around half arctic tundra

Stern: Highlights of Possible Climate Impacts
on Species Extinctions and Ecosystems

Northern
Sportiff Lemur
(19 individuals
estimated to
remain)

– Polar bears have survived the interglacials of the Pleistocene Epoch (last 2 million years) and earlier based
on DNA evidence. The last interglacial period (125,000 years ago was warmer than today and the polar bears
survived but their habitat shrunk.
– Whales in the arctic are at risk due to infectious diseases that will be carried by whales (like orcas) from
warmer waters as their habitat moves North (ex. Bowhead/ Narwhale)
– As a last resort, polar bears could be fed by humans and kept on nature preserves.
– many species are already threatened, with some like this Northern Sportiff Lemur (a fairly close relative with
which we share a common ancestor, 63 mya) on the brink of extinction. If we cannot bother to save close
relatives with only 0.8 0C of average surface temperature change, one wonders whether preventing an
extinction will be a priority with 3 or 4 0C of change.

(tonnes CO2e/
century)

E
E
$

∆E = 1 / tonne

∆ TD = $100

Suppose that total damages are linear and increasing at a
rate of $100/tonne. What are marginal damages?

100

200

$/ tonne CO2e

100 MD

– The marginal damage is the rate at which total damages change with emissions and corresponds to the slope of a tangent on the TD curve.
-Calculus Students: MD = dTD/dE. TD = integral of MD from 0 to E, i.e. area under the MD curve. Similarly, MAC = dTAC/dE.

(tonnes CO2e/
century)
TD
E
E

MD = ∆ TD/ ∆E
= (200 – 100 tonnes)
/(1 tonne)

= $100/tonne

$
∆E = 1 / tonne
∆ TD = $100
Suppose that total damages are linear and increasing at a
rate of $100/tonne. What are marginal damages?
100
200
$/ tonne CO2e

33 34

GHGs/ century

$/ tonne CO2e
E

MD = slope
tangent on
TD.

Now suppose total damages are increasing at an increasing
rate as estimates suggest. What does MD look like?

∆E = 1 tonne

∆ TD = $

400

∆E = 1 tonne

∆ TD = $ 50

50
400

– the MD is the slope of a tangent on the total damage curve. To get the slope of a point on the TD curve, draw a tangent line and then pick two
points on the tangent and calculate the rise over the run to get the slope.

Summary MD Shifts:

As GHGs accumulate in the atmosphere, each
additional emission is predicted to cause
increasingly more damages. This results in a
yearly marginal damage curve which is fairly flat
as each emission added in a given year causes
about the same amount of damages as the last
one.

Over the longer time frame, the marginal damage
curve slopes upward.

4- Relate Shifts of MAC
and MD to possible $ SE
Price and Emissions
Trajectories.

– Next we put the MAC and MD shifts together to
illustrate how the socially efficient carbon prices
and emissions levels and BAU emissions levels may
change over time .

– Assume MDs shift upwards over time and that
the MAC shifts in due to renewable energy
adoption being the dominant reason for the MAC
shift.

– There are multiple possibilities.

$/tonne
CO2e

Emissions
(Gt CO2e

/year)

M
AC

2000

Suppose in 2000, the SE price of carbon is $25/tonne
and the SE emissions is 40 Gt.

ESE
2000

MD 2000

– Note that my carbon prices are much lower than Sternʼs estimates but are similar to Nordhausʼs. My shifts are not realistic and my y-intercept
is too low.

$/tonne
CO2e
Emissions
(Gt CO2e
/year)
0
42

M
AC 2000

If the MAC & MD shift as illustrated, in 2010, the $SE
price of carbon is $50/tonne & the $SE emissions is 30 Gt.

ESE
2000

MD 2000
MD 2010

M
AC 2010

25
50
ESE
2010

4030

$/tonne
CO2e
Emissions
(Gt CO2e
/year)
0
42
M
AC 2000

Suppose in 2020, the MAC & MD have shifted as
illustrated, now the $SE price of carbon is $25/t & the SE
emissions is 40 Gt.

ESE
2000
MD 2000
MD 2010
M
AC 2010
25
50

M
A

2020

ESE

2010
ESE

2020

4030

MD 2020

time

Socially Efficient Carbon Price
Trajectory

Socially Efficient GHG Emissions
Reduction Trajectory

gT
CO2e/year
$/tonne
CO2e

25
50

2000 2010 2020

22
2000 2010 2020

– The shifting MACs and MDs can be used to trace out the monetarily SE emissions trajectories and $SE carbon price trajectories.
– These are outputs from climate economy models to be discussed later.

Optimal emissions reduction trajectory: For < 550 ppm CO2 eq target:

2000

peak during
2005 to

2025

fall at rate of 1%
to 3% per year

net GHG
emissions
(Gigatonnes
CO2-eq)

Optimal emissions reduction trajectory:
For < 450 ppm CO2 eq target:

2025

You are in your 60s
with a world economy
which Stern suggests
may be 3-4 times
“larger” with over 9
billion people. You may
have grandchildren.

42
2050

31.5 (25% reduction)

11 (70% reduction)

2050

peak
during

2005 to
2015

fall at rate of
5% per year

Note: James Hansen, the famous NASA scientist recommends 350 ppm or lower. His target is
based on actual observations of temperature changes and Paleoclimate.

net GHG emissions
(Gigatonnes CO2-eq)

time
time

Sketches of the Stern Trajectories

– Stern uses a variety of methodologies with his climate economy being referred to as PAGE. Much of his analysis looks at cost effective ways to
meet the 450 to 550 ppm stabilization targets recommended by the international panel of scientists under the UN IPCC (United Nations
International Panel on Climate Change).
– Note emissions are allowed to rise. The later or higher the peak, the faster we need to reduce later to meet the same stabilization target.

675

Conc
CO2
(ppm)

180

Year

We need to go back 32
million years to get this conc.
of CO2!! (poles about 4
degrees warmer)

– Nordhaus socially efficient trajectory
– Nordhaus BAU trajectory

390

BAU

280

1050

back 36 million years to get
this conc. of CO2!! (poles
about 5 degrees warmer
based on sediment proxy)

Sketch Nordhaus Results:

2011

– Nordhaus does not constrain his models based on UN IPCC targets but instead the target is determined within the model based on weighing
the tradeoffs between abatement costs in near future with damages which are higher in the more distant future. His DICE and RICE models
contain both a model of the economy and a very basic climate model. His model suggests its optimal to let temperatures rise almost 30 relative
to preindustrial with atmospheric CO2 at 675 ppms which significantly higher than targets suggested by UN IPCC panel of scientists. He
estimates that under BAU, emissions would rise to 1050 ppm (a level not experienced for about 36 million years). He recommends a carbon tax
but a lower one than Stern.
– Norhausʼs model is provided in books like “A question of Balance” available on the web and at his webpage.
Nordhausʼs web page: http://nordhaus.econ.yale.edu/

Nordhaus $ SE conc. 1050

280

180

ppm
CO2-eq

pre-industrial

depth ice age

650

Nordhaus Est. BAU

Eocene
Thermal

Max

– To get an idea of what kind of impacts we would expect from BAU emissions and the Nordhaus
“socially efficient” stabilization target of 650 ppms, check out the graph of Zachos et al.
– These scientists used oxygen isotope ratios in ocean temperatures to estimate past
temperatures going back 70 million years. Note that 65 million years ago, a large asteroid hit
the planet causing the dinosaurs to go extinct. The planet was very hot back then with no polar
ice caps and with high CO2 concentrations of more than 1000 ppm. After this, it gradually gets
even hotter at a peak 55 mya. It then gradually gets colder until about 35 mya when we start to
build ice caps on Antarctica. The thicker parts of the curve indicate oscillations in temperature
due to glacial cycles and they are biggest during the Pleistocene Epoch (last 2 mya until
Holocene) when there is more ice on the poles. Recall that during the depth of the Pleistocene
ice ages, CO2 is about 180 ppm, 100 ppms lower than the pre-industrial level.
– When there are no ice caps, there are no glacial cycles so curves are thinner.

– Stern and Nordhaus Models give very different
carbon price trajectories.

Source: Nordhaus, W. “A Question of Balance”

– Source, Nordhaus, W. “A Question of Balance”, pg. 188
– Entire book is available here: http://nordhaus.econ.yale.edu/Balance_2nd_proofs
– For students interested in learning the details of climate economy models, this book is a great
place to start. Unfortunately, the modelling is complex requiring background in long run growth
models (sometimes taught in 4th year Macroeconomics and learned in Masters Level
macroeconomics). If you have studied the Solow model, you will have some idea of how these
models work.

6- Predictions of BAU
Emissions

http://webarchive.nationalarchives.gov.uk/+/http://www.hm-treasury.gov.uk/media/3/2/Chapter_7_Projecting_the_Growth_of_Greenhouse-
Gas_Emissions (see page 173 Stern Review, ch. 7)

BAU emissions can be estimated by making projections
of individual components of Kaya Identity:

CO2 emissions
from energy

Population GDP/
person

Energy
Use Per
Unit of
GDP

CO2
emissions
per unit
energy
used

* * *

287,000,000
people *

34,430
$/person

=
2.52
tonnes CO2
/toe

*
230.8 * 106
toe/ GDP

20.02 tonnes CO2/person287,000,000
people

= *

= 5.7 Gigatonnes CO2/ year

– from section 7.3, Stern Review
– one tonne oil equivalent = 41.87 gigajoules
– for students interested in a detailed analysis, see part III of the Stern Review with
chapter 7 giving an overview.
– the example given is for the USA. Canadaʼs is slightly larger as is Australias. These are
more than twice the size of the footprint of a British, French or German Person.
– note that these footprints are from the perspective of production. Consumption footprints
can be lower or higher….for example, if the people in a country import a lot of GHG
intensive manufactures.
– the two last terms multiplied together give the carbon dioxide intensity of GDP

Current:
7 billion
people!!

– If all other
aspects of the
Kaya equation
stay equal, by
2050, population
would increase
by 32% and GHG
emissions would
increase by 32%
per year.

http://qualicuminstitute.ca/cause.php

GDP is also rising
which (all else equal)
would cause CO2 to rise.

– 8 fold increase in real
GDP measure over 20th
century

– 1900 – 2000 (2.9%/year)
– 1950 – 2000 (3.9%/year)

– unequally distributed net
benefits of these GHGs.

We can see that CO2 emissions per head are
correlated with GDP per head in the USA

Stern, Pg. 181

– Basically, the more stuff that is consumed, the more energy required and the more emissions. There are some factors which would tend to
decrease GHGs as income increases. For example, high income people are generally more educated and so can adopt post materialistic
attitudes and can afford to buy (what are often more expensive) low GHG versions of goods and services. Also, as they have higher incomes,
they are more likely to be able to afford to put into place pollution control technologies. However in the case of GHGs, the effect of income on
being able to purchase more stuff strongly outweighs the other steps. As most peopleʼs incomes rise, so does their carbon footprint. For
discussion of environmental Kuznetʼs curve, see appendix ch. 7 Stern Review.

http://www2.yk.psu.edu/~dxl31/econ14/lecture12.html
http://qualicuminstitute.ca/cause.php

– energy and materials throughput into economy at
expense of natural capital (ecosystem productivity)
– limits to growth
– disinvestment in natural capital like our
atmosphere, our fisheries, our forests.
– all else equal increasing GDP will increase GHGs

Ecologists warn of limits to increasing GDP

http://data.worldbank.org/indicator/EG.GDP.PUSE.KO.PP

Real GDP per unit energy use (PPP $ per kg of oil
equivalent) has been rising==> energy use per unit
real GDP has been falling. All else equal this
would reduce CO2 emissions.

– Price elasticity of demand for energy estimated at 0.23 %. This means
that if price increases by 10%, energy demand would decrease by 2.3%
– Country data on energy use per unit GDP for countries can be found
here.http://unstats.un.org/unsd/mdg/SeriesDetail.aspx?srid=648
– http://data.worldbank.org/indicator/EG.GDP.PUSE.KO.PP

1994 – 2006:
– Canada (0.86 to 0.73)
– Germany (0.52 to 0.43)
– Europe (0.54 – 0.45)
– China (3.99 to 2.85) (fell from 7.98 to 3.99) from 1980 to 1994)

Globally, the greenhouse intensity of GDP is falling but
unevenly. All else equal, this would tend to decrease
GHGs.

– Data for all other countries available here:
[XLS] World Carbon Intensity – U.S. Department of Energy

ftp://ftp.eia.doe.gov/pub/international/iealf/tableh1gco2.x

Although CO2 per unit output is falling due to less energy
per unit output and less CO2 per unit energy, growth in
population and output dominates causing CO2 to rise.

CO2 emissions
from energy

=
Population GDP/
person
Energy
Use Per
Unit of
GDP

CO2
emissions
per unit
energy used

* * *
*

1.4 %

= *
=

1.4 % 1.9 % 1.9 %

– from section 7.3, Stern Review
– one tonne oil equivalent = 41.87 gigajoules
– for students interested in a detailed analysis, see part III of the Stern
Review with chapter 7 giving an overview.
– note that even if the population growth rate was reduced to 0, if the
cancelling out of GDP per person and CO2 intensity per unit GDP was
to continue, energy CO2 emissions would stay constant–but we need to
bring them down to prevent increases in the CO2 concentration.

“ Overall, the statement that under BAU,
global emissions will be sufficient to
propel GHG concentrations to over 550
ppm by 2050 and over 650 to 750 ppm by
the end of the century is robust to a wide
range of assumptions.”

— Nicolas Stern (2006)

http://www.epa.gov/climatechange/emissions/globalghg.html

Emissions keep rising –reducing them will
be a great challenge

http://www.epa.gov/climatechange/emissions/globalghg.html

– We can see sources of GHG emissions growth (or
shrinkage) across countries can be broken down into the
four components of the Kaya Equation. Note highest growth rates
in non-Annex 1 Parties including India and China. Both have high
GDP growth rates. China’s energy intensity of GDP is falling the
fastest (from an inefficient start point) but its carbon intensity of
energy is rising.
– UK and economies in transition are reducing CO2 emissions.

Stern, Pg. 179

– We can see here that GHGs are rising fastest in the non Annex 1 countries. However, even if these countries did not exist, the GHGs from the
early industrializers would still lead to dangerous anthropogenic global warming. Per capita footprints need to be reduced in the affluent
countries and developing countries will need to develop in a non-carbon intensive manner.

6. Shifts MAC MD under
Future Emissions Reduction
Scenarios.

– Four main groups of narrative story lines were identified with 3 subgroups in A1 scenario (fossil fuel intensive, non-fossil fuel intensive,
balanced). These were completed by 1998.
– Teams then began quantifying the various storylines to estimate GHG emissions. These include Sulphur emissions as these are aerosols
working against global warming.

Figure TS2 from UN IPCC Special Report on Emissions Scenarios (2002)
http://www.grida.no/publications/other/ipcc_sr/

– Estimates of components behind MAC and
MD shifts and hence BAU trajectories and SE
emissions and carbon price trajectories are
based on emissions scenarios which include
what policy (or lack of policy) we take to
reduce GHGs.

– Does not include UN FCCC process explicitly
(ex. Kyoto)

– The IPPC released a Special Report on
Emissions Scenarios in the third annual
report (TAR, 2002).

For a one page summary of the Special Report on Emissions Scenarios (SRES), please click here: (see pg. 18 of IPCC Fourth assessment
Report of 2007. http://www.ipcc.ch/pdf/assessment-report/ar4/wg1/ar4-wg1-spm

– how quickly we replace fossil fuels with low GHG energy
sources.
– how efficient we are in using energy and GHGs to make energy.
– whether we can safely capture emissions using “capture and
storage technology” like pumping CO2 along pipelines into oil
wells and if it is safe to deposit liquid CO2 at bottom of oceans.
– how we change our land use to repair the carbon sinks
– the population growth rate and the extent to which we
change per capita energy use (including rises in what are currently
low income countries).
– our political will to put into place policies like carbon taxes and
whether we cooperate as a world under UN FCCC to
coordinate these taxes or go it alone.
– rate of adoption of post materialistic attitudes.
– shift to information and service based vs material economy.

What emissions trajectory actually occurs
will depend upon what we do–including:

– Climate scientists have attempted to estimate
emissions trajectories based upon a variety of
possible fossil fuel emissions scenarios for the
future.

– It is hoped that this will help point policy in a
direction of low emissions. The IPCC (3rd report)
has developed 4 basic story lines as follows.

– Four Basic Story Lines (A1, A2, B1, and B2) include
BAU (increased fossil fuel use) and conservation
scenarios.
– No probabilities assigned to scenarios (uncertain)
– note: only includes fossil fuel emissions on graphs.

1) Emissions scenario A1: “One Global Family”
– A1-F1 : fossil fuel intensive
– A1T: non-fossil fuel intensive
– A1B: mixture

– rapid growth in total energy
consumed and produced.
– big decrease in global
income inequality.
– population peaks in mid 21st
century at 9 billion people and
then falls.
– new more efficient
technologies invented and
deployed.

Assumptions:

– Recall A1F1 has a high probability of taking us to a 4 degree warmer world by 2099.
Special Report on Emissions Scenarios, UN IPCC, 2002 http://www.grida.no/publications/other/ipcc_sr/

– None of these trajectories
allows for stabilization at
450 ppms

2) Emissions scenario A2: “A Divided World”

– In this world, people fail to
make international
agreements to reduce
emissions but adopt local
solutions to environmental
problems. Technological
growth is slower and
population keeps rising.

B1 Story Line: Global Utopia

– global agreements to
reduce GHGs

– rapid switch to
information and service
economy away from the
“material girl” world.

– population peaks by
2050 and then falls.

– low GHG technologies
and more efficient use of
GHGs.

DP: page 86

– world population
continues to increase

– mid levels of raising
global real income.

– new energy technology
develops relatively slowly.

– failure at international
agreements to reduce
GHGs and instead work
locally.

“Scientists make no attempt to estimate the
likelyhoods for any of these possible scenarios
occurring; the uncertainties are simply too
large.”

Michael Mann and Lee Kump (2009), DP page 87

– A view of two scientists.

Photo sources:
Lee Kump http://www.marine.usf.edu/news/archives-2009.shtml
Michael Mann
– Famous for tree ring temperature and carbon dioxide hockey stick graphs supporting the theory that the greenhouse effect due to fossil fuel
powered industrialization is causing the temperature to rise.
Mann has been heavily attacked by climate change deniers.
http://www.realclimate.org/index.php/archives/2004/12/michael-mann/

The only story line which comes close to meeting the
450 – 550 ppm UN IPPC target is the B1 Story Line:
Global Utopia

– global cooperation in .

– rapid switch to
information and service
economy away from the
“material girl” world.
– population peaks by
2050 and then falls.
– low GHG technologies
and more efficient use of
GHGs.

DP: page 86

– although there is global cooperation with “emphasis on local solutions to
economic, social, and environmental sustainability including improved equity”,
there is no UN FCCC process.
– “ It is worthwhile noting that only the most conservation-minded scenarios are
likely to avoid warming in excess of 2 degrees C. This is the benchmark rise that
is often cited as constituting dangerous human-interference with the climate (see
pg. 108 DP).” (Quote by Mann and Kump, pg. 88 DP).
– ? why do the scenarios ignore the potential of the UN FCCC process when there
is a pollution haven effect in its absence. Do the scenarios include the possibility
of tariff wars?

These different emissions scenarios draw
attention to the importance of

– global international agreements
to solve prisoner’s dilemmas.
– pricing GHGs to provide incentives to
switch to low GHG technology and to
become more energy efficient.
– change in materialistic attitudes to
stewardship attitudes.
– policy to slow population growth
and then reduce the population.

Exercise: Pick one of the SRES scenarios and write down how you think that the MACs and MDs will shift given the scenario. I bet your
emissions trajectory wonʼt look nearly as tidy as our nice hypothetical one on slide 104.

7-Summary

In this lecture, we investigated reasons for shifts in MACs
and MDs. We then showed how this would affect future
socially efficient emissions and carbon price trajectories and
also BAU emissions levels in theory.

We then looked at methods scientists use to predict
emissions trajectories with the help of the Kaya Equation.

We then looked at the IPCC emissions scenarios (SRES).
These illustrated that key components of meeting the
Copenhagen target of less than 2 degrees C temperature rise
relative to pre-industrial.

These are: global cooperation, pricing greenhouse gas
emissions, slowing and reversing population growth and
adopting conservationist attitudes which would enable us
to use less energy.

Although energy efficiency and more generally using the
GHGs efficiently is important, it was also argued that it is
important to rapidly develop renewable energies so as
to avoid Jevon’s paradox.

Spinoffs technologies like green batteries are
expected to develop in response to adoption of renewable
intermittent energy sources.

Fossil fuel resources are finite with oil projected to run
out this century. So, even if there was no global warming
problem, it still makes economic sense to adopt and
invent renewable energies today. Saving fossil fuels will
also provide us with a store of hydrocarbons for valuable
plastics production.

Grim as things may look, there are solutions! As Al Gore
notes, perhaps our main barrier to success is “political will”.

References:

Special Report on Emissions Scenarios, UN
IPCC (2002)

http://www.grida.no/publications/other/ipcc_sr/

Look at Table SPM-1a for numbers like the
population estimated for each scenario, the
GDP, Ratio of income in Annex 1 to non-
Annex 1, energy intensity, primary energy,
coal share of primary energy, and how these
change over time.

L8 Putting a Price on GHG Emissions
and Natural Carbon Sink Destruction.

N2O CH4

F-gases

– (c) Ruth Forsdyke, 2013,
* Draft version only. Not for widespread distribution. All copyright permissions not attained so limited distribution under Dalhousie Copyright
Agreement. No copyright claim on public domain or any copyrighted material due to no permissions acquired.

Topics List:
1.Introduction
2.Nova Scotia’s Global warming policy, targets
& progress to date
3.Policy Analysis Using MAC – MD
Framework

– carbon tax
– emissions standard
– abatement subsidy

4.Equity, the Price of GHG intensive goods
and guiding the invisible hand (to make it
“green”)
5.

Summary

6. Practice Questions

* note that answers to last page of the the MAC MD worksheet
can be found under topic 3.

1-Introduction:

Now that we have
illustrated how the MAC
MD framework is related
to the underlying demand
and supply framework, we
will use it to illustrate how
policies that directly target
GHG emissions work.

baskets
bill/year

MACP

M
C

PSE=85

PM= 6

MSP

=15

MCE

BAU

$/good

baskets
bill/year

GHGs
(tonnes
CO2e/

year)

/year

100

QMQSE

– Assume baskets are average bundles of real goods, services and inputs
produced in the world economy as a whole.
– Recall, we assumed each average basket of goods, services and inputs caused
1 tonne of GHGs.
~ year 2000 net emissions
= 42 gT
– Assume baskets are average bundles of real goods, services and inputs
produced in the world economy as a whole
– in very short run, the only available means to abate is to reduce output of
goods, services and inputs.

Recall, we have shifted our focus from policies
that directly target goods, services and inputs to
those that target the GHGs.

Similar to the case of “goods” targeting policies,
GHG targeting policies can be categorized as
either price, quantity or quality mechanisms.

1) Carbon Taxes
2) Emissions Standards
3) Emissions Abatement Subsidy
4) Cap and Trade (briefly discuss)

– Firstly, we look at the price policies in Nova
Scotia and characterize according to whether
they target “goods” or GHGs & whether they are
price, quantity, or quality mechanisms.

– Then, we look at individual policies giving
examples.

– Next, we briefly compare two policies,
emissions standards & carbon taxes,
based on the possible welfare criteria of
government revenue generation, and ability of
producers and consumers to finance abatement
costs.

2-Examples of GHG reduction
policies (case study: Nova Scotia)

you are here!

– Source of Contour Graph= NovaNet News
– Nova Scotia Today

– Full sea level rise > 70 metres
– High prob. eventually under BAU
– Timing Uncertain (100s to 1000s yrs)

Canadian Provincial per Capita Production GHG Emissions (2010)

40
50

70
80

Ne
w
fo
un
dl
an
d

PE
I

NS NB Q
ue O

nt
M
an

Sa
sk

Al
ta BC

Province

o
n

n
e
s
C

O
2

e
/

p
e
rs

o
n

Nova Scotia’s per capita production GHG emissions
are 23 tonnes CO2e/capita, slightly higher than the
national average of 21 but about more than
double that of Quebec at 10 & about 1/3rd of
Saskatchewan’s footprint. Why are the production
carbon footprints different

– The footprints of BC, Quebec and Ontario are low due to high use of low GHG
energy sources for electricity production. B.C., Quebec, and Ontario have plentiful
hydro resources.
– The high footprints of Alberta and Saskatchewan are due to heavy use of fossil
fuels to make electricity and heavy use of energy for mining activities including
Tar (Oil) Sands.

Note: Our consumption carbon footprint will be different because we import and
export carbon intensive goods.

Source: Canada’s National Inventory of GHGs/ Stats Canada Population Data

http://climatechange.gov.ns.ca/doc/ccap

The biggest single source of GHGs in Nova Scotia is
the electricity sector. As there are already available low
GHG electricity sources, electricity GHGs are
considered relatively cheap to abate and so they are
our primary Copenhagen 2020 target focus.

– many transport emissions could be replacing private passenger
vehicles with efficient public transit.
– there is so much traffic congestion in Halifax that buses move slowly
and are often unreliable.
– the #20 is mainly used by low income people living in Spryfield with
higher income types mainly driving their cars. This contrasts with large
Canadian cities in which transit is used by a wide range of income types.
– an efficient transit system could save people time as the buses or
skytrain would run more frequently and buses would not get stuck in
traffic jams.

Nova Scotia’s CO2 Emissions from Large
Emitters (2009):

Imperial Oil
(Exxon Mobil)

Oil Refining
(Dartmouth)

.74
NSPI (Emera)

Lingan 3.94

Point Aconi 1.45

Point Tupper 1.02

Trenton 1.

Tufts Cove 1.14

9.37

Oil Extraction
(Thebaud Platform)

.15

Pulp and Paper

Northern Pulp NS
Corp

0.08

Maritimes
Pipeline North

East Ltd Partner

Natural Gas
Transmission

Electricity
(Dartmouth)

a
l

gas

Tot. elec.

0.05

Minas Basin Pulp &
Paper Co.

0.04

Imperial Oil
(Exxon Mobil)

Tot. P&P

0.12

Tot. fossil
fuel 0.95

Total All =
10.4 Mt

Data Source: Canadaʼs Greenhouse Gas Inventories

– Nova Scotia generates and consumes more than
12,000 GWh (gigawatt-hours) of electricity per
year (amount of energy).
– The average power is 12,000 G Watt/8760 = 1.4
GW (i.e. 1.4 billion Watts).

– the electricity units are very ugly due to the hour second component.
– a Watt is a Joule per second (energy per unit time). A Watt hour is a
watt multiplied by an hour, so it is the amount of energy that a 1 Watt
energy source will provide over a one hour period.
– a one Watt light bulb is very small. We are all familiar with a 100
Watt light bulb.
– over one hour, the amount of energy is 100 Watts* 1 hour
= 100 Joules/second * 3600 seconds = 360000 Joules.

$/tonne

E
(mT CO2e

year)
0
?

18.2 19

C 1990

A
nnex 1 E

U
1

9
9

E
A

ct
u

a
l

21.5

18 %

Nova Scotia’s Kyoto Target is 18.2 megatonnes
(6% 1990 level of 19 mT). Today, our emissions are
about 21.5 megatonnes (18 % above target)..

E
T

a
rg

e
t

– The MAC is drawn as linear for schematic purposes. I do not know the intercept.
– The blue shaded area is the total abatement costs (TAC). Recall, it is the area
under the MAC curve corresponding to the total consumer and producer surplus
given up by abating. Note that the MAC will have shifted over the period and so my
yearly TAC representation (blue triangle) has incorrectly assumed “no shifts” for
heuristic purposes.
– Note also that I have ignored the win – win region of the MAC (below x axis) for
heuristic purposes. Abatement can be a net private benefit in many cases such as
insulating a home with owners not being aware of how much money they can save on
heating bills.
– Notice the y axis does not intercept the x-axis at 0 given scale shown.

$/tonne

Emissions
(mT CO2e

year)
0
?
18.2 19
M
A
C 1990

E
B

A
U

1
9

9
0

E
A
ct
u
a
l

~21.5

18 %

However, since our MAC has shifted, it would be
incorrect to use the 1990 MAC to estimate our total
abatement costs to reach the target.

E
T
a
rg

e
tM

A
C 2012

– We look at shifts in our next lecture. I have drawn the shift as linear
and also the lines as linear based on a lack of knowledge as to what
these curves actually look like.
– note that we have climate change policy so our BAU emissions should
be higher than our actual emissions. This is why my x-intercept is
drawn above the BAU level. For example, we have a tax on gasoline,
even though it is much lower than Europe’s (see last lecture).

$/tonne
Emissions
(mT CO2e
year)
0
?
18.2 19
M
A

C
1990 E

B
A
U
1
9
9
0
E
A
ct
u
a
l

~ 21.5

20 %

Our new target set under the ESPGA (2007) is 17.1
mT by the year 2020.

E
K

y
o

to
-t

a
rg
e
t
M
A

C
2012

17.1

E
C

o
p

e
n

-t
a
rg

e
t
?

– Note that the EU’s Copenhagen target is also 20%, but they made
progress under Kyoto while we didn’t. Also, note that the EU has
offered to abate by 30% unconditionally but is willing to make a
commitment to 30% if other countries do.
– Nova Scotia intends to make most of the cuts in electricity sector
(almost 50% of our GHGs) and so, get ready to watch the wind turbines
go up!

In the next few slides, I have posted, Nova Scotia’s
overall EGSPA target and some specific
policies to reach the targets.

When you read these think about whether they are
price, quantity or / and quality mechanisms. Then
check your answers.

After that, we move back to our more
abstract MAC – MD framework.

NS Kyoto Target *
18.2

22.3

1990 201020001995 2005 2015 2020

BA
U

E
m

iss
io

ns
Projection

Reduction Trajectory
17.1

EGSPA target

(e) greenhouse gas emissions will be at least ten per cent
below the levels that were emitted in the year 1990
by the year 2020, as outlined in the New England Governors
and Eastern Canadian Premiers Climate Change Action
Plan of 2001;

mT/
year

– this policy is referred to as an emissions standard, a quota on emissions at the level of the province. It is non exchangeable which is the
main reason it differs from cap and trade; we are required to reduce the emisions ourselves; we can not pay others to offset our emissions.
– The EGSPA target is also our Copenhagen target for 2020.
– Many provinces including Nova Scotia have set targets that are tighter than the national Copenhagen target of a 17% reduction in
emissions relative to the 2005 level by 2020 (a laxer target than Canada’s failed Kyoto Target).
– Nova Scotia’s 2020 target: Reduce emissions by 5.2 megatonnes (5.2 billion kg) to EGSPA target of 10% below 1990 levels for annual
emissions of 17.1 tonnes. This is a 22% reduction relative to the current level. We will still need to reduce by 78 % more to become
carbon neutral.
– Data based on graph on Pg. 4, Towards a Greener Future, Nova Scotia’s Action plan
– my estimation of Kyoto target based on assumption that Nova Scotia’s goal was 6% so as to take an equal share of the Canadian target
reduction of 6% relative to the 1990 baseline. Click here: http://climatechange.gov.ns.ca/doc/ccap )

0
2050

currently 22 %
above Kyoto Target

C
arbon N

eutral

Econom
y,

this w
ay…

mT/year

Kyoto
Copen
-hagen

2008- 2012 (period
to meet the Kyoto
target by)

2050
Target

– Putting a different y-axis which goes all the way to 0, provides us with a better view of how far we need to
reduce
– Way to calculate very rough estimate of reparations owed if carbon was priced. Say NS pays for all
excess GHGs over the 5 year commitment period, I get ~ 3.3 mT/year * 5 years = 16.5 mT (eyeballing
graph estimate)
– at Carbon Price of $10/tonne CO2e, reparations about $165 million (reasonable as same as EU
ETS price). At a higher Carbon Price of $50/tonne CO2e, reparations about $825 million
GDP of Province = $36.352 bill/year (2010), so reparations based on this calculation would be 2.3 % of the
GDP. This will allow us to get a better sense of how much reparations would cost us and also what damage
we have done to the world at these prices.
Question: Do you think Canada should have to pay some reparations for exceeding our Kyoto Target? Why
or why not?

(b) the Province will adopt emissions standards
for greenhouse gases and air pollutants from
new motor vehicles, such as the standards
adopted by the State of California by the year
2010;

b) This is enacted by a fuel efficiency standard, a type of
performance standard. (kg per Litre of gas/ the US and Canada have
national standards under the Corporate Average Fuel Efficiency
Standards. In absence of strong national action, California set higher
standards.

(a) twelve per cent
of the total land
mass of the Province
will be legally
protected by the
year 2015;

Ecosystem Carbon Sink Floors

a) This is a quantity mechanism — it is a floor on land mass — which is
related to a floor on natural carbon sinks and biodiversity.
– setting aside natural areas like Provincial Parks (quantity floors) protects
biodiversity and carbon sinks and provides areas for recreation and teaches
people about nature. More biodiversity increases ecosystem health so they
capture more CO2 emissions helping with mitigation. Also, more
biodiversity increases the ability of ecosystems to adapt to climate change and
is an important and essential component of our adaptation strategy. So
conserving biodiversity is an end in itself but also a means to helping us
mitigate and adapt to climate change.
http://en.wikipedia.org/wiki/Provincial_parks_in_nova_scotia

Tidal
Wind

(g) eighteen and one-half per cent of the total
electricity needs of the Province will be obtained from
renewable energy sources by the year 2013;

Biomass

Renewable Energy Quota’s

g) This is called a renewable energy quota in a specific sector of the economy (electricity–almost half of the provinces total emissions). It is a technology standard specifying a specific mix of
technologies to be used to produce 18.5 % of electricity). It is also a quantity standard as it imposes a quantity on the share of electricity to be produced by renewable energy.
– solar, wind and to a lesser extent tidal have serious problems in that the energy source is intermittent. If the wind drops, natural gas turbines are rapidly ramped up to keep the electricity flowing.
– The basic problem is that of storing the electricity. If a grid gets above 30% intermittent energy sources, there will be problems.
– some solutions include massive high voltage DC super-grids, which smooth out renewable energy over large areas (ex. if wind is not blowing in place X, it may be in place Y). (cost around 4
trillion for the EU with North Africa becoming a major solar energy exporter).
– smart grids are another solution such that when the wind and solar power drop, the price of electricity rises providing people with a signal and incentive to defer doing things like your laundry until
the price drops. You need an electricity price monitor. You can buy your power at rates based on time of day and get lower rates at non-peak hours, so you help smooth out the grid from the demand
side.
– batteries are going to add to costs and have mining impacts. Lots of R&D being conducted.
– water gravity batteries in which wind is used to pump water uphill where it is stored until the wind drops and then is allowed to run over a hydro turbine to generate power is another option. This
is being used in the Fjiords of Norway. Another interesting option is are underwater air balloons which are pumped up by wind turbines and then released later to make power.

Feed in Tariffs (Control Access Price):
cents/ kwh

– Emera forced to buy power from smaller scale
generators through two-way metering.

– these are needed because Nova Scotia Power has a monopoly on
electricity transmission services and a near monopoly on generation. In
absence of regulation, it is expected charge entering renewable energy
companies high access prices in order to deter entry which would
complete with its near monopoly in renewable energy.

– the Nova Scotia Utility and Review Board is charged with regulating
prices charged by NS Power.
– NS Power was a public company until the 1990s when it was privatized.
The privatization of these public assets was a common occurrence in the
1990s.

Tidal = 65.2cents/kwh

– this would be expensive for NS Power. Hence, it is trying to develop
its own turbines as are other countries.
– Our tides in the Bay of Fundy are the strongest in the world making it
very challenging to harness the power. There have been problems with
blades breaking due to ice and mud flows at the bottom of the bay.

Wind > 50 kw==> 13.1 cents /kwh
< 50 kw==> 49.9 cents per kwh

– wind power (current costs around 7 cents per kWh.
– Care is required in siting wind turbines due to killing birds and bats. A solution to this problem is
radar systems which turn turbines off when flocks approach. Increases costs.
– biofuels

left: > 1 MW
right: around 300 Watts.

– average household uses about 1 kW but this varies according to whether they heat with electricity.
Heating with electricity is expensive and takes up a large chunk of the household’s bill in the winter
but not in the summer.
– if you test out the NS Power energy calculator, you will find heat devices in the home are big
electricity heaters.

Run of the River Hydro = 14 cents/kwh- Lower Churchill River Muscrat falls imported from
Labrador (fixed cost estimated $ 6.2 billion for
underwater cables and dam)
– NSPI will buy enough for 10% of NS’s electricity (and up
to 30%)

– hydro (not much in the province but under consideration is the Lower Churchill Falls project) which requires building an underwater
cable from Labrador to Nova Scotia.
– Harper guarantees $6.2 billion loan –is this Green Monetary Stimulus? –it is from the perspective of GHGs …BUT….there are other
serious environmental impacts here.
– threats to biodiversity including migratory caribou with one deer-like species threatened with extinction as there are only 100 left. See
picture above illustrating effects of water diversion.
– loss of traditional way of living to First Nations People of Labrador.
– 824 megawatts (20% to Nova Scotia for 35 years = 8 to 10% of provinces energy supply)–Emera would build the cable as part of the
contract).
– complex contractual arrangements here.
Read more: http://www.cbc.ca/news/canada/story/2011/04/01/f-lower-churchill-development.html
history and source of lefthand picture: http://www.ieee.ca/millennium/churchill/cf_history.html
right hand picture: http://en.wikipedia.org/wiki/Churchill_Falls#Hydroelectric_power_project

– Combined Heat and Power (CHP) Biomass
– 17.5 cents/ kwh
– branches/ wood from saw mills.
– fast growing grass like switch grass.
– potentially carbon neutral BUT fertilizer
emissions and loss of natural carbon sinks can
make it worse than fossil fuels.

Biofuels are potentially carbon neutral–grow plants –make fuel –combust fuel (CO2
released). Plants grow back taking the CO2 out of the air.
– but some studies of biodiesel find its footprint is higher than regular diesel. These
take into account the full life cycle including estimates of sink reduction. Ex. more forest
clearing.
– problem with land being used to grow crops for food being replaced to grow crops for
biofuels –cars for rich vs. food for poor.
– Less land is now available for natural ecosystems with loss of carbon sinks and
biodiversity loss–ex. replace natural rainforest with palm oil plantation monoculture. Also,
the fertilizers and pesticide energy currently made from fossil fuels. One student brought up
interesting topic of algae biofuels in class.
Photo source: http://en.wikipedia.org/wiki/Biofuels

tracking mirrors
= heliostats

Mirrors reflect sunlight to
tower–heats water–turn
turbine–generates
electricity

– solar energy (photovoltaic cells and solar collectors–also solar is
used to heat water to heat buildings with no electricity intermediate)
Photo Source: Solar Thermal Collector http://en.wikipedia.org/wiki/
Solar_thermal_collector
– Here is an example of a company in Nova Scotia called ProSolarTech
which is using solar power to melt metal for metal work. This is really
interesting because it provides us with a low GHG way to make the
metal required to build the green economy.
click here to see: http://www.prosolartec.com/

Source Photo: Photovoltaic cells http://en.wikipedia.org/wiki/
Photovoltaics

(n) a policy of preventing net loss of wetlands
will be established by the year 2009

(q) a sustainable procurement policy for the Province will be
developed and adopted by the year 2009

(t) a government facility will be constructed as a
demonstration facility in accordance with a leading standard
for building energy efficiency and sustainability, such as the
Leadership in Energy Efficiency and Environmental
Design (LEEDs standard) by the year 2015;

and

(u) the Province will adopt strategies to ensure the
sustainability of the Province’s natural capital in the areas
of forestry, mining, parks and biodiversity by the year 2010.

n) quantity floor but no specifics given. Related to 1) carbon sinks, 2) biodiversity &
3) adaptation to climate change as acts as buffer against storm surges. Uses a natural
vs. engineering method of adaptation. Recall, wetlands are the best carbon sinks on
average.
q) sustainability performance but no specifics given (possible example all wood for
desks would be purchased from firms that are certified to use sustainable logging
practices).
t) a performance standard (LEEDS)
u) This is a performance standard for sustainable production. It is not specified how
the goal will be achieved. Reducing electricity GHGs is one component. Natural
capital is the “capital stock” of the natural production systems –like the ecosystems,
the quality atmosphere, the quality oceans (normal pH)

– provincial strategies depend heavily on quantity and
quality mechanisms (ex. emissions standards and
renewable energy quotas)
– Simple and has advantage of hitting caps if
enforced (vs. carbon tax), is liked by firms because
they don’t have to pay to pollute if below cap…this
helps with financing renewables, BUT….

1) Unlikely to be cost effective in comparison to
price mechanisms
– not flexible across technology so more expensive
technologies may be implemented.
– not flexible across time. Ex. may be cheaper to pay global
south to save rainforests.

2) Low marginal incentives to invent and adopt low
GHG technology (environmental textbooks tend to ignore
financing very high fixed costs — ex. nuclear tens billions $)

3- Policy Analysis Using MAC –
MD Framework

Now, le
ts use th

e MAC
– MD f

ramewo
rk to

investiga
te a vari

ety of p
rice and

quantit
y

mechan
isms. N

ote, the
MAC

is the sa
me as

our long
running

exampl
e, appro

ximately

global
emissi

ons for
the yea

r 2000
.

You can
check t

he last f
ew ques

tions on
the

worksh
eet..

– Our first policy to investigate is a “carbon tax” which is
short hand for a tax on GHGs measured in CO2 equivalents.
Efficient carbon taxes fall on all GHGs not just carbon dioxide.

As we will see later, carbon taxes are highly recommended
by economists due to predictions that they are 1) money
cost effective (allow us to meet aggregate target as cheaply
as possible (in money but not necessarily happiness) ) and 2)
they provide high incentives to adopt and invent
lower GHG technologies in order to escape the tax and
they provide firms with flexibility of timing to reduce
emissions*.

One drawback is firms are taxed which may make it difficult
to finance the adoption and research and development.
However, taxes can be returned as a lump sum to producers
and consumers making the tax “revenue neutral”. Also,
taxes may be set incorrectly such that target is not met.

– we will look at pros and cons more carefully later after you
become familiar with the framework.
* firms can choose to pay tax or to abate depending on which is
cheaper.
– globally harmonized taxes prevent free-riding countries from
getting a comparative advantage in pollution intensive goods
thereby causing pollution havens.

3-i) Taxes on Net Greenhouse Gas
Emissions

We will put the tax
on carbon and take it off

income

– It was the fall of 2008 when Stéphane Dion, the Liberal Party leader who named his dog Kyoto, ran for Prime
Minister on a “Green Shift” platform but was defeated. His policy platform contained a carbon tax. People were
likely afraid about the effect this would have on prices given the US economy had just collapsed. He was defeated
by Stephen Harper who wanted to replace Canada’s Kyoto obligation with a “Made in Canada Plan” which would
include a cap and trade system but with a safety release valve to discuss later. The cap and trade system was
never implemented nationally. The NDP ran on a policy platform of a Cap and Trade without a safety cap, while
the Greens favoured the carbon tax.
-Prior to the election, Canadian Academic economists signed a petition supporting a carbon tax policy and urging
the government to take action (led by Professor Chris Green of UBC).

– British Columbia has a carbon tax of 30$/tonne CO2e but it is not applied on all sources or gases.

EBAU
= 40

$/tonne

ESE
= 15

Emissions
(Gt CO2e/

period)

MAC
= 80 – 2E

$ MD = 50

BAU
A

C
D

PSE = 50

What marginal carbon tax would you recommend
to get the private parties to abate from EBAU to ESE?

M
A
C

Recall that marginal (heights of marginals curves) refers to the
tax on an additional unit of emissions, while total (areas under
curves –add up infinitely thin rectangles which respond to
marginals) refers to the tax on all units.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/

period)
0

80
MAC
= 80 – 2E
$ MD = 50
BAU
A

B C
D

PSE

marginal carbon tax = $50/ tonne.

t = 50 =

Find total tax?M
A
C

– Start at the “business as usual” (BAU) level of emissions. The Private Party
Polluters have a choice:
1) pollute the tonne and pay tax of $50 per tonne = marginal benefit of abatement
OR
2) abate and save the marginal abatement cost = net marginal cost of abatement
(marginal private surplus given up).
– we see that above 15 gT, the marginal tax saved by abating exceeds the MAC and
so, private parties have an incentive to abate.
– we see that below 15 gT, the marginal tax saved by abating is lower than the
MAC and so private parties will not abate below 15 gT. Hence, the money socially
efficient tax is $50/tonne.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE

total carbon tax = Area B = $50/ tonne
* 15,000,000,000 tonnes = $ 750 billion

t = 50 =

Find total tax
saved?MA

– Note that the polluter pays tax only on the net emissions that are emitted. They abated from
40 billion tonnes to 15 billion tonnes and hence do not have to pay tax on these emissions
because they were not made. The tax agrees with “moral precepts” that polluters should pay
called “the polluter pays principle”. The externality is internalized with the tax.
Question: Suggest ways to ensure that the tax is equitable (fair and just)?
Answers: Progressive income taxes with reductions on low and middle income people. Lump sum
rebates to poor within and between countries (Climate Superfund).
– Taxes can be used to subsidize renewable energy adoption and research and development,
education (helping to counteract the Koch Brothers), healthcare, food aid, birth control, etc.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE

total tax saved (C+D)
= $50/ tonne *
25,000,000,000 tonnes
= $ 1250 billion

t = 50 =

How much total tax do private parties save by abating from
BAU emissions to the SE emissions level?

M
A
C

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D

PSE t = 50 =

What are the private parties total abatement costs
(TAC) = total loss in private surplus?

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE t = 50 =

The private parties total abatement costs (TAC) = area
C (this is the total consumer and total producer surplus given
up) by abating from 40 to 15 gigatonnes per year.

M
A
C

Question: What is the private parties overall total surplus gain
from abating?

Answer: They save the total tax of C+D but incur the abatement
costs of C. Hence they make a surplus of D by abating.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE t = 50 =

M
A
C

Surplus change

Private Parties
– (C + B) = (TAC
+ total tax

Third Parties D+C

Government + B (total tax)

Society as a Whole + D ($ TSS gain)

All groups changes in
net benefits:

Notice that if we started at 0 and increased to 15, Private parties would get A
+B at a cost of B to the third parties. So, Ese = 15 has a higher TSS than E = 0
baseline by area A.

Note: Curves will be shifting about as renewables enter. My graphs assume
that the only way to abate GHGs is by reducing output. This is true in the very
short run only. We will see in next lesson that renewable energy adoption
which displaces fossil fuel sources is expected to shift the MAC inward since
Ebau will fall.

3-ii) Quotas on Net Greenhouse Gas
Emissions

– Rough picture of what Halifax would look like if all ice caps melt (80
meters)!
– This may happen hundreds to thousands of years in the future if we
combust all the fossil fuels.

– Quotas on emissions that are not tradable are
called emissions standards.

– Polluters are required to abate to the
standard and if above it they are fined.

– Ex. Nova Scotia Power

– Ex. Kyoto Protocol targets (but lacked
enforcement mechanism).

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE = 50

What Quota would get the private parties to abate
from EBAU to ESE ?

M
A
C

EBAU
= 40
$/tonne
ESE
= 15

Emissions
(gT CO2e/

period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE = 50

Set Quota at ESE = 15 gigatonnes per period.

Fines and jail sentences
for exceeding quota

M
A
C

Question: What is the minimum marginal fine applied on emissions
above 15 gigatonnes which will achieve abatement to the SE level?
Answer: $50/ tonne.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
$ MD = 50
BAU
A
B C
D
PSE = 50

Total Government Quota rent if auctioned = 15
billion quotas * $50/ tonne = $ 750 billion

M
A
C

– To understand, recall that the height of the MAC is the marginal
private surplus of emissions (for consumers plus producers). This is
the most people are WTP for an additional right to pollute a tonne of
CO2e and so the MAC is the demand curve for emissions. For the 15th
gigatonne, they are willing to pay $50 per tonne and so if the quotas
are all sold at one price in a perfectly competitive auction, they will
each sell at $50/each.

As with quotas on goods, services, or inputs, quotas
on emissions can be auctioned or given away or
a mixture.

auctioned or given away
or a

mixture

– Nova Scotia
(emissions
standard)
– EU ETS
first stage

– Nova Scotia
(emissions
standard)
– EU ETS
second stage

EU ETS = European Union Emissions Trading Scheme.
– Give away is obviously preferred by polluters because they are given a valuable
right. This may help them to finance adoption of low GHG technologies and research
and development (R&D).
– NS Power fine is 500,000/day for exceeding the emissions standard.
– Auction generates revenue for the government similar to the tax. If the auction is
perfectly competitive, the quotas theoretically sell for $50 each (assumes all sell at
same price). This is the most polluters are willing to pay for the last permit to emit 1
tonne of emissions (at Ese = 15). If auctions are not competitive (ex. few buyers or
collusion to bid rig), then quotas may sell for less. If government takes bribes, some
of the total value of the quotas (quota rent) will escape to corrupt officials.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0

80 M
A
C

$ MD = 50
BAUA

B C
D
PSE = 50

Total Quota rent is equal to the number of quotas
sold * how much they sell for = B = $750 billion.

-The quota rent goes to firms under give away while it goes to
government under competitive auctions and it is divided up between
the two (and possibly the corrupt officials) under non-competitive
corrupt auctions.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E
$ MD = 50
BAU
A
B C
D
PSE t = 50 =
M
A
C

Surplus change

Private Parties

– C

Third Parties D+C

Government 0

Society as a Whole + D ($ TSS gain)
All groups changes in
net benefits:

– same result as tax assuming the policies are set correctly.

carbon tax or
perfect quota
auctions

emissions
standards (give
away

Private Parties – (C + B) = (TAC
+ total tax

– C

Third Parties D+C D+C

Government + B (total tax) 0 (if given away)

Society as a
Whole

+ D ($ TSS gain) D

Policy Comparisons based on distribution of
costs and benefits of the policy

– clearly firms like the emissions standards better.

Quotas

tradablenot tradeable
“Cap and
Trade” (ex. EU ETS)

Emissions
Standards

– global target
– Kyoto Target for Annex
1 countries as a group
(5.2 % relative to 1990).
– Kyoto country and EU
group targets
– Nova Scotia
– quantity
mechanism

Ex. – EU ETS
– Quebec and
California
– quantity
mechanism and
price mechanism

Ex.

– Taxes are price mechanisms, emissions standards are quantity
mechanisms while cap and trade are both, the quantity is set and then
the price of the permits to pollute is adjusted in markets.

– If enforced, a merit of emissions standards and cap and trade is that
the cap is hit while with a tax, if the government does not adjust the
tax to meet the target, there is not guarantee of meeting the target.

Under the cap and trade system, the total amount of
emissions for a particular group (ex. the European
Union under the EU ETS) is capped and quotas
(permits) for the right to emit a given amount of
greenhouse gases are allocated to the private parties
(ex. firms, households or even entire countries).

Private parties can then trade permits with those with
high abatement costs buying permits from those
with low abatement costs.

Can be used on producers or consumers (ex. carbon
debit card runs out when permits are used up and
consumers buy more from consumers with excess).

CA
P
left over
perm

its

ex
ce

ss
CO

pe
rm

its

TRADE

permits

– For example, suppose these two firms are each are allocated permits allowing them
to emit 10 tonnes CO2e per year. Firm ONE has installed renewable energy like tidal
power while firm TWO does not. In order to produce the excess emissions, firm TWO
needs to buy permits from ONE. ONE gets money and hence makes a profit helping to
finance the adoption of even more renewable energy.
– Firm TWO might not have been in a place rich in renewable energy and so found it
more expensive to abate than ONE. So, the theoretically expected result is that the
firm with the lowest abatement costs abates first making the cap and trade market
theoretically cost effective….i.e. the aggregate abatement target is met as cheaply as
possible. We will also show that carbon taxes are theoretically cost effective in money.
We will do this carefully later. This is a preview.

Pros and cons of tax vs
quota?

– go back over previous note to make a list.

3 iii) Marginal Subsidies to Reduce
Net GHG Emissions

200 Mt 150 Mt

Suppose Canada’s electricity firms are required to
reduce their emissions by 50 megatonnes over
the year.

∆ECan_electricity
= – 50 Mt

– recall that a megatonne is 1,000,000 tonnes, i.e. 1 million tonnes
(these are metric tonnes).

200 metatonnes

∆ = – 50
megatonnes

They are given the option of reducing their emissions
directly or paying other parties to reduce their
emissions, a process called “offsetting”.

Ex: Companies in places without wind, solar and could pay electricity companies in windy and sunny places to reduce
their emissions by closing fossil fuel plants and installing renewable energy.

– They could also pay people in other countries not to install fossil fuel generated electricity plants that would have
been installed under BAU because this would reduce emissions relative to BAU.
– Problems are that it may be very difficult to determine BAU emissions resulting in carbon leakage, a situation in
which the 50 megatonnes are not abated but it looks like they have been.
-Also, supposing the new fossil fuel plants would have been set up in low income countries and now are not, the firms
in the high income countries now continue to pollute and the people in the poor country forgo cheaper electricity and
the considerable benefits this brings (ex. internet access for all).
-Also, the high income country is in a stronger position to carry out the R&D on renewable energies such that such an
offsetting scheme can slow urgently needed technical change.

CO2CH4 NO2

Instead of paying other emitters like electricity
companies to abate, the Canadian electricity companies
could pay people NOT to convert forest carbon sinks
into agriculture or to restore them. These are called
forest offsets.

How much forest would need to be saved to absorb
50 Mt? Lets look at rainforest which sequesters a
stock of 1000 t/ha in soil and leaves.

Land needed
= 50,000,000 t / 1000t/ha
= 500 km2

1000 t/ha

100 m

22.4 km

22.4 km
500 km2

50,000,000 t

– The numbers are taken from the sink sequestration graph for the various biomes (see lecture 1).
– 1 hectare (ha) is 100m * 100m (think of a 400 meter track to get an idea of scale).
– 1 km = 100 ha.

– only includes soil and plant carbon sequestration. Ex. will not include carbon sequestered by Amazon
River. – You could also count the methane emissions from cows and or rice patties in the offset.
– I should subtract off carbon sequestered by the pasture but have not done so here. It will take time for
this carbon to be sequestered in the soil and so there is an important time element missing in my “back of
the envelope analysis”.
– To calculate the MAC, we would need to estimate the consumer and producer surplus from the
agriculture finding numbers like steaks per km, prices and people’s WTP for steaks and so on.

Currently, it is possible to offset emissions by paying
$10/ tonne CO2e to conserve rainforest. The rainforest
owners are then receiving a subsidy (s = $10/tonne).

200 Mt
$ 500 mill

offset
= 50 Mt

– We could avoid the firm part and the government could just pay the
forest people $10/tonne.

EBAU
= 200

$/t CO2e

Net
Emissions
(Mt CO2e/y)0

MAC = 40 – E/5

s = 10

Suppose that 2000 km2 of rainforest is to be
converted to agriculture. Suppose the MAC (i.e.
marginal private surplus lost due to the reduced
agriculture per tonne) is:

If agriculturalists are paid
a marginal subsidy of
$ 10/t, how much
rainforest will be saved?

All farmlandAll rainforest

– this price is set in a global offset market.

EBAU
= 200
$/t CO2e

Esubsidy
= 150

Net
Emissions
(Mt CO2e/y)

0
40

MAC = s
40 – E/5 = 10
30 = E/5
Es = 150 Mt

A
B C
D
s = 10

To solve for amount of
abatement under subsidy, set:

∴ 1/4 of the forest will be
saved (500 km2) preventing
the escape of 50 Mt from
the soil & plants.

All farmlandAll rainforest
0

Decision Rule of Private Parties with Subsidy Regulation in Place:

Abate a tonne ==> the marginal benefit to private parties = receive $10.
Marginal cost is the MAC (i.e the private surplus given up abating that tonne).
If MAC < s ==> abate the unit
If MAC >s ==> don’t abate the unit
When to stop? When MAC = $10/tonne which is SE.

– If this was the only forest in the world and the demand for offsets was 50 Mt, this would
be the equilibrium price assuming a one period world.

EBAU
= 200
$/t CO2e
Esubsidy
= 150
Net
Emissions
(Mt CO2e/y)
0
40

Total subsidy
= $10/t * 50 Mt
= $ 500
= Area C + D

A
B C
D
s = 10

Find the total subsidy paid by the Canadian firms
to the agriculturalists.

All farmlandAll rainforest
0

– I constructed the MAC so as to ensure that we got 50
megatonnes of abatement.

EBAU
= 200
$/t CO2e
Esubsidy
= 150
Net
Emissions
(Mt CO2e/y)
0
40
Total subsidy
= $10/t * 50 Mt
= $ 500
= Area C + D
A
B C
D
s = 10
Find the total subsidy paid by the Canadian firms
to the agriculturalists.
All farmlandAll rainforest
0

EBAU
= 200
$/t CO2e
Esubsidy
= 150
Net
Emissions
(Mt CO2e/y)
0

40
A

B
C
D
s = 10

Now suppose that the agriculturalists have been lying
about the MAC and were only going to cut down half
of the forest under BAU so the true MAC is:

All farmlandAll rainforest
0

MACTrue = 40 – E/2.5

EBAU_est
= 200

$/t CO2e

Eactual
= 75

Net
Emissions
(Mt CO2e/y)0
40
C
D
s = 10

If the forest is not being monitored carefully, the
agriculturalists will abate until the true MAC equals
the marginal subsidy:

All farmlandAll rainforest
0

MACTrue = s
40 – E/2.5 = 10
EActual = 75
∴ only 25 Mt emissions
are abated relative to the
true BAU.

EEst
= 150

EBAU_True
= 100

EBAU_est
= 200
$/t CO2e
Eactual
= 75
Net
Emissions
(Mt CO2e/y)0
40
C
D
s = 10

The Canadian firms have overpaid. They paid $500 million
for 50 Mt to be abated but only 25 Mt were abated. The
carbon leakage equals the amount that the Canadian
firms didn’t abate (50 Mt) minus the amount the
agriculturalists actually abated (25 Mt) = 25 Mt.

All farmlandAll rainforest
0 EEst

= 150
EBAU_True
= 100

A
B

The Canadian firms
should have paid area A
+B = $250 mill.

EBAU_est
= 200
$/t CO2e
Eactual
= 75
Net
Emissions
(Mt CO2e/y)0
40
C
D
s = 10

Even worse, now suppose that monitoring is perfect such
that abatement to 75 reveals to the Canadian government
monitors that the MAC estimate is incorrect. Suppose
they reestimate the MAC to be the true MAC. Now the
agriculturalists are paid A+B = $250 million.

All farmlandAll rainforest
0 EEst
= 150
EBAU_True
= 100
A
B

Will it pay the
agriculturalists to lie
about their MAC?

EBAU_est
= 200
$/t CO2e
Eactual
= 75
Net
Emissions
(Mt CO2e/y)0
40
C
D
s = 10

If the agriculturalists pretend their true MAC is the fake one, they
will cut down 3/4 of the forest and receive the $500 million subsidy.
In this case, emissions increased from the true BAU (100 Mt) to
150 Mt. So not only have the Canadian firms not abated 50 Mt but
the agriculturalists cut down the forest causing an additional 50 Mt
of GHGs so the carbon leakage is 100 Mt !!!

All farmlandAll rainforest
0 EEst
= 150
EBAU_True
= 100
A
B

– Canadian firms don’t have a strong incentive to monitor the
forest only caring that the $10/tonne is less than abating
themselves. Yet, we can see that careful monitoring by
government can lead to an even worse result. The problem is the
difficulty in determining BAU emissions.

In the above, the subsidy was part of an offsetting
policy.

However, subsidy payments could be made by the
Canadian government as part of a government
directed international offsetting scheme or by the
rainforest country’s government in order to meet
Copenhagen targets.

In this case, the subsidies need to be financed. The
most efficient means to finance the subsidy is by
taxes on GHG emissions.

– Costs Government $

– uncertainty in BAU level of emissions
with possible “carbon leakage” and
government over-paying.

– Carrots may
provide better
incentives than
sticks.

Pros:

– Money
Efficient and
money cost
effective if set
correctly and
enforced.

– Can be politically difficult to
remove later due to job losses
and loss of profits.

Cons:

– Gives polluters a property
right to emit at BAU level which is
not the socially efficient level.*

* conflict with the “polluters’ pay principle”.
– it might be a better idea to tax forests based on the emissions
the forests would have sequestered had they been in the natural
state.

C
A

P left over
permits

ex
ce
ss
CO
2
pe
rm
its
$
TRADE
permits
&

Can you see how cap & trade
has both a tax & a subsidy
within it?

– The big emitter is “taxed” because it has to pay for the extra permits while firm which has reduced its emissions and so can sell permits is effectively subsidized to
reduce its emissions.
– Cap and trade is theoretically money cost effective if markets are competitive, hits cap if monitoring and enforcement is perfect so as to get full compliance to the
policy. It also provides a high incentive to adopt and invent low GHG technology because firms can sell excess permits for profit or avoid paying for extra ones!
– In theory, cap and trade is a sort of best of both worlds of the quota and the carbon tax. There are some big drawbacks however. For example, since new markets
are created and will need to be regulated since markets can be gamed to be discussed later. Hence, regulatory costs are higher.
– cap and trade may also include sinks like forests called “forest offsets”. A problem here is determining the BAU amount of deforestation with potential for big
emitters to pay “offsets” to save forests when the forest would not have been cut down anyway under BAU. In this case, net emissions need not change (or could
even increase) so the cap and trade policy is ineffective and could even be harmful.
– We can now see why James Hansen refers to such schemes as “loopholes” preferring simple systems like carbon taxes and fees and quotas on fossil fuels at the
point of extraction (direct targeting of inputs which was described in the section on Pigouvian taxes and quotas).

Interpreting MAC & MD as
Inverse Demand & Inverse

Supply

for Emissions

EBAU
= 40
$/tonne
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E

Explain why the MAC is the inverse demand for
emissions. Hint: Who is demanding the emissions and
why?

– The MAC is the private surplus forgone by reducing emissions
by one tonne (more generally, its the rate at which private parties
forgo surplus due to abating).
– Hence, it is the producer and consumer willingness to pay
for the right to pollute an additional unit, i.e. the marginal WTP
for the right to pollute such that MAC(E) = MWTPPrivate_Parties(E).
– Hence, the MAC can be thought of as the inverse demand for
emissions, i.e. the maximum price private parties are WTP for the
right to pollute an additional unit.

EBAU
= 40
$/tonne
Emissions
(Gt CO2e/
period)
0
80

$ MD = 50PSE = 50

Explain why the MD is the inverse supply for
emissions. Hint: Who is damaged?

– The third parties are damaged at a rate of $50/tonne CO2e.
– Imagine that they could charge the private parties for the right
to pollute. They would demand a minimum of at least $50/tonne
as compensation.
– Hence, $50/tonne is the minimum they will be WTA as
compensation for damages. This is their opportunity cost and it
is what they would be paid if there was not a missing market for
GHGs.
– Hence, we can think of the MD as the supply curve for
emissions.

EBAU
= 40
$/tonne
ESE
= 15
Emissions
(Gt CO2e/
period)
0
80
MAC
= 80 – 2E

$ MD = 50
A

B C
D
PSE = 50

Hence the MAC and MD are the demand and supply for emissions.
These are said to be “derived” demand and supply curves as the
GHGs are residual byproducts of the markets for goods, services
and inputs.

D
em

and
Supply

4 – Equity, the Price of Thneeds
and guiding the invisible hand (to

make it “green”)

D
S

Coal generated
electricity

Q
P

Low GHG electricity

D
S
Q

– Carbon taxes and emissions standards raise the relative cost of making GHG intensive
goods, thereby raising the relative price and causing demand to fall (move along demand curve).
The demand for the Low GHG goods rises since they are relatively cheap. This drives up the price
of the low GHG goods making it profitable for firms to increase production which then lowers the
price due to factors like scale economies, incentives to lower costs to make more profits, and
market entry creating competition.
– All of the policies of carbon taxes and subsidies to renewables guides the invisible hand in the
low-GHG direction –towards the carbon neutral economy.
– Informed ethical consumers will shift demand curve down for the dirty goods and increase the
demand for the low GHG goods.
– Education and moral suasion are important government policies to promote ethical
consumption.

Policies like carbon taxes,
emissions quotas, cap and trade
raise the price of carbon
intensive goods and services
(most of them)

This can be very inequitable.

Income redistribution like
Climate Superfund needed,
rebates to low income people.

Progressive income taxes.

– Source picture starving child: http://www.prlog.org/
11146863-can-we-end-poverty-new-group-believes-we-
can.html

Too low to meet target and does not
cover all sectors.
– BC Target = 33 % below 2007 levels by
2020
– Too low! Jaccard estimates this will
only bring BC 8% of the way towards its
target.

– Ex. BC carbon tax ($ 30/tonne) is revenue neutral…this
means that for all carbon taxes collected, taxes are removed
elsewhere.
– Efficiency enhancing.

1) income taxes reduced
2) corporate taxes reduced.

– lump sum rebates given to public.

Challenge Making Tax Fair:

This person will not get
compensated for higher
prices through this
system.

– As low GHG alternatives are developed, prices would hopefully fall.
– Policies need to be applied gradually to prevent large macroeconomic
shocks.

– BCs Carbon Tax Act Can be found here:
http://www.leg.bc.ca/38th4th/3rd_read/gov37-3.htm

Summary

– We looked at Nova Scotia’s policies which are mainly
quantity and quality mechanisms.

– These include an emissions standard for the province,
forest sink floors, fuel efficiency standards for
ground transport, design standards like building codes,
technology standards in the form of a renewable energy
quotas, and feed in tariffs to encourage adoption of
renewable energy since NS Power is forced to buy renewable
energy at prices which are high enough to make it profitable
to enter the renewable energy industry.

– We then looked at a variety of policies using the MAC &
MD framework including carbon taxes, emissions
standards, cap and trade (brief), and emissions
reductions subsidies.

– We saw the subsidy system could result in carbon
leakage, with the potential to cause emissions to increase.
The problem is determining the true BAU emissions level.

– Also, cap and trade contains both a tax element and a
subsidy element with the latter making it vulnerable to
carbon leakage.

– If these policies are properly monitored and enforced and
the BAU level of emissions is known, all of these policies
are expected to raise the relative price of GHG
intensive goods helping to guide the invisible
hand to create the carbon neutral economy.

– Policies for equity need to be simultaneously
considered.

6- Practice Questions:
1) List some of Nova Scotia’s policies? Are these quantity or
price mechanisms?
2) Would you recommend a cap and trade system as a
method of population control? Explain how this would
work? Suggest some pros and cons? Do you think this would be
equitable?
3) Under an emissions standard (quota on emissions), what area
on the graph represents the firm’s total abatement costs
(TAC)?
4) Do you think firms and consumers will prefer a carbon tax
or an emissions standard. Explain. Show how much money
they lose under each policy relative to BAU.
5) Will firms like taxes better or cap and trade (under permit
give away) ?
6) Explain why the target may not be met such that there is
“carbon leakage” under a subsidy system.

Answers:
3) C
4) tax-pay total tax + TAC = B + C
emissions standard- pay TAC only as they get to pollute 15
for free. This is called the total cost of compliance to the policy
and its lower for the emissions standard. Hence, we see
strenuous lobbying against carbon taxes.
5) They will prefer cap and trade as they are given permits and so
have to pay lower total cost of compliance under the cap and
trade system than under a carbon tax.

L7_Marginal Abatement Cost Marginal Damage Worksheet
(MAC MD)
Ruth Forsdyke

The MAC-MD model is used estimate the social benefits and costs of the net GHG emissions in order to
estimate socially efficient (SE) trajectories and prices of greenhouse gas emissions, that is those that
maximize the total social surplus from the GHG emissions over time.

The MAC(E) and MD (E) equations in units of happiness units/tonne CO2e can be derived “top down” as
outputs from dynamic optimization models (called IAMs) in which there is a benevolent social planner,
the objective of whom is to maximize the happiness (utility) of the greatest number of people and other
organisms over time; The social planner takes the utilitarian objective as the criteria the evaluation of
“social welfare” in the model. The models are then calibrated using money estimates of abatement costs
and net damages from emissions where money units can be converted into theoretical typical consumption
units by dividing money world income by the price of an “average basket of goods and services”. More
detail will be provided when we discuss IAMs. The MAC and MD curves can also be estimated from the
“bottom up” by estimating costs of abating GHGs given the technological options and monetary estimates
of damages.

The MAC is the demand equation of the private parties for emissions while the MD is the supply
equation.

This worksheet shows how the MAC MD framework relates to the Pigouvian goods, services and output
framework developed in L3 to L5. Note that the following interpretation assumes that the objective is to
maximize the total money social surplus over time and not the utility of the greatest number as in the
IAMs model. The social welfare criteria of the planner in our worksheet model hence corresponds to a
situation of money social efficiency in which the total money private surplus from emissions – net negative
externalities from emissions (valued in money) is maximized. This would be the case in which the
externalities were paid for, i.e. “internalized” by the private parties such that they have to pay the third
parties for the net damages inflicted, i.e. the producers’ MC curve would correspond to the social supply
curve in the Pigou model.

The private party surplus (net benefits) from emissions is derived indirectly through the surplus from the
thneeds, the output of which creates the residual GHG byproducts.

The framework divides parties up into two groups instead of 3 as in the Pigou model. This makes the model
simpler to analyze but at a cost of information about how private surplus is divided up between consumers and
producers. The two parties are:

1) Private parties = consumers and producers (get consumer and producer surplus)
2) “Third parties” who experience the net negative externalities.

This work sheet is designed to be guided discovery, letting you discover the concepts on your own. Try
answering the questions. As you go, you can check your answers with the answer key or use them to help you
out if you get stuck. You may find that there is a lot to keep track of right now!—with practice, the concepts
should become clear.

1a) List some benefits of net GHG emissions?

b) List some costs of net GHG emissions?

2) Next, we will develop the MAC-MD framework from Pigou’s market framework focusing on one
particular good, service of input (thneed).

Graph 1: Market for Thneeds with Externalities:

a) At socially efficient allocation, find:
Economic allocation socially efficient (QSE) Privately efficient (QM)
Total social surplus
Total private surplus
Total external costs

b) Label on your graph.
* Recall that marginal benefit private is equal to the consumers’ marginal willingness to pay =
MBPrivate = 100 – Q. This is also equal to the marginal social benefit because we assumed no positive
externalities such that MBSocial = MBPrivate + 0 (more realistically, think of MCexternal as having netted out
the positive externalities.

3) Plot the marginal private surplus (marginal consumer benefits – marginal producer costs) and the
marginal external costs ($50/unit) on the graph below. Use the table to help you.

Quantity of good
(units)

Marginal private
benefit

Marginal private
cost

Marginal private
surplus

Will total private
surplus increase or
decrease if output is
increased by one unit?

0 100 20 80 increase
15
40
60
80
100
Q 100- Q 20+Q (eq’n 1) Depends on Q

Graph 2: Marginal Private Surplus for Thneeds and External Costs

4) The area under the $ marginal private surplus curve from 0 to Q represents the _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
from production and consumption of Q goods.

5) The area under the $ marginal external cost curve from 0 to Q represents the _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
of production and consumption of Q goods.

100

QMarket
=

QSE
= 15

3) At s o c i a l e ff i c ie n t q u a n t it y of 15
goods:
T o t a l p r iv a te s u r p l u s = area
__________= $________________

T o t a l e x te r n a l c o s t s = area ___________
= $__________________
T o t a l so c ia l s u r p lu s = T o t a l p r i v a t e
s u r p l u s – to t a l e x te r n a l c o s ts =
Area __________________ – Area
______________ = Area _______________=
$__________________

4) At p r i v a t e l y e ff i c ie n t q u a n t it y of
40 goods:

T o t a l p r iv a te s u r p l u s = area ________=
$_____________
T o t a l e x te r n a l c o s t s = area _________ =
$ ________________
T o t a l so c ia l s u r p lu s =
Area _______________ – Area _____________ =
Area ______________ = $_______________

Quantity
thneeds
(units/ year).

$ /good

Notice how the new graphical framework is simpler due to aggregating the benefits and costs of the
private parties to get the marginal private surplus. The framework is simpler, but with a cost in
terms of loss of information.

Note: The external costs are really “net external costs” whereby external benefits like lower winter
heating bills have been subtracted out. Adding the external benefit curve to the graph would make it
more complicated and hence more difficult to learn.

6) Now we modify the framework to focus directly on emissions. Assume that each unit of output
causes one tonne of GHG emissions (E) such that Q = E, where E represents GHG emissions in
CO2e/year.1

a) Marginal private surplus of Q goods = _________________ (eqn. 1 from table above)

Now substitute E for Q, where E = Q into equation 1 to get:
b) Marginal private Surplus (E) = _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ( a l s o c a l l e d t h e M a r g i n a l
A b a t e m e n t c o s t a s p r i v a t e p a r t i e s g i v e u p s u r p l u s d u e t o a b a t e m e n t ) .

MAC(E) = __________________

7) Plot MAC and MD curves on the graph below. Note that the units on the vertical axis are $/tonne
while those on the horizontal axis are tonnes/ year. These are unrealistic numbers for simplicity.

1 Note that if the relationship between Q and E changes, the translation between our two graphical set ps
will not be as simple.

– If we increase emissions by one unit (left to right on graph), the private parties gain
marginal private surplus (a net benefit), while the third parties experience a net
marginal external cost (a net cost) of $50/tonne.

– If we decrease emissions by one unit (right to left on graph), the private parties
loose the marginal private surplus and hence incur a net cost (loss of producer and
consumer surplus) while the third parties make a net gain equal to the marginal
damages saved ($50/tonne).

– Economists, call the marginal private surplus of emissions the marginal cost of
abatement [MAC(E)] — taking the right to left perspective.

Graph 3: The Market for Greenhouse Gases (MAC-MD)

8) What area represents the total private surplus of producing 15 tonnes CO2e/year?
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

9) What area represents the total damages to 3rd parties of producing 15 tonnes CO2e/year?
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

11) What area represents the total damages reduced to third parties by abating emissions from the
competitive market equilibrium level of 40 tonnes to 15 tonnes? _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

12) The MAC represents the maximum marginal willingness to pay (max WTP) of the private parties
to emit an additional tonne of GHG emissions and is hence the _____________(demand or supply)
for/of emissions equation while the MD represents the minimum willingness to accept (minWTA) for
emissions and is hence the ____________ (demand or supply) for/of emissions

13) For each emissions level (E) in the table, find the MAC and MD and indicate whether decreasing
emissions by one additional tonne causes total social surplus to rise or fall.

Emissions
(tonnes)= E

MAC = loss marginal
private surplus
emissions due to
reducing emissions
by one unit = 80 – 2E

MD = marginal
surplus gain due to
reduced external costs
to 3rd parties = $50/
tonne CO2e

Marginal social
surplus change =
MD – MAC

Will total social
surplus from
emissions rise or
fall if emissions are
abated by one unit
given E emissions?

100

EMarket
= 40

ESE
= 15

0
20
40
60

7b) At s o c i a l e f f i c i e n t
q u a n t i t y of 15 tonnes:

T o t a l p r i v a t e s u r p l u s =
Area __________ = $_____________
T o t a l e x t e r n a l c o s t s
=___________
Area ___________ = $ ____________
T o t a l s o c i al s u r p l u s =
Area (A+B) – A = A = $ 225/
year

7c) At p r i v a t e l y e f f i c i e n t
q u a n t i t y of 40 tonnes:

T o t a l p r i v a t e s u r p l u s =
Area _______________= $ ____________
T o t a l e x t e r n a l c o s t s =
Area _____________ = $ _____________
T o t a l s o c i al s u r p l u s =
Area ______________________________=
$ _____________________________

Emissions (tonnes
of CO2e/year

$ / tonne
CO2e

17) a) What marginal tax on emissions (carbon tax) will induce firms to abate to money socially
efficient level? b) Find total carbon tax collected. (Show on a graph)

18) What quota on emissions (emissions standard) will induce firms to abate to the money socially
efficient level? (Show on a graph)

b) How could the subsidy be financed?

c) Suppose that the government overestimates the business as usual (BAU) level of emissions to be .
Will the government pay less or more subsidy than it needs to?

L7_MAC MD Worksheet Answers
Ruth Forsdyke

1a) List some benefits of net GHG emissions?
1 ) P r o d u c e r s ’ R e v e n u e f r o m s e l l i n g G H G i n t e n s i v e g o o d s .
2 ) U t i l i t y / h a p p i n e s s / w e l l b e i n g d e r i v e d f r o m n e e d s a t t a i n e d f r o m c o n s u m i n g G H G i n t e n s i v e

g o o d s ( m e a s u r e d i n m o n e y u n i t s a s m a r g i n a l W T P ) .
E x . T r a n s p o r t e n e r g y ( p u b l i c a n d t r a n s p o r t ) , f o o d , h o m e a p p l i a n c e s , c o m p u t e r s , l i g h t s , h e a t f o r
h o m e s , n e w c l o t h i n g , m o v i e s , f u r n i t u r e , w o o d f r o m u n s u s t a i n a b l y l o g g e d f o r e s t s a n d f i s h f r o m
u n s u s t a i n a b l y f i s h e d s e a s , t h e l o c a t i o n a l c o m p o n e n t o f h u m a n s e t t l e m e n t s w h i c h h a v e d i s p l a c e d
n a t u r a l c a r b o n s i n k s , e d u c a t i o n .

b) List some costs of carbon dioxide emissions? D r o u g h t s , f l o o d s , b l e a c h i n g o f c o r a l r e e f s , c o a s t
l i n e e r o s i o n , l o s s o f c o a s t a l l a n d f o r f a r m s , r e s i d e n t i a l a r e a s , i n d u s t r i e s a n d e c o s y s t e m s d u e t o
s e a l e v e l r i s e , d a m a g e f r o m i n t e n s e w e a t h e r e v e n t s l i k e h u r r i c a n e s a n d t o r n a d o s , s p r e a d o f
d e s s e r t s , s h r i n k a g e o f a r c t i c h a b i t a t ( e x . r i n g e d s e a l s a n d p o l a r b e a r s ) , l o s s o f c o r a l s a n d h a r m t o
o c e a n e c o s y s t e m s d u e t o w a r m e r w a t e r , h a r m t o o c e a n e c o s y s t e m s a n d f i s h i n g i n d u s t r y d u e t o
m o r e a c i d i c w a t e r s c a u s i n g s h e l l s o f s h e l l f i s h a n d c r u s t a c e a n s ( e x . c r a b s a n d l o b s t e r s ) t o
d i s s o l v e , f o r e s t f i r e s d u e t o d r y i n g o u t , b e e t l e a n d m o t h d a m a g e s t o t r e e s d u e t o m o t h s a n d b e e t l e s
h a b i t a t m o v i n g p o l e w a r d s , i n c r e a s e d d i s e a s e s i n p o l e w a r d r e g i o n s d u e t o s p r e a d o f d i s e a s e v e c t o r s
l i k e M a l a r i a m o s q u i t o s .

2) a) At socially efficient allocation, find:
Economic allocation i) Socially efficient (QSE) ii) Privately efficient (QM)
I)Total social surplus ($) 225 225 – 625 = – 40

II) Total private surplus 975 80*40 = 1600
Total external costs 50* 15 = 750 50 * 40 = 2000

b) Graph 1: Total Social Surplus, Private Surplus and External Costs: Comparison with Market
and Money Socially Efficient Level.

I) Total Social Surplus (consumers, producers and third parties)

i) Socially Efficient Level ii) Perfectly Competitive Market Level

II) Total Private Surplus: (consumers and producers)

i) Socially Efficient Level ii) Perfectly Competitive Market Level

III) Total net external Costs (positive externalities netted out & I have just called these “external
costs”)
) Socially Efficient Level ii) Perfectly Competitive Market Level

• We can see that the total external costs are much larger at the market level than at the SE level.
• The top pink total social surplus graphs are attained by subtracting the mustard total external

costs from the blue total private costs.

3) Plot the marginal private surplus (marginal consumer benefits – marginal producer costs) and the
marginal external costs ($50/unit) on the graph below.

Table to help with plotting the marginal private surplus curve:
Quantity of good
(units)

Marginal private
benefit

Marginal private
cost

Marginal private
surplus

Will private surplus
increase or decrease if
output is increased by
one unit?

0 100 20 80 increase
15 8 5 3 5 5 0 I n c r e a s e
40 6 0 6 0 0 N o c h a n g e
60 4 0 8 0 – 4 0 D e c r e a s e
80 2 0 1 0 0 – 8 0 D e c r e a s e
100 0 1 2 0 – 1 2 0 D e c r e a s e
Q 100- Q 20+Q ( 1 0 0 – Q ) – ( 2 0 + Q )

= 8 0 – 2 Q
Depends on Q

4) The area under the $ marginal private surplus curve from 0 to Q represents the t o t a l p r i v a t e
s u r p l u s from production and consumption of Q goods.

5) The area under the $ marginal external cost curve from 0 to Q represents the t o t a l p r i v a t e
s u r p l u s of production and consumption of Q goods.

6) Now we modify the framework to enable us to focus directly on emissions. Assume that each unit of
output produces one tonne of GHG emissions (E) such that Q = E, where E represents GHG emissions
in CO2e/year.

a) Marginal private surplus of Q goods = 80 – 2Q (eqn. 1 from table)

Now substitute E for Q, where E = Q into equation 1 to get:

b) Marginal private Surplus (E) = 8 0 – 2 E ( i n $ / t o n n e G H G s ) ( a l s o c a l l e d t h e
M a r g i n a l A b a t e m e n t c o s t a s p r i v a t e p a r t i e s g i v e u p s u r p l u s d u e t o a b a t e m e n t ) .
MAC(E) = 8 0 – 2 E .

c) Recall that Marginal external cost (Q) = 50 $/ unit of good ( c o n s t a n t a n d h e n c e i n d e p e n d e n t o f Q
i n o u r e x a m p l e ) . Since Q = E, and each additional good produced causes external costs of 50 $/unit (the
marginal external cost), it follows that each additional tonne of GHGs (in CO2e) causes external
damages of $ 50 to the third parties called marginal damages. MD (E) = $ 5 0 p e r t o n n e o f G H G s
( t h i s i s c a l l e d t h e “ m a r g i n a l d a m a g e ” )
7) a) Plot MAC and MD curves on the graph below. Note that the units on the vertical axis are $/tonne
while those on the horizontal axis are tonnes per year.

Graph 3: MAC-MD Framework

8) What area represents the total private surplus of producing 15 tonnes CO2e/year?
A + B = $ 9 7 5 ( t h i s i s t h e t o t a l p r o d u c e r a n d c o n s u m e r s u r p l u s f r o m t h e G H G s —
i f c o n s u m e r s w e r e f o r c e d t o a b a t e t o E = 0 f r o m t h e S o c i a l l y e f f i c i e n t l e v e l , t h e y
w o u l d l o s e t h i s ! )

9) What area represents the total damages to 3rd parties of producing 15 tonnes CO2e/year? B = $ 7 5 0
( a g a i n i f t h e p r i v a t e p a r t i e s h a d t o a b a t e f r o m S E l e v e l t o 0 , t h e t h i r d p a r t i e s
w o u l d s a v e t h e s e d a m a g e s w h i c h w o u l d b e a n e t b e n e f i t t o t h e m ) .

10) What area represents the loss of net total private surplus due to abating emissions from the
competitive market equilibrium “Business as usual” (“BAU”) level of EBAU = 40 tonnes/yr to the $
socially efficient (SE) level of 15 tonnes/yr? C = $ 6 2 5 , t h i s i s t h e p r i v a t e p a r t y ’ s t o t a l
a b a t e m e n t c o s t s f r o m B A U e m i s s i o n s t o t h e s o c i a l l y e f f i c i e n t l e v e l ( w h i c h w o u l d
o c c u r u n d e r e n f o r c e d “ i d e a l ” r e g u l a t i o n s ) .

100

60
A =
$225

D=
$625

C =
$625

B =
$750

Emissions (tonnes
CO2e/year)

$ / tonne

Marginal Private
Surplus of
emissions = MA

Marginal
Damages

7b) At s o c i a l l y e f f i c i e n t
q u a n t i t y of 15 tonnes:

T o t a l p r i v a t e s u r p l u s =
Area A+ B = $ 975
T o t a l e x t e r n a l c o s t s =
Area B = $ 750
T o t a l s o c i al s u r p l u s =
Area (A+B) – A = A = $ 225/
year

c) At p r i v a t e l y e f f i c i e n t
q u a n t i t y of 40 tonnes:

T o t a l p r i v a t e s u r p l u s =
Area A+B+C = $ 1600
T o t a l e x t e r n a l c o s t s =
Area B+C+D = $ 2000
T o t a l s o c i al s u r p l u s =
Area_(A+B+C)- (B+C+D) = A-

= $ 225 – $625 = – $400

Price
CO2e =
50

ESE
= 15

EMarket
= 40

11) What area represents the total damages reduced to third parties by abating emissions from the
competitive market equilibrium level of 40 tonnes (BAU) to 15 tonnes? D + C = $ 1 2 5 0 ( t h i s
w i l l i n c l u d e b o t h d a m a g e s a v o i d e d ( e x c r o p l o s s d u e t o d r o u g h t s ) a n d a d a p t a t i o n
c o s t s a v o i d e d ( e x . U S f a r m e r s a v o i d i n s t a l l i n g e x p e n s i v e w a t e r s t o r a g e a n d
i r r i g a t i o n s y s t e m s / e x . c o a s t a l h o m e s d o n o t h a v e t o b e m o v e d i n l a n d ) .

12) The MAC represents the maximum marginal willingness to pay (max WTP) of the private parties
to emit an additional tonne of GHG emissions and is hence the D E M A N D for/of emissions equation
while the MD represents the minimum willingness to accept (minWTA) for emissions and is hence the
D E M A N D (demand or supply) for/of emissions (IF private parties are made to pay the third parties for
the damages).

13) For each emissions level (E) in the table, find the MAC and MD and indicate whether decreasing
emissions by one additional tonne causes total social surplus to rise or fall.

Emissions
(tonnes
CO2e/year)
= E

MAC = loss marginal
private surplus
emissions due to
reducing emissions
by one unit = 80 – 2E

MD = marginal
surplus gain due to
reduced external costs
to 3rd parties = $50/
tonne CO2e

Marginal social
surplus change =
MD – MAC

Will total social
surplus from
emissions rise or
fall if emissions are
abated by one unit?

0 8 0 5 0 – 3 0 D e c r e a s e
1 0 6 0 5 0 – 1 0 d e c r e a s e
1 5 5 0 5 0 0 N o c h a n g e
4 0 0 5 0 5 0 I n c r e a s e

17) a) What marginal tax on emissions (carbon tax) will induce firms to abate to money socially
efficient level?

Graph 4: Carbon Tax in the MAC-MD Framework

– T h e m a r g i n a l c a r b o n t a x i s $ 5 0 / t o n n e .

80
100

EMarket
= 40

ESE
= 15
0
20
40

Price
CO2e =
50

B =
$750

Emissions (tonnes
CO2e/year)

$ /tonne CO2e

Marginal Private
Surplus of
emissions = MAC

Marginal Damages
= Marginal Carbon Tax

D
C

Total carbon
tax = B

– F o r E > 1 5 , p o l l u t e r s w i l l s a v e m o r e t a x o n e a c h u n i t a b a t e d t h a n i t w i l l c o s t
t h e m t o a b a t e ( i n t e r m s o f p r i v a t e s u r p l u s l o s s ) . H e n c e , t h e y w i l l a b a t e a t o n n e .
T h e y w i l l s t o p a b a t i n g a t E = 1 5 b e c a u s e t h e m a r g i n a l t a x s a v e d w i l l b e e q u a l t o
t h e m a r g i n a l p r i v a t e s u r p l u s l o s t . T h e y w i l l n o t a b a t e f u r t h e r t h a n 1 5 t o n n e s
b e c a u s e t h e t a x s a v e d p e r t o n n e i s l e s s t h a n t h e m a r g i n a l p r i v a t e s u r p l u s l o s t .
– M a r g i n a l t a x l i n e i s s a m e a s M D b u t o n l y h o l d s b e c a u s e t h e M D i s c o n s t a n t .
– A c o n s t a n t M D i s r e a s o n a b l e o v e r a s h o r t t i m e f r a m e l i k e 1 y e a r b e c a u s e e a c h
a d d i t i o n a l t o n n e o f e m i s s i o n s c a u s e s a b o u t t h e s a m e d a m a g e s . I n t h e l o n g e r r u n
( s a y 1 c e n t u r y ) t h e M D c u r v e i s e x p e c t e d t o s l o p e u p w a r d a s m o r e d a m a g e s a r e
e x p e c t e d t o b e i n f l i c t e d b y l a t e r e m i s s i o n s a s t h e G H G s c o n t i n u e t o b u i l d u p i n
t h e a t m o s p h e r e .

b) Find total carbon tax collected. (Draw on your graph)
– T h e t o t a l c a r b o n t a x i s $ 5 0 / t o n n e * 1 5 t o n n e s / y e a r = $ 7 5 0 / y e a r
– T h i s c o r r e s p o n d s t o t h e a r e a u n d e r t h e M D c u r v e f r o m 0 t o 1 5 t o n n e s ( B )
– I f t h e p r i v a t e p a r t i e s d i d n o t a b a t e a t a l l , t h e y w o u l d h a v e t o p a y 4 0 * 5 0 =
$ 2 0 0 0 o f c a r b o n t a x , s o t h e y s a v e a r e a D + C .

18) What quota on emissions (emissions standard) will induce firms to abate to the money socially
efficient level? (Draw on your graph) T h e g o v e r n m e n t s e t s a n e m i s s i o n s s t a n d a r d o f 1 5
t o n n e s p e r y e a r a n d t h e f i r m s a r e f i n e d i f t h e y e m i t m o r e t h a n 1 5 t o n n e s p e r
y e a r . G r a p h i c a l l y , d r a w a v e r t i c a l l i n e a t 1 5 t o n n e s / y e a r .

19) a) What marginal abatement subsidy could be used to get the firm to abate to the money socially
efficient level? b) What is the total subsidy if government correctly estimates business as usual
emissions? (Draw on your graph). T h e m a r g . a b a t e m e n t s u b s i d y i s $ 5 0 / t o n n e — i . e f o r
e a c h t o n n e a b a t e d b e l o w B A U , t h e g o v e r n m e n t p a y s t h e f i r m $ 5 0 . T h e t o t a l
s u b s i d y i s ( 4 0 – 1 5 ) * 5 0 = $ 1 2 5 0 ( A r e a C + D ) .

Graph 5: Marginal Abatement Subsidy in the MAC-MD Framework

80
100

$ /tonne CO2e
Marginal Private
Surplus of
emissions = MAC

Marginal Damages
= Marginal Abatement
Subsidy

C
D
ESE
= 15
EMarket
= 40

Total carbon
subsidy = B

b) How could the subsidy be financed?
T h e s u b s i d y i s f i n a n c e d b y t a x e s o r t h e g o v e r n m e n t i s s u e s b o n d s t o b o r r o w t h e
m o n e y i n w h i c h c a s e , i t l a t e r p a y s t h i s m o n e y b a c k t o l e n d e r s o u t o f f u t u r e
t a x e s .

c) Suppose that the government overestimates the business as usual (BAU) level of emissions to be .
Will the government pay less or more subsidy than it needs to?
T h e g o v e r n m e n t w o u l d p a y t o o m u c h s u b s i d y . F o r e x a m p l e , s u p p o s e t h e
g o v e r n m e n t i n c o r r e c t l y e s t i m a t e s t h e B A U e m i s s i o n s l e v e l t o b e 4 5 t o n n e s / y e a r .
I t w i l l e n d o u t p a y i n g ( 4 5 – 1 5 ) * 5 0 = $ 1 5 0 0 o f t o t a l s u b s i d y ( m o r e t h a n i n
p a r t a ) .

20) Why should we be concerned about using monetary social efficiency as a social wellbeing
criterion to determine optimal carbon taxes, abatement subsidies, emissions standards or sink
photosynthesis floors in a world, which has a very unequal income distribution?
– T h e p o l i c i e s a r e s e t t o m a x i m i z e t h e T o t a l s o c i a l s u r p l u s ( = m o n e t a r y t o t a l
p r i v a t e s u r p l u s m i n u s t h e t o t a l d a m a g e s t o t h e t h i r d p a r t i e s ) . T h e u s e o f m o n e y
p u t s m o r e w e i g h t o n h i g h i n c o m e v s . l o w i n c o m e p e o p l e ’ s b e n e f i t s a n d c o s t s a n d
s o t h e f i n a l a l l o c a t i o n m a y n o t m a x i m i z e t h e t o t a l s o c i a l s u r p l u s w e r e i t t o
i n s t e a d b y m e a s u r e d i n h a p p i n e s s o r u t i l i t y u n i t s ( u t i l s ) . I t i s q u e s t i o n a b l e
w h e t h e r u t i l i t y c a n b e m e a s u r e d i n t h e o r y a n d i n p r a c t i c e .

L6: Correcting Market Failure
(c)Ruth Forsdyke

– Fossil fuel use for international trade was not accounted for under the Kyoto Protocol. Raising the price of fossil fuels would raise the price
of transportation helping to correct the externality

– International trade agreements like the WTO and the NAFTA fail to contain provisions to make users pay for their GHG and other environmental
externalities. In absence of Pigouvian pricing of inputs to production (like a tax on GHGs), it would be money efficient to allow importers to
place tariffs on imports based on the GHGs that were created during production of the good. This is difficult to do under WTO rules. WTO rules
need changing. Currently, the EUʼs carbon tax on emissions on air traffic is being challenged by China under WTO rules.
===================================================================
* Draft Copy_ not for widespread distributions as permissions for copyrighted items not attained.
– no copyright claim on copyrighted or public domain media. Copyrighted media used under Dalhousies Copyright Act. Hence, this document is
not for public distribution.
Cover picture container ships released into public domain by Ruth Forsdyke (please cite).

Topics List:
1.Introduction & basic policy types.
2.Backgrounder on Transport Emissions.
3. Regulating Markets with GHG Negative Externalities

3.1 Quotas
3.2 Taxes
3.3 Targets along supply chain
3.4 Quality Mechanisms

4. Comparing Price vs Quantity Mechanisms
5. Regulating Markets with GHG Positive externalities.
5.1-Backgrounder forest carbon sinks

5.2- Pigou’s model of Positive Externalities.
5.3- Regulating a market with Positive Externalities.

6. Removal of Inefficient Subsidies on Fossil Fuels
7. Equit

8. Summary

1-Introduction:

– Having just introduced the Alfred Pigou’s
externalities and monetary social efficiency
framework, the key framework employed in
environmental economics, and a necessary tool to
understanding global warming economics, we are now
ready to investigate policies to correct the
market failure.

Arthur Cecil Pigou
(1877 – 1959)

Recall that Pigou’s framework illustrates that if there
are negative externalities, a perfectly
competitive model market will maximize the total
private surplus of the market but not the total social
surplus; Prices will be too low because they do not
reflect full social costs while output will be too high.

Pigouvian policies work by getting private
parties to take into account their externalities by
making them pay the external costs or rewarding
them with the external benefits.

This is called “internalizing the externalities”.

– There are a variety of available policy tools .

– Economists categorize policies according to:

1) Whether they target prices, quantities,
or qualities of GHG impacting goods or
services.

2) What is the most direct target of the
policy.

The policy can most directly target:

i) intended outputs of production units, i.e.
“thneeds”, including goods, services and intermediate
goods at the various stages along the supply chain,

ii) residual byproducts (the GHGs)
iii) human attitudes, beliefs, norms, values via
information provision and moral suasion.

– Multiple policies can be employed simultaneously.

In this lecture, we will focus on policies, which most
directly target the thneeds markets.

– There are two types of production units to
consider. Those that cause atmospheric GHGs
to…

1) increase and hence cause negative
externalities (ex. transport in cars) or

2) decrease and hence cause positive
externalities (ex. natural forests or wetlands).

Firstly, since we have already developed the corresponding
Pigouvian framework, we’ll look at policies to correct
failure in markets that cause negative GHG externalities.
Our application will be gasoline.

Secondly, after introducing Pigou’s framework to examine
market failure due to positive externalities, we look at a
positive-externality-causing thneed, the service of
protecting natural forests, which remove carbon
dioxide from the atmosphere through photosynthesis and
store it in the carbon sinks (carbon sequestration).

Throughout, we’ll discuss pros and cons of policies
which target market prices, quantities or qualities vs. other
targets such as the GHGs themselves.

2-Brief Backgrounder on
Transport Emissions

Source image: Transport and Its Infrastructure (IPCC, 4th Assessment Report) http://www.ipcc.ch/pdf/assessment-report/ar4/wg3/ar4-wg3-
chapter5

To investigate policies to correct market
failure in the case of negative GHG externalities,
we will investigate the context of travel
emissions.

– for detailed discussion of the

Transportion services are an important source of
GHG emissions. In 2004, transport emissions made up
about 13% of world GHG emissions about 6.4
Gt.

θWTransport
= 0.13

EW2004 = 49 Gt Transport Share
= θWTransport * EW2004
= 0.13 *49 Gt
= 6.4 gigatonnes

The 2004, emissions from the transport
sector weighed about 50 times as much as
the human population.

To calculate world (W) emissions from the
transport sector, multiply world total emissions by
the transport share.

– Fastest growing share in Annex 1 countries and second in non-Annex 1 countries.

6.4 Gt underestimates the total share of
emissions due to transport as many transport
emissions are accounted for in other sectors.

– energy to make
transport
vehicles, roads,
ports, airports
and railway tracks
and to provide
power for these
sectors.

6.4 Gt

– ex. GHG
byproducts of
growing crops
like corn and
palm oil to
make biofuels
and food to
power
cyclists,
pedestrians
and donkeys.

– Details are found in National GHG inventories and these would allow us to make estimates of the amounts of the other sectors that contribute
to the transport sector.
– The sectoral picture here is constructed from the GHG inventory data available at:
Greenhouse Inventory Data: http://unfccc.int/ghg_data/items/3800.php

– Under business as
usual (BAU), i.e. a lack of
regulation, transport
GHG emissions expected
to double globally by
2050.

– fastest growing sector in
Annex 1 countries and
second in non-Annex 1
countries.
As such, regulating transit
emissions is essential to
preventing a 20C
temperature rise.

Source image: Transport and Its Infrastructure (IPCC, 4th Assessment Report) http://www.ipcc.ch/pdf/assessment-report/ar4/wg3/ar4-wg3-
chapter5 { also see pg. 162, DP for a brief summary}
– Shipping of crude oil and oil products made up 40% of the demand for shipping services in 2005 (pg. 335)
– Canadaʼs transport sector (only including oil combustion not making cars and so on) was responsible for 24% of GHGs (considerably higher
than the world average)
– From 1990 to 2008, emissions from Canadian cars fell by 12%. While this looks good on the surface, it isnʼt because emissions from “light
trucks” rose by 55%.
– Under the Corporate Average Fuel Efficiency Standards (CAFE standards), car maker fleets had to achieve average fuel efficiency standards
for new vehicles. Cars had a tighter standard than light trucks. Car makers responded by marketing light trucks to consumers instead of cars,
thereby successfully changing peopleʼs preferences. These “light trucks” are the SUVs and minivans which were not popular before the 1990s.
This is an example of a poorly designed policy.
– Another reason for North American automakers favouring light trucks was due to a higher tariff rate on light trucks than cars. The tariffs were
imposed on European automakers in retaliation for a European tariff on frozen chickens.
– Emissions from domestic aviation, domestic marine, rail, buses and motorcycles also rose.
International trade increased massively in the 1990s, for example due to signing of free trade agreements (ex. WTO and NAFTA). This also
increased transport emissions..
http://www.climatechange.gc.ca/default.asp?lang=En&n=97C0E131-1

Under BAU, the stock of light duty vehicles
(i.e. cars and “light trucks”) is expected to triple by
2050.

– Light duty vehicles include cars, SUVs and minivans, i.e. private passenger vehicles.
– According to the Stern Review (Annex 7c.), in the early 2000s, fuel efficiency in the USA was about 2/3 the level in the EU. The EU has
significantly higher gasoline taxes providing people with incentives to drive more fuel efficient cars. Crude oil is also higher priced in the EU vs
American market (Brent Spar Price is $113/barrel vs. $ 98/barrel in USA.
– the Keystone XL pipeline is being extended from Cushing to Port Arthur Texas to export oil from US refineries. Without a current increase in
production from Alberta Tar Sands to Cushing, we would expect the US price of gasoline to rise. The State of Nebraska has approved the
pipeline. There is great pressure for Obama to approve it. However, American climate scientist has heavily advised against this warning that in
order to prevent the > 2 degrees temperature rise, non-conventional oil and gas must remain in the ground.
Source Image: Pg. 334 of 334, Transport and its Infrastructure (IPCC)
http://www.ipcc.ch/pdf/assessment-report/ar4/wg3/ar4-wg3-chapter5

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1000
people

year

Canad

ChinaGhana
India

Germany

Russian Fed.

Brazi

Denmark
Japan

We can see that cars per capita varies greatly by country
with an upward trend globally with about 13% owning cars.

World

– Passenger cars refers to motor vehicles other than 2-wheelers, intended for carriage of passengers and designed to seat no more than 9
people (so this includes SUVs).
– Interestingly we get a massive increase in cars per capita in the USA after the crash. One hypothesis as to the reason is recessionary
spending. Another is that due to a steep increase in the price of oil, people decided to buy a second more efficient car but have not yet retired
their gas guzzlers. This might be an interesting 4th year project.
– Although Germany has more cars per capita than Canada, they are more fuel efficient.

Kaya Type Equation for Cars:

Total Emissions from cars

= Population * Cars/capita * Average
distance driven per car * Average
energy per unit distance * GHGs/
unit car energy

Some ways to reduce emissions from cars:
1) Make fewer cars by building efficient public transit systems and efficient urban planning such as compact cities/ this will also save

people

time.
2) make engines more efficient.
3) change to less carbon intensive fuel.
4) reduce emissions from non-CO2 GHGs from vehicle exhaust and climate controls.
5) reduce the birth rate.
6) roundabouts which keep traffic flowing/ ban drive throughs.
7) use existing cars less.
8) make them lighter.
9) working from home.
10) job sharing so people are not so rushed.
11) Regulate automobile advertising which targets self esteem.

Kaya Type Equation for Cars:
Total Emissions from cars
= Population * Cars/capita * Average
distance driven per car * Average
energy per unit distance * GHGs/
unit car energy

= 1,337,825,000.00 0.04381451535*
= 58,616,154 cars

PopulationChina2010 * Cars/capitaChina2010

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people

2003 – 2010: In China, cars per 1000 people increased
from 10 to 44. Due to the large and growing population, #
of cars rose from ~ 12 to 59 million between 2003 & 2010.

# of cars per 1000 people data source: http://data.worldbank.org/indicator/IS.VEH.PCAR.P3
population of china data source: http://search.worldbank.org/data?qterm=population&language=EN

100 km

Calculating GHG footprints from driving:

– Suppose this car meets the CAFC fuel efficiency
standard = 6.8 L/ 100 km

– Carbon footprint (E) = 6.8 L * 3.0167 kg/L
= 20 kg CO2e

– External cost to drive 100 km = ?

– Assume PCO2e = $50/tonne

– To visualize 6.8 L of oil, imagine 6 litres of milk.

100 km
Calculating GHG footprints from driving:
– Suppose this car meets the CAFC fuel efficiency
standard = 6.8 L/ 100 km
– Carbon footprint (E) = 6.8 L * 3.0167 kg/L
= 20 kg CO2e

– External cost to drive 100 km = 20 kg
CO2e * 50 $/tonne CO2e * 1 tonne/ 1000 kg = $1

– Assume PCO2e = $50/tonne

– To visualize the equivalent weight of 20 kg of carbon dioxide, note that 20 kg = 44 lbs– so imagine the weight of 44 lbs of butter. This is also
about 1/3rd of my weight.
– Since GHGs are invisible, we have a hard time taking them seriously, visualizing them may help us to understand the problem.

100 km

– Current gasoline price in Halifax = 125.1 cents/ L

(41.82 cents of this is tax including provincial,
federal excise taxes and GST/PST)

Current gasoline cost consumer to drive
100 km = 125.1 cents/ L* 6.8 L/100km = $ 8.51

If drivers had to pay for the GHG externality at the
low carbon price of $50/tonne, how much would it
cost them?

– For example, the Nova Scotia excise tax on gasoline is 15.5 cents/L with the national excise tax of 10 cents/L. The GST/PST of 15% is then
applied on top of that.
– The tax breakdown is a sales tax of 16.32 cents/L and 25.5 cents/L of excise tax.
– Since drivers do not pay the full social cost of driving (i.e. this tax is too low), they are subsidized. Subsidies are inefficient.
– The subsidy is even worse for other types of fuel. For example, Nova Scotiaʼs fuel taxes are:
15.5 cents/L gasoline.
15.4 cents/L diesel.
Propane = 7 cents/ L.
Marine fuel = 1.1 cents/L
Aviation fuel = 2.5 cents/L
Biofuels (which have higher GHG footprints than diesel when sink damages are estimated) are subsidized in many places.

100 km

If we made this driver pay for the estimate of the
damages inflicted on others, which is referred to as
“internalizing the externality”, given our
(rather low) carbon price, it will cost this person
$1 more to drive a 100 km raising the price to
$9.51/km.

– As more people switch to public transit, there will be more routes and the bus will stop more frequently reducing the current inconvenience of
the bus in Halifax. Cars confer negative externalities on bus riders by clogging up the road and reducing ridership of public transit making it less
efficient.
– Bus riders confer positive user externalities both on other bus riders (due to increasing demand which increases # and frequency of routes)
and due to reducing traffic conjestion which helps both cars, buses and cyclists move faster. Once public transit is efficient, car riders have more
incentives to use it.

100 km

– On average, about 40% of the GHGs from driving are
produced when the car is made.
– Hence, as a rough estimate of the full LCA GHG
footprint, our car would produce 1.4 * 20 kg CO2 e/100 km
= 28 kg CO2e/100 km raising the external cost to 1.4 $/
100 km.
– The GHGs released when the car is driven are called
variable external costs (they vary with the output level,
here driving)
– The GHGs released when the car is produced are called
fixed external costs.

– The #s ignore sink damages
such as when Tar Sands oil is
mined in Canada or Venezuela or
when biofuels are used.

– If a person commuted 20 km per day to work and back, the cost of commuting per week would only increase by $1 such that this carbon tax
would not affect driving much.
– At a carbon price of $100/tonne, the number rises to $2.8 additional dollars per 100 km.
– At a carbon price of $200/tonne, the number rises to $5.6 additional dollars per 100 km.
– At a carbon price of $1000/tonne, the number rises to $22.8 additional dollars per 100 km.
Say, you drive 10,000 km per year (about 200 km per week), your yearly tax with a carbon price of $50/tonne CO2e would be $140/ year. We
can see that this carbon tax is too low to have much of an impact on driving for the typical Canadian.
A carbon tax of $500/year would increase this number of $1400/year which would affect low and middle income people who drive cars given that
the median Canadian income is $23,000 with a median Nova Scotian income of $17,000 per year. However, the government generates revenue
in an efficient manner and can reduce income taxes on these groups.
– As more people switch to public transit, there will be more routes and the bus will stop more frequently reducing the current inconvenience of
the bus in Halifax. Cars confer negative externalities on bus drivers by clogging up the road and reducing ridership of public transit making it
less efficient.

Transport Policy
– fuel efficiency standards
– taxes or quotas on gasoline, diesel, aviation fuel or crude oil
(or all).
– measuring GHGs as they exit tailgate of transport vehicle
and taxing them as part of a general carbon tax policy.
– taxing cars when purchased.
– subsidizing public transit.
– good urban planning.
– subsidies to take inefficient vehicles off the road.
– policies to reduce birth rate.
– subsidies to low GHG fuel sources.
– subsidies to R&D on low GHG transport technologies.
– job sharing.
– moral suasion (provide information about global warming
crisis and encourage people to reduce transport footprints/
regulation of car ads may help.)

– Fuel efficiency standards are a good thing (if applied without SUV/minivan loopholes) but on their own are insufficient. If your car is more
efficient, it takes less energy to drive a km making the price of driving cheaper. People may then decide to drive more because it is cheaper.
This can actually cause GHGs to increase. This is an example of Jevonʼs Paradox by the 19th century economist Stanley Jevons.

3-Pigouvian Policies to
regulate markets with
Negative Externalities

Now, we will use our Pigouvian framework to
investigate policies which directly target markets
which produce goods, services or inputs including
fossil fuels.

We will assume that the thneed is gasoline.

Quantity of
Thneeds/ period

$ / thneed

0
0

100

Qm =

Pm = 60

Pr
iva

= 2
0 +

$ MB Private

= 100 – Q=

$ MB Social

$ MCExternal

= $50 / thneed

$M
C

cia
l

= 7
0 +

Recall our market failure.

QSE = 15

PSE =
85

– Make sure you understand the graph before moving on. Identify the
deadweight loss of the market.

Money Socially efficient allocation = Policy Goal

Quantity of
Thneeds/ period
$ / thneed

0
0
100

Qm = 40

Pm = 60

$M
C
Pr
iva
te
$ MB Private

= $ MB Social

C
So

cia
l

PSE

Privately
efficient
allocation

DWL

= Max TSS

– The perfectly competitive market produces 40 thneeds at a price of $60/ thneed. This results in a loss of total social
surplus (relative to the maximum) of the area labelled DWL (deadweight loss).
– The money socially efficient allocation maximizes the total social surplus (pink triangle) at the socially efficient price of
$85/tonne and quantity of 15 thneeds/ period.
– To “correct the market” regulations will “internalize the externalities” meaning that they fall on private parties
changing their incentives such that the regulated market will operate at the socially efficient allocation.
– The essence of the environmental economics approach is to align private costs and benefits with social costs and
benefits.
– We saw in the car example that charging people $50/tonne CO2e will not make much of a difference on Canadian
driving habits. However, it may help to get people used to the idea and it will provide government revenue allowing
reductions in inefficient taxes like income taxes and corporate taxes.

There are three basic types of policies
which directly target externalities in a
market. These are:
1) Price mechanisms (ex. taxes on output of goods with
negative externalities like transport and subsidies to goods with positive
externalities like forests and wetlands)

2) Quantity mechanisms (ex. quotas on output of goods with
negative externalities and floors on goods with positive externalities such as
forests and wetlands.

3) Quality mechanisms (ex. quotas on output of damaging
varieties of goods such as electricity produced using inefficient coal fired
generators or a minimum on the amount of electricity produced using renewable
energy such as renewable energy quotas). Performance standards (ex. fuel
efficiency standards), Technology Standards, and Design standards (like urban
planning rules) are examples.

Next, we look at these 3 policy types for goods
which produce negative externalities using
gasoline as our example.

What quota would you impose on the
good, service or input to achieve Social
efficiency?

3.1_Quotas

Quota

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100

Qm = 40

Pm = 60
$M
C
Pr
iva
te
$ MB Private
= $ MB Social

$M
C
So

cia
l

QSE

= 15

PSE =

Privately
efficient
allocation

– The quota can be illustrated as a vertical line at the socially efficient
point.
– The quotas will need to be distributed among firms (for example, by
permit giveaway or by auction).
– A problem with this can be political corruption whereby politicians
accept bribes from firms to secure quotas.
– Bribes may be indirect (ex. election campaign finance)
– Ways to enforce quotas include fines and jail sentences.
– Firms with deeper pockets to hire expensive lawyers may challenge
government in court, increasing regulatory costs.

What does the new supply
curve look like with the Quota?

– Go back to last slide, think about the question and try to draw the new supply curve before moving on.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
Qm = 40
Pm = 60
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15

PSE = 85

Old Supply

New Supply

Demand
Immediately after
quota is applied,
price is $60/ thneed.
Is there excess
demand or excess
supply?

– The new supply curve is the same as the old supply curve below the
quota. If P< 35, the inverse supply is: P (Q) = 20 + Q - If P = $ 35/ thneed, firms will supply 15. - If the price exceeds $ 35/ thneed, they will still supply 15 because they will be fined otherwise. Hence, the supply curve is a vertical straight line for P>=15 (i.e. above the quota)
– The crimson dots represent the new supply curve.

What happens to the market price
after the Quota is Imposed?

Hint: Look back at the previous slide and notice
that immediately after the quota is imposed, the
price will be the old market equilibrium price of
$60/ thneed.

Is there excess demand or excess supply at
the old equilibrium price?

Right after quota is imposed, BEFORE price has adjusted, the
price is Pm = 60 $/ thneed (the old equilibrium price) ….

Demand (60) = 40 thneeds/ year

New Supply (60) = 0 thneeds/ year

Demand (60) > New Supply (60)
==> Excess Demand

Prices are driven up. Prices stop rising at PSE = $85/ thneed
at which point, Demand (85) = New Supply (85)

This is the regulated market equilibrium. Note that the
regulator targeted the quantity but the market did the work
raising the prices. Hence, the quota is called a “quantity
mechanism”.

The Invisible Hand Adjusts the Price:

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
Qm = 40
Pm = 60
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

Demand (60) = 40

Supply (60) = 15

Demand > Supply

∴ excess demand

Prices rise unt

Demand = Supply

– “Shift” Supply
– Move along Demand

Excess
Demand

– Note, the supply curve “shifts” and then we move along the demand
curve –i.e. as the price rises, people reduce their demand.
– If the quota is set correctly, social efficiency is attained.
– We note that the price increase rations the goods to the people with
the highest willingness to pay and so we can see how Pigouvian Policy
can potentially harm low income people. However, the money income is
highly correlated with GHG footprints.
– If quotas are given away (not auctioned), government will collect no
revenue to compensate low income people for price increases.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
Qm = 40
Pm = 60

C
Pr

va
te

$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

Under Quota, the
quantity falls and
the price rises until
the new demand
=the new supply at
the SE allocation
such that TSS is
maximized.

Now lets look at the effect of the policy on
the social welfare of the private parties,
third parties and government.

The government can either give away
quotas or auction them or a combination
of these two approaches. If quotas are
given away, the government receives no
revenue. In the next example, we will
assume that the quotas are given away.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

How does Quota
affect
consumers?

Find total consumer
surplus under market
allocation, under
quota and the change.

Pm = 60
Qm = 40

– Try this on paper and then check your answer on the next slides. Use
letters to indicate the areas.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15

PSE = 85 A
B

C
D
E
F
G
H
I

Total
Consumer
Surplus (QM)
= A+B+C+D

Qm = 40
Pm = 60

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I

Total
Consumer
Surplus
(QSE) = APm = 60

Qm = 40

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F

∆ Total
Consumer
Surplus

= – (B+C+G)

G
H
I
Pm = 60
Qm = 40

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

How does Quota
affect
producers?

A
B
C
D
E

F
Find total producer
surplus under market
allocation, under
quota and the change.

G
H
I
Pm = 60
Qm = 40
– Try this on paper and then check your answer on the next slides. Use
letters to indicate the areas.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F

Total
Producer
Surplus(Qm)

= D+ HG

H
I
Pm = 60
Qm = 40

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I

Total
Producer
Surplus(QSE)

= B + C + D

Pm = 60
Qm = 40

– Now the total revenue is B+C+D+E and the total producer costs is only E (they sell less
goods).
– Selling fewer goods will DECREASE producers total revenue but each good sells
for a HIGHER price and this effect will INCREASE their revenue. If the latter effect
dominates, then the total producer surplus could increase (as when a monopoly restricts
output to drive up the price thereby increasing their profits).
– Hence, the effect on the total producer surplus is ambiguous depending on the size of
the quota.
– Note that many firms are not competitive. For example, Nova Scotia Power is a
regulated monopoly in electricity transmission and has a near monopoly in generation
and is subject to price ceilings.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I

∆ Total Producer
Surplus(QSE)

= (B + C + D) –
(D+H)

= B+C – H

Pm = 60
Qm = 40

If H > B+ C

If H < B+ C

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

If, instead of being
given away, quotas
are instead
auctioned off in a
perfectly competitive
market…

A
B
C
D
E
F

Total
Producer
Surplus= B

G
H
I
Pm = 60
Qm = 40

– Firms are going to like quota give away but will not like it if quotas
are auctioned. An example of a situation in which quotas are auctioned
is fish permits. In practice, large trawling companies have purchased
quotas or rent them from individual fishers to whom they were given.

What about the change in welfare of the 3rd Parties
due to the quota policy? (the people and animals
who experience the damages from byproducts like the
GHGs and biodiversity losses).

– To find the total change in surplus to the third parties, we will need to
find the area representing the total external costs under the quota
policy and subtract it from the area representing the total external costs
under the market policy.
– Try this and then check your answer on the upcoming slides.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E

F Total External
Costs (Qm)
= C + D + F + G
+ H

G
H
I

Pm = 60
Qm = 40

– Note that the total external costs at the market allocation is the area under the
marginal external cost curve from 0 to 40. However, since we have removed
the marginal external cost curve we will illustrate this area another way.
– Since total social costs is equal to the area under the marginal social cost
curve and the total private costs are the area under the marginal private cost
curve, the area between the marginal social cost curve and the marginal external
cost curve must equal the total external costs.
– Recall that marginal external costs are $50/ thneed, so total external costs at
market quantity are equal to $50/thneed * 40 thneeds = $2000.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I
70
Pm = 60
Qm = 40

Total External
Costs (Qm)
= C + D

– Now the external costs are much smaller as there are fewer thneeds
and hence fewer GHGs.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I
70
Pm = 60
Qm = 40

∆Total External
Costs
= (C + D) – (C +
D + F + G + H)
= – (F + G + H)

The total external costs fell by area H + G + H making the third parties
better off which was the point of the policy.

∆ Total Consumer
Surplus

= B+C – H
∆ Total Producer
Surplus(QSE)
= – (B+C+G)

– ∆Total
External Costs

= (F+G+H)

∆ Total Social
Surplus = + F

– Based in changes in their respective total money surpluses,
consumers are worse off, producers may be either better or worse
off, third parties are better off, and society as a whole is better off
(the total money social surplus went up by the area equal to the
deadweight loss).
– Recall that F is the total deadweight loss!
– I have assumed quotas were given away here. If they were
auctioned, producers are also worse off but government will gain a
revenue from selling the quotas. Identify the government revenue
under quota auction as an area before moving to the next slide.

Quota
Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

How does Quota
affect each group?

A
B
C
D
E
F

Government Revenue
(if auctioned) = $50/
quota * 15 quotas =
$750

G
H
I
70
Pm = 60
Qm = 40

– This assumes that the auction is perfectly competitive in which
case the firmʼs are willing to pay $50 per quota which is their marginal
profit from the quota.
– If the quota market is not competitive due to few firms and possibly
corrupt practices like bribes to government officials and bid rigging
(where firms meet before and collude to agree to make low bids), the
government would get less than the area C+D with the firms getting
the portion that the government does not get.

Summary Quota Model
– the regulator sets the market quota equal to the
SE quantity and passes a bill of law making it illegal
for firms to supply more than this amount.
– there is excess demand at the unregulated price
and so the price rises to the $ SE price. The
regulated market is now in equilibrium at the $ SE
allocation.
– the externality is internalized. The users pay the
full social costs. The total private surplus and
total consumer surplus falls while the total
producer surplus may rise or fall.
– the total social surplus is maximized such that
the regulated market is said to be monetarily
socially efficient. 56

– Efficient quota alloction may not occur due to rent
seeking activities like bribes (such as election
campaign finance) and bid rigging.

– if relationship between thneed output (ex coal or crude
oil) and GHGs is known, quota can be a quick way to
hit the target GHG reduction with fewer possibilities of
cheating via loopholes. For example, James Hansen
recommends regulating rate of fossil fuel extraction.

– firms will prefer quotas to taxes because they get to
pollute for free. This leaves them with more has a merit
of giving them money to finance green technology
invention and adoption conditional upon government
imposing incentives for them to do so.

– politics should not inhibit our ability to think clearly about “in principle options”.
– bid rigging is illegal under Competition Law.
– an example of a firm getting contracts without a proper process is Halliburtonʼs war reconstruction contracts in Iraq. The ex CEO of
Halliburton was Dick Cheney who at the time of the contract allocation was the Vice President of the USA. He also served to profit from this
due to holding stock options. This is an example of the common phenomenon of a “revolving door”. Halliburton was a key player in the also
BP Deepwater Horizon Oil Spill in the Gulf of Mexico due to using substandard cement practice. This was the biggest oil spill of all time (42
times bigger than the Exxon Valdez oil spill). Oil spills are another massive externality from transport.

– quotas may lead to inefficiency if quotas are not
tradable because firms may be unable to adjust their
scale to an efficient level. Ex. in an extreme case, if all
firms get equal number of quotas which are not
tradable and the industry shrinks such that each firm
has too small a scale to be profitable, it would be
efficient to allow some firms to leave the market.

– On the other hand, environmental regulations may
make efficient scale smaller (ex. due to higher transport
costs) in which case, lack of tradable quotas would not
allow firm size to shrink.

– For example, suppose we had 10 firms in the market. Under the market allocation, each firm
would produce 4 thneeds. Under the regulation, each firm would produce 1.5 thneeds. The firms
may be unable to cover their fixed costs of production and all of them would need to leave the
market. On the other hand, if 7 firms leave the market, the 3 remaining firms would produce 5
thneeds each enabling them to cover their fixed costs. With only three firms, the market is
unlikely to be competitive and so we would need to use a different model.
– Recall first year model of perfect competition in which firm scale is found at point were U shaped
MC intersects minimum of U-shaped average cost curve (with 0 profits but positive variable
profits–i.e. producer surplus).

3.2_ Pigouvian Taxes
on Outputs of
Production Units

The second class of policies are price mechanisms
which means the price is the direct target.
Pigouvian taxes are directly levied on goods with
negative GHG externalities raising their relative price,
thereby providing incentives to substitute out of the
good entirely or into low GHG versions.

Source: International Energy Agency
G

e
rm

a
n

U
.K

F
ra

n
ce

Ja
p

a
n

C
a
n

a
d

U
S

AAvg Tax
$/ Litre
March
2008

1.36 1.32 1.27

0.60

0.31
0.11

– In which of the countries in the graph would you expect people to drive more efficient cars?
Answer EU
– The main reason is higher gasoline taxes which provide people with incentives to either not drive, to drive less or to drive more fuel efficient
cars (Resources for the Future). If you go to Europe, you will notice cars are smaller.

– Fuel efficiency standards are tighter in Europe also while crude oil also has a higher price (http://www.bloomberg.com/
energy/)
Fuel Tax Graph: International Energy Agency

– A Pigouvian tax targets price directly and
then quantities adjust via the “invisible hand
mechanism.

– Consider a constant marginal tax (T = $50/
thneed) equal to the MCExternal of producers.
– The producers’ $MCPrivate (inverse supply)
shifts up by T to $MCPrivate_New (social inverse
supply) so they internalize the externality–see
green dashed line.

$MCPrivate_New = $MCPrivate_Old + T
= 20 + Q + T
= 70 + Q

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
= 2
0 +
Q
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

70
Pm = 60

Qm = 40
$M

C
Pr

iva
te (n

ew
)

= 2
0 +

Q
+

The marginal tax is
equal to the marginal
external cost at the SE
output level (which is
$50/ thneed).

The MCPrivate rises by the
marginal tax (green
arrow) causing the
inverse supply curve to
shift up by $50/ thneed
(green dashed).

– In our example, in which the marginal external costs are constant such
that the marginal external cost is a horizontal line. If it were not
horizontal, the new supply curve will not overlap the marginal social cost
curve (as here), but will still intersect it at the socially efficient allocation.

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85
70
Pm = 60
Qm = 40
$M
C
Pr
iva
te (n

ew
)

We can think of the
new marginal private
cost as the “social
supply curve”, the
supply curve that would
exist if the producers
had to pay the full
monetary social costs
of the externality.

$M
C
Pr

iva
te (o

ld
)

Question: Right after the tax is imposed, the price of thneeds is $60/tonne. Use
the concepts of excess demand or excess supply to explain what happens to
the price and quantity of thneeds as the market adjusts to the regulation.

Answer: Start in unregulated market with Pm = $60/thneed and Qm = 40 thneeds.
Now add the tax causing the supply curve to shift upward to the left. At the price
of $60/ thneed, the demand is 40 thneeds while the supply is 0 thneeds. Hence,
demand exceeds supply. The firms will discover they can increase prices. As
they increase prices, demand will fall (movement along demand curve).

Now lets look at the effect of the Pigouvian
tax policy on the social welfare of the
private parties, third parties and
government.

Source Picture Parliament Buildings of Canada:
http://en.wikipedia.org/wiki/Parliament_of_Canada

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85

How does Tax
affect
consumers?

A
B
C
D
E

F Find total consumer
surplus under market
allocation, under
quota and the change.

G
H
I
Pm = 60
Qm = 40
$M
C
Pr

iva
te (

ne
w)

– Try this on paper and then check your answer on the next slides. Use
letters to indicate the areas.

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I
Total
Consumer
Surplus (QM)
= A+B+C+D
Qm = 40
Pm = 60
$M
C
Pr
iva
te (

ne
w)

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I

Total
Consumer
Surplus
(QSE) = A

Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)

– The socially efficient allocation is where the marginal cost social curve intersects the marginal social
benefit curve (as long as its socially efficient to produce any thneeds at all which wouldnʼt be the case if the MC
social curve intersects the y-axis above 100 in our case).
– Suppose the Factory is producing a quantity (Q) on x axis that is less than Qse), we see that the marginal
social benefit exceeds the marginal social cost. For Q < Qse,t is socially efficient to produce an additional Qth unit as the society will gain more social benefits than it costs them so the marginal social surplus must be positive. - If, on the other hand, at a given Q, the marginal social benefit is lower than the marginal social cost, as is the case when Q < Qse, then it will increase the total social surplus if you decrease output by one unit since you will forgo fewer social benefits than social costs saved. Social “when to stop rule”: MBsocial = MCsocial (if Qse > 0).

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F

∆ Total
Consumer
Surplus
= – (B+C+G)

G
H
I
Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)
– The socially efficient allocation is where the marginal cost social curve intersects the marginal social
benefit curve (as long as its socially efficient to produce any thneeds at all which wouldnʼt be the case if the MC
social curve intersects the y-axis above 100 in our case).
– Suppose the Factory is producing a quantity (Q) on x axis that is less than Qse), we see that the marginal
social benefit exceeds the marginal social cost. For Q < Qse,t is socially efficient to produce an additional Qth unit as the society will gain more social benefits than it costs them so the marginal social surplus must be positive. - If, on the other hand, at a given Q, the marginal social benefit is lower than the marginal social cost, as is the case when Q < Qse, then it will increase the total social surplus if you decrease output by one unit since you will forgo fewer social benefits than social costs saved. Social “when to stop rule”: MBsocial = MCsocial (if Qse > 0).

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F

Find total
producer
surplus under
market
allocation, tax
regulation, and
the change.

G
H
I
Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)
– Try this on paper and then check your answer on the next slides. Use
letters to indicate the areas.

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
Total
Producer
Surplus(Qm)

= D+ HG
H
I
Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)

– Recall this is the total revenue (D+ H + E + I) – total producer costs (E
+I)

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I

Total
Producer
Surplus(QSE)

= B

Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)

– Now the total revenue is B+C+D+E and the total producer costs is only E (they sell less
goods).
– Selling fewer goods will DECREASE their total revenue but each good sells for a
HIGHER price and this effect will INCREASE their revenue. If the latter effect
dominates, then the total producer surplus could increase (as when a monopoly restricts
output to drive up the price thereby increasing their profits).
– Hence, the effect on the total producer surplus is ambiguous depending on the size of
the quota.
– Note that many firms are not competitive. For example, Nova Scotia Power is a
regulated monopoly in electricity transmission and has a near monopoly in generation
and is subject to price ceilings.

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I

∆ Total Producer
Surplus(QSE)

= (B) – (D+H)

Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)

– Note that this is the same welfare result as would occur under
quotas if they are auctioned off in a perfectly competitive market.
– We can see here that firms are going to tend to prefer quota give-
aways to Pigouvian taxes. We will expect strenuous lobbying by
firms to prevent Pigouvian taxes being put into place and we do.
Usually, they firms are reported in the paper as saying that jobs will be
lost. Firms may also threaten to leave the country to operate in a
country with lower pollution regulations. This is called a “pollution
haven” effect.

What about the change in welfare of the 3rd Parties
due to the quota policy? (the people and animals
who experience the damages from byproducts like the
GHGs and damages to the natural ecosystems).

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E
F
G
H
I
70
Pm = 60
Qm = 40
∆Total External
Costs
= (C + D) – (C +
D + F + G + H)
= – (F + G + H)
$M
C
Pr
iva
te (

ne
w) The third parties gain

due to the reduction in
the total external costs
(identical result as with
tax)

The total external costs fell by area H + G + H making the third parties
better off which was the point of the policy.

Question: How much tax revenue will the government collect? Show
using areas on graph.

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
= 15
PSE = 85 A
B
C
D
E

F Government
Tax Revenue
= C+ D
= $50/ thneed *
15 thneeds
= $750/ period.

G
H
I
70
Pm = 60
Qm = 40
$M
C
Pr
iva
te (
ne
w)

– Note that if the MCExternal is not horizontal as in our example, the green
new supply curve will not overlay the MCsocial curve and it may be the case
that the total tax is greater than the total external costs. In this case, lump
sum rebates can be provided or the tax may only be applied above a
particular output level. The problem here is that is would be
administratively complex to apply a tax rate that increases with output
levels.
– Since MCExternal are constant over short run for GHGs due to these being
cumulative pollutants, we do not have to worry about this problem for
global warming regulations.

OR
∆ Total Consumer
Surplus

= B – (D+H)

∆ Total Producer
Surplus(QSE)
= – (B+C+G)
– ∆Total
External Costs
= (F+G+H)

∆ Total Social
Surplus

= + F
∆ Total Tax
Revenue = C+D

– Based in changes in their respective total money surpluses,
consumers are worse off, producers are worse off, third parties are
better off, and society as a whole is better off (the total money
social surplus went up by the area equal to the deadweight loss).
– Recall that F is the total deadweight loss!

3.3 Targets along Supply
Chain

75(5) 7(7) 90 (45) 385 (385)

Extraction
Initial
Processing RefiningTransport Transport

Combustion
Final
Product

10.32 L

125.5 ¢/L

Pigouvian Taxes are ideally levied along the supply chain
at the stages where the emissions are produced. This
provides the most direct incentive to reduce the emissions
at the point of creation. We can see here that the Tar (Oil)
Sands CSS Bitumen creates the same amount of
emissions as conventional oil (West Texas Intermediate)
when combusted (385 kg CO2e/ bbl gasoline) but creates
far more emissions in total (560 vs 450)

3(3)

Source: IHS CERA:
http://www.api.org/aboutoilgas/oilsands/upload/CERA_Oil_Sands_GHGs_US_Oil_Supply
– This source is based on a Life Cycle Analysis commissioned by the oil industry. It does not include GHG emissions due to damage to the
carbon sinks or due to pipeline construction. The CSS bitumen is the dirtiest oil source based on the analysis because the process of steam
injection is very energy intensive. The mining is slightly less energy intensive but results in destruction of boreal forests and wetlands such that
overall, it may have the higher GHG footprint.
– The CSS bitumen mining could have its footprint lowered by switching to lower GHG energy sources such as wind power, solar power or
nuclear power.
– That said, even for the CSS bitumen, 64% of the emissions are produced during combustion for a total of 360 bbl refined product (ex. gasoline
or diesel).

Crude Production

Crude Transport

Distribution
Crude Refining

tonnes CO2e/
barrel refined
crude

0.1

0.2

West
Texas
Int.

CSS
Bitumen

– If we only levy the tax on the
final product (ex gas tax at
pump), the Tar (Oil) sands
gasoline would be priced the
same as the West Texas
Intermediate providing no
private incentives to
substitute into the lower GHG
oil or for the Tar Sands
producers to find lower GHG
ways to make the oil if cost
effective.

– Other than GHG emissions differences in the two basic extraction processes, strip mining and In Situ, the 7 categories of Tar Sandʼs crude
differ according to the liquids in which they are diluted. Since bitumen is a tar like substance, it cannot be piped along lines or refined in
conventional refineries until it is diluted to make it into a liquid form. The bitumen can be diluted in light oils and also in condensed natural
gas. The GHG intensity of the diluting fossil fuel will hence also affect the GHG intensity of the crude oil.
– Mining and in situ will also differ with respect to their impact on carbon sinks, biodiversity loss and other local water and air pollutants.
Source Data = IHS CERA: http://www.api.org/aboutoilgas/oilsands/upload/
CERA_Oil_Sands_GHGs_US_Oil_Supply

If taxes are applied based on GHGs at each stage, the
CSS bitumen gasoline costs 24% more.

$50/tonne * 0.175
tonnes/barrel
= $8.75/barrel

upstream tax

$50/tonne * 0.06
tonnes/barrel
= $3/barrel

CSS
Bitumen

West
Tex. Int.

pump tax
$50/tonne * 0.385
tonnes/barrel
=

$ 19.25/
barrel

full life-
cycle tax

$ 28/barrel

$ 22.25/
barrel

$ 19.25/
barrel
10.32 L

– We can see that the CSS bitumen is much more GHG intensive during the extraction – processing- transport and refining stages than the
cleanest crude oil (almost 3 times the GHG emissions) while both oils produce about the same amount of GHG emissions during combustion.
Along the whole life cycle, the CSS bitumen produces about 27% more GHGs than the cleanest crude.
– Note: The 7 Tar Sands crude oil categories are one out of two basic categories 1) Strip mined and 2) In Situ (with two categories Steam
Assisted Gravity Drainage (SAGD) and Cyclic Steam Generation (CSS). Under strip mining, the boreal forests and Earth crust from above the
oil is removed. Under In Situ methods, the tar sands are too deep to be strip mined. Because the bitumen is highly viscose, it can only be
removed by heating it up to make it flow. Steam is injected down the drill and the bitumen becomes viscous enough to force it out. Ignoring the
GHG emissions due to sink destruction and pipeline construction, the In Situ process uses 15% more energy over the entire life cycle than
the average US crude while the mining uses 5% more energy.
– these taxes are on the refined final product (ex. gasoline).

Blunt Tax
= $50/tonne CO2e * .
0.480 tonne CO2e/ barrel
= $24/barrel

Correct Tax CSS
Bitumen
= $50/tonne CO2e *
0.560 tonne CO2e/ barrel
= $28/barrel

Ex. Apply full Pigouvian tax on average
GHG final product (gasoline pump)

Production
GHGs

Combustion
GHGs

West Tex Intermediate

US Av’g Dom. Crude

Mining Dilbit

Mining Bitumen

SAGD Dilbit

Mining SCO

SAGD Bitumen

SAGD SCO

CSS Bitumen

0 .4 .6.2

GHGs (tonnes CO2e)

T
a
r

S
a
n

d
s

C
a
n
.

– All estimates based on IHS CERA report (see figure three)

Houston

Keystone
(built)

Keystone XL
(proposed)

Port Arthur

Cushing

Steel City

Hardisty

Northern
Gateway
(proposed)

Trans Canada

Enbridge

Exports

Oil Sands

– Note that Enbridge has many other pipelines (ex. from Tar Sands to Chicago linking up to Montreal (where there are refineries) and running
down to Cushing, a big pipeline hub (not shown).
– An Environmental impact assessment of the Northern Gateway Pipeline is currently underway. Concerns are oil spills off BCs coast which
would ship diluted bitumen in tankers to places like China and California for refining.
– The Cushing to Port Arthur Stage of Keystone XL Pipeline has already been approved. If the top part is not allowed to go ahead, we would
expect higher oil prices in the USA because some of the oil will be exported. This might increase pressure for the top portion to be built to allow
for more Canadian crude exports.
– Oil shocks have macroeconomic impacts.

3.4_Quality Mechanisms

Source Photo: Alfred Cecil Pigou: New School Website

Other means to directly regulate markets include
technology, design, and performance standards.

An example of performance standards is are fuel
efficiency standards (CAFE) which specify that the
fleet of new cars must meet a minimum fuel efficiency.
These do not guarantee GHG caps will be met due to
reducing the price of driving a mile such that people
may increase their driving which can include decisions
to build homes further from work (Jevon’s Paradox).

Renewable energy quotas specify that a minimum
amount of energy will be made by renewable
energy. For example, there are minimum quotas on
biofuels and for electricity, many places including
Nova Scotia have renewable energy targets.

Studies have found that ethanol biofuels produced
from corn create more GHGs than diesel such that
this policy was poorly designed. If instead, full Life
Cycle Analysis had been conducted and taxes
levied on GHG produced by each type of fuel, these
high GHG biofuels policies would not have been put
into place.

Searchinger, T. et al (2008) Use of U.S. Croplands for Biofuels Increases Greenhouse Gases Through Emissions from Land Use
Change, Science, 319, 1938.

Technology, design and performance standards can work
faster than markets due to human brains being
substituted for markets.

For a trivial ex., this unnecessary plastic laundry scoop
could be banned as a wasteful technology without any
LCA as it is a “no brainer” wasteful product.

They may also allow early deployment of technologies
which are currently expensive but are expected to
become cheaper over time (ex. solar power).

The big drawback is flexibility in contrast to general
policies like carbon taxes which leave firms with freedom
to choose cheapest abatement technology, thereby
making use of decentralized force of invisible hand.

4_ Comparing Price vs.
Quantity mechanisms

1) Pigou taxes generates revenue while quota (if given
away) does not. Uses include:

– tax shifting reduce other taxes helping to compensate
consumers for the price rise (ex. income taxes + lump sum
rebates particularly on low & middle income groups).
– finance green climate fund, part of the Copenhagen
mechanism to provide lower income countries with GHG
mitigation and adaptation capacity.
– corporate tax reductions reducing probability of
movement to low tax zones called pollution havens.
– subsidize subsidize renewable energy adoption and
research and development (R&D) by government &
universities, or paid as grants to firms.

-The BC carbon tax is revenue neutral meaning that taxes were removed elsewhere (income and corporate) so
government revenue did not change. Many of the tax decreases were on corporations. Lump sum rebates given to
households.
– It is important to note that even though one might think that the low income people will merely go and buy the same
products thereby undoing the policy, they will still find that the GHG intensive thneeds are relatively expensive in
comparison to green alternatives. For example, the bus will be relatively cheap in comparison to the car due to fewer
GHG emissions per passenger mile while the CSS Bitumen gasoline will be relatively expensive in comparison to
the Texas Intermediate.
– Taxes on externalities are monetarily socially efficient (as illustrated above). To contrast, taxes such as income tax
reduce total social surplus (in money). Hence, taxes on externalities allow us to replace inefficient taxes with efficient
ones.

MCExternal

Quota
hits target

Thneeds/
year

$ / thneed

2) Hitting the target: If the government does not estimate
demand and supply curves accurately (which is likely due to
difficultly of getting estimates of firm’s costs), quotas (if
enforced) guarantee output is capped whereas with a tax,
output may not fall as much as the government wants such that
total external costs are higher than wanted. This is particularly
problematic if the marginal external cost curve is increasing
rapidly above the desired cap.

– Similarly, a strict floor on forest size and quality guarantees a minimum amount while subsidies to get private parties to conserve forests donʼt
guarantee that we will save the minimum.

4) Tax enables firm scale to adjust flexibly to the
policy in contrast to quotas. For example, if the
industry gets smaller, some firms may need to leave
the industry. On the other hand, if efficient scale gets
smaller with environmentally friendly technologies,
firms may want to enter industry. Tradable quotas can
work similar to taxes in this respect although they may
also enable big firms to hoard quotas to prevent
market entry reducing competition.

3) quotas are highly subject to political lobby which
can lead to corruption. Ex. firm Y donates money to
campaign of politician X.

5) quotas may be rapidly applied to reduce or ban
obviously wasteful practices or technologies. For
example, plastic laundry scoops bundled with powder
laundry detergent, or bottom trawling (which damages
ocean bottoms) could rapidly be banned. The same
holds for tech, design and performance standards.

6) quotas with rations may be a very fair policy and
this is why we see food rations during wars. For
example, a one child policy is more equitable than
allowing people to buy the rights to have children
(tax on children).

– it seems to me that powder is likely to be better than liquid laundry detergent all else equal due to being much lighter which reduces transport
emissions. Refilling containers of powder detergent seems to be the greenest option. A LCA comparison could be done to compare these.

7) a drawback of the tax is that lower profits leaves
firms with less finance for research and development
and adoption of low GHG technologies (ex. electric
cars, fuel cell tech.). However, tax revenue could be
used to provide marginal subsidies to incentivize firms
to reduce their GHGs.

– multiple policies can be used simultaneously. For
example, we could tax carbon dioxide emissions and ban
plastic laundry scoops sold and place limits on fossil fuel
extraction rates while putting floors on the amount of
natural ecosystems and their quality.

– we will revisit this when we look at direct regulation of emissions. The arguments will be similar.

5_ Direct Regulation of
production units which
provide positive GHG
Externalities

http://www.cbc.ca/news/canada/british-columbia/story/2010/12/09/bc-forests-carbon-dioxide-report.html

Recall that we are looking at policies to correct market
failure due to GHG externalities with a focus on policies
which target output of either goods, services or inputs.

In the last section, we investigated policies which target
output of goods which cause negative GHG
externalities (ex. gasoline).

Here, we will investigate policies which target outputs of
goods which cause positive GHG externalities.

What is a good which causes a GHG externality?
Give an example?

– the concept of a “policy target” is important here. Recall our gasoline policy was levied on the gasoline itself. An alternative would be to target
the GHGs themselves — next lecture.

5.1_ Backgrounder on
Ecosystem Sinks as ex. of
goods which provide
positive externalities.

http://www.cbc.ca/news/canada/british-columbia/story/2010/12/09/bc-forests-carbon-dioxide-report.html

Ecosystems provide
essential services
like CO2 removal
from atmosphere.
– Recall that
deforestation caused
net emission of
~ 9.25 gigatonnes in
2009.

Equity
&

Human
Wellbeing or

“Ultimate Ends”
Economy,

Technology, Politics
& Ethics or

“Intermediate Means”

Natural Environment or Ultimate Means

Herman
Daly’s
Triangle

– Herman Dalyʼs triangle draws attention to the fact that our human civilizations with our human production systems depend on the natural
systems. Both the human production systems and the natural ones, the functioning of which we determine by our decisions, provide us with
goods and services. For example, the natural systems provide us with oxygen, nitrogen fixation and carbon dioxide removal services.
– Grab shot from economics lecture by Herman Daly available here:
http://vimeo.com/11507591 (excellent lecture–Daly was head Environmental Economist at the World Bank and is perhaps the most famous
founder of the field of “ecological economics”). Unlike Daly, some ecological economists do not understand neoclassical economics.

The natural systems like this forest provide humans with
many thneeds like oxygen production and carbon dioxide
removal and nitrogen fixation. Natural systems currently
absorb about 50% of anthropogenic GHG emissions.

When humans decide to conserve, repair and expand natural
areas, we are deciding to produce natural goods, services
and inputs–”natural thneeds”.

Source: Natural Resources Canada

When this Boreal forest and lake system
is converted to human uses to produce
thneeds such as…

Source: Natural Resources Canada

synthetic crude oil, we loose the natural
goods and services, the carbon dioxide
renewal services and the many other
services which nature provides us with.

– Estimated 315 billion barrels of recoverable crude oil with 175 to 200 billion barrels privately economically recoverable using current
technology.
– mining and processing bitumen to form synthetic crude releases 0.075 tonnes CO2e/ barrel (source
– GHG footprint mining and processing Canadian Tar Sands:
= 0.075 CO2e/barrel *(175 – 200 billion barrels) =13.125 – 15 tonnes CO2e
– At carbon price of $50/barrel, this is an external cost of $ 656.25 – 750 billion ( bit more than a 3rd of annual GDP).
-At a carbon price of $100/ tonne CO2e, the number rises to $1312 – 1500 billion (almost our annual GDP)
-At a carbon price of $200/tonne CO2e, the number rises to $2624 – 3000 billion (almost 2 years of annual GDP)
Note: most of the footprint is further down the supply chain when the final fuel is combusted. So, the full lifecycle analysis (LCA) footprint is
about 4.5 the above number (ignoring the sinks) = 2952 – 3375 bill (at the low $50/tonne carbon price) or 11800-13500 at the $200/ tonne price
(7 – 8 years of Canadaʼs GDP).
– Data from Canadian Energy Board and Sharpe, A. et al. The Valuation of the Canadian Tar Sands, Centre for the Study of Living Standards.
– No permissions for image of Tar (Oil) Sands obtained/ used under Dalhousie Copyright Agreement for fair use. Other photos available here:
http://www.edwardburtynsky.com/WORKS/Oil/Oil_Sands_Large/OLF_ALB_11_07_big

100

1750 – 3000 tonnes CO2
per hectare of land
(boreal forest sink lost
to wetlands #)

= 80 to 150 typical
Canadian yearly
footprints (20 tonnes/yr)

– To get the total footprint, we would need to figure out what portion is strip mined vs. what portion is mined using cyclic steam stimulation (which
does not result in this massive damage) and multiply by footprint estimates for each type (mining shown here vs cyclic steam stimulation which
injects the steam underground).
– It is difficult to estimate the rate of success of land reclamation activities at this point in time. A small amount of land has been reforested but
the land type has completely changed from wetlands and boreal forests (the best carbon sinks) to a sandy highland.

101

Other anthropogenic causes
for damages to Canada’s
carbon sink forests include:

– agriculture
– forestry,
– human residential and
industrial building & roads,
mining.
– global warming causing…

a) tree eating beetles and
moths able to survive
winters further North,
b) increased incidence of
forest fires
[ positive feedback loops]

– these are positive feedbacks of global warming.
– warming causes forest fires, which causes a net release of GHGs into the atmosphere causing more global warming and more forest fires and
so on.

102

2004:
The Forestry sector is
responsible for 17% of total
greenhouse gas net emissions
globally.

– deforestation (carbon sink
destruction) = 6 Gt CO2e/year
– decomposition logging debris,
peat fires, peat decay = 2 Gt
– reforestation = – 3.3 Gt

Net emissions forestry
= 5.7 Gt/ year.

Forests give positive
externalities!

– Data Source: Kump and Mann (DP), Pg. 174 – 175. Based on UN
IPPC FAR.
– Country trends on page 175.

– Balsam firs are an important tree species in Acadian Coastal Forest
Ecosystems.

103

!”
#!!”

$!!!”

$#!!”

%!!!”

%#!!”

&!!!”

&#!!”

‘()
*+,
-.”

‘/
0*
/(-
1/”

2)
(/-
.”

‘3
45
(-”

6(
)*
.-4
57
”

‘()
*+,
-.”
8-
9-
44
-:
”

‘/
0*
/(-
13
(/”
;(
-7
7.-
45
7″

=
/1.
-4
57
”

=
/+>
:1
/5
“?9
/(-
>/
”

soil = rose
plants = blue

– Accounting for changes in atmospheric GHGs due to
land use, land use change and forestry (LULUCF) is
complicated with uncertainty in numbers.

tonnes
CO2/ha

104

Enhancing Forest Health to increase its carbon sink
Capacity is an important way to slow global warming.

Alberta

-This map illustrates estimates of flows of CO2/year of the Canadian land mass.
– The numbers are in units of carbon (atomic weight = 12 amu). To convert to carbon dioxide weight (44 amu), multiply the numbers by 44/12 =
3.77. Ask me to go over this in class.
– This slide shows flows of CO2 while the previous slide shows the amount that is stored (stocks). We can see that stocks are much bigger.
Carbon accounting for LULUCF is complicated and there is large uncertainty, yet measures are improving.
Alberta map Source: http://en.wikipedia.org/wiki/Oil_sands
– According to Natural Resources Canada, Canadaʼs managed forests oscillate between being net sinks and net sources of emissions.

Source Map: Chen, Jing M. (2003) Spatial Distribution of carbon
sources and sinks in Canadaʼs forests, Tellus, 55B, 622 – 641. http://
faculty.geog.utoronto.ca/Chen/Chen’s%20homepage/PDFfiles/
p71_chen_tellus_b55

105

– Also, forest destruction causes many other externalities than just the destruction of natural carbon sinks. They provide habitat for many
species like this common redpol. When forests are destroyed for farming, forestry, industry and residences and roads, natural ecosystems
shrink. Humans need ecosystems upon which to recycle the building blocks for the living systems of which human beings depend.
– To estimate a monetary valuation of the positive externalities from forests, we would need to figure out the carbon sink capacity and then
multiply this by the carbon price. We would also need to consider all other ecological benefits like nitrogen recycling, oxygen production and
also put a value on species like this common redpol (a somewhat dubious exercise).

106

Hairy Woodpeckers

– These Hairy Woodpeckers are medium sized woodpeckers and have similar markings to the smaller Downy Woodpeckers. There are also
much bigger Piliated Woodpeckers (these are the ones with the great red crest). I saw a piliated woodpecker on two occasions as a child.
– Once, massive Ivory Billed Woodpeckers, inhabited the forests of the Western USA. These birds were reported to be so large and fantastic
that people would call them “Oh Lordy Birds” because this is what people would say if they saw one, so amazed were they by its splendor. The
Ivory Bills went extinct in the 20th century. Cause: Anthropogenic. Source of this story: Barbara Kingsolver, “The Lacuna”

107

5.1_ Pigou’s model of
positive externalities.

http://www.cbc.ca/news/canada/british-columbia/story/2010/12/09/bc-forests-carbon-dioxide-report.html

108

– Lets model a naturally produced thneed (here
a natural forest) which produces positive
externalities as a byproduct of the human
decision to allow the natural system to operate in
this land area.

– While it may seem strange to think of the
demand and supply of natural forests and
wetlands, humans are ultimately in charge of
deciding how much natural forest we provide.

– It can make sense to think of natural
ecosystem production systems as part of the
economy.

– Ex. demanding forests = donate money to a nature trusts which buy
up forest lands to protect them, or people replacing lawns with forests,
carbon forest offsets (to be discussed later) or through voting for
governments with green platforms and influencing governments (ex.
write letter) to put into place Pigouvian regulations.

Natural
Forest
(km2/period

$ / km2

20
0
0

100 $M
C

Pri
va

$ MB Private
QSE
= 15

Pm = 60
Qm = 40

MBExternal
= 50

Find SE allocation with a positive externality
This is the marginal
opportunity cost of
having a natural
forest (ex. cut it down
for the wood or mine
the land under it)

– Lets model a naturally produced thneed (here a natural forest) which
produces positive externalities as a byproduct of the human decision
to allow the natural system to operate in this land area.
– For simplicity, we assume that there are no negative externalities
from the forest. Assume marginal external benefits are $50 per km
sq. natural forest.

Natural
Forest
(km2/period
$ / km2
20
0
0

100
$M

C
Pri

va
te

$ MB Private
QSE
= 65

Pm = 60
Qm = 40

The Market for forests fails to produce the socially
efficient amount of forest. The price is too low and quantity
too low.

150

MBExternal
= 50

$ MB social

PSE = 85
$M

C
So

cia
l

– Add the marginal external benefits to the marginal private benefits (marginal willingness to pay) to get the marginal social
benefits. MBsocial = 100 – Q + 50 = 150 – Q
– Since, I assumed no marginal external costs, the marginal social costs are equal to the marginal private costs.
MCsocial = 20 + Q + 0 = 20 + Q
– Find the SE level of output. This is the level which maximizes the total social surplus = total social benefits – total social
costs.
Set: MB social = MCsocial ==> 150 – Q = 20 + Q ==> Qse = 65 km sq / period.
Plug back into MCsocial or MBsocial equation to get the socially efficient price, Pse = $85/kmsq.
– think of social MB as the marginal willingness to pay (MWTP) of society as a whole (including future generations) to conserve
natural forests. This is higher than the private MWTP ($MBPrivate ) because private parties will fail to take into account positive
externalities when deciding how much forest to provide.

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Show that the SE allocation maximizes TSS at Qse but not
at Qm so market fails

150

$ MB social
PSE = 85

A
B

C
D

E
F
G
H
I

$M
C

So
cia

– Recall that to do this, you must identify areas under marginal graphs
which correspond to respective totals.
– Find total social benefits at Qse.
– Find total social costs at Qse.
– Find total social surplus at Qse. (area between

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Find Total Social Benefits (Qse)
150

$ MB social
PSE = 85
A
B
C
D
E
F
G
H
I
J
$M
C
So
cia
l

– Total social benefits at Qse = A+B+C+D+E+F

+G+H+I+J

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Find Total Social Costs (Qse)
150

$ MB social
PSE = 85
A
B
C
D
E
F
G
H
I
J
$M
C
So
cia
l

– Total social costs at Qse = F + J + I (there are also total private
costs, i.e. all the paid inputs)

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Find Total Social Surplus (Qse)
150

$ MB social
PSE = 85
A
B
C
D
E
F
G
H
I
J
$M
C
So
cia
l

– Total Social Surplus = Total social benefits – Total social costs
(A+B+C+D+E+F+G+H+I+J) – (F + J + I) = A+B+C+D+E+G+H
Question: Now find the total social surplus for the market allocation and
show it is lower. Check your answer using the next few slides.

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Find Total Social Benefits (Qm)
150

$ MB social
PSE = 85
A
B
C
D
E
F
G
H
I
J
$M
C
So
cia
l
– Total social benefits at Qse = A+B+C+D+E+F

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri

va
te =

$M
C
So
cia
l
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Find Total Social Costs (Qm)
150

$ MB social
PSE = 85
A
B
C
D
E
F
G
H
I
J

– – Total social costs at Qse = F (there are also total private costs,
i.e. all the paid inputs)

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Find Total Social Surplus(Qm)
150

$ MB social
PSE = 85
A
B
C
D
E
F
G
H
I
J
$M
C
So
cia
l

– Total Social Surplus = Total social benefits – Total social costs = (A
+B+C+D+E+F) – (F) = A+B+C+D+E
– We can see that the total social surplus is lower at the market allocation
in comparison to the SE allocation by area G+H which is the deadweight
loss of the market. As with a negative externality, when a good, service or
input causes a positive externality, the market fails.
– With the negative externality (ex. bitumen), the market produces too
much and the price is too low while with positive externality (ex natural
forest), the market produces too little and the price is too low.

118

5.3 How can we correct a market
with a positive externality?

– As with the negative externality causing thneed
(gasoline) we will now consider the price and the
quantity mechanisms to provide the socially
efficient amount of forest.

Qualities also need to be considered. Ex. boreal
forests store more carbon dioxide than tropical
rainforests, yet the latter contain vastly more
biodiversity.

– As the negative externality, we will consider the price and the quantity mechanisms. Qualities also need to be considered. For example,
some land will be more suited for highly productive forests than others. A section of forest which is home to an endangered species would also
need to be a priority.
– As climate changes, ecosystems will change as warm tolerant species are able to migrate further North. Maintaining North-South forest
corridors which enable species to move is important. Its especially important to conserve forests around riparian zones due to symbiotic
relationships between terrestrial and aquatic ecosystems. For example, bears leave fish carcasses in the forest and also their dung. Hence,
the ocean provides fertilizer for the forest. The nutrients from the forest run into the rivers and are delivered to the oceans and lakes enhancing
their productivity.

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Marginal Subsidy = S

150
$ MB social
PSE = 85
$M
C
Pri
va

te – S

Price Mechanism:
– If we pay the firm a subsidy (S) of $50 per km sq of natural forest, its
private marginal costs fell by $50/ unit and so the supply curve shifts
down by this much.
– Now human production units can afford to produce the good (here
forests) at a lower price. Due to the lower price, the demand for forests
rises and we move along the demand curve so more forest is provided
in equilibrium.

Natural
Forest
(km2/period
$ / km2
20
0
0
100
$M
C
Pri
va
te
$ MB Private
QSE
= 65
Pm = 60
Qm = 40

Set Floor on amount of natural forests
150

$ MB social
PSE = 85

Quantity Floor

Quantity Mechanism:
– A quantity floor is the opposite of the quotas we discussed (which are also quantity
ceilings). The floor provides a minimum on the amount of forest that must be
supplied. Quality conditions can also be specified. For example, a section of
Northern Madagascar contains the 19 last individual members of the Northern
Sportiff Lemur species which are almost extinct. This forest could be preserved
under a quality criteria of prioritizing habitat of species that are highly endangered.
Given that lemurs are primates with which humans recently share ancestors (about 63
million years ago), I think that the conservation of this species should be a massive
global priority.

121

5.4- Removal of
Inefficient Subsidies on
Fossil Fuels

Socially Efficient

Quantity of
Thneeds/ period
$ / thneed
20
0
0
100
Qm = 40
Pm = 60
$M
C
Pr
iva
te
$ MB Private
= $ MB Social
$M
C
So
cia
l
QSE
PSE

Private
Efficiency

Qsubsidy = 40

$M
C
Pr
iva

te –
S

Allocation
with subsidy

– Unfortunately, instead of taking the advise of economists, to raise the
price of goods which create GHG byproducts, the fossil fuels are often
subsidized. Returning to our original example of the thneed (like the
bitumen) which produces a negative externality, suppose that the
government mistakingly gives the bitumen company a subsidy of S. This
shifts the supply curve downwards so that the firms prices are driven
downwards. When prices are lower demand increases (move along
demand curve) so more bitumen gets sold and more GHGs are produced.
Now the deadweight loss has grown from A under the market allocation to
A+B in the subsidized situation.

123

6- Equity
Pigouvian policies whether falling on goods, services, inputs or on
greenhouse gas byproducts will affect people differently.

For example, suppose you emit 10 tonnes of CO2/year and the
carbon tax is $25/tonne CO2e (as in Australia), your
yearly carbon tax will be 10 *25 = $250/year. It the
tax was $100/tonne, your yearly tax is $1000.

Middle and High income Canadians will not be hurt much by this
tax unless they have gigantic footprints.

However, low income people will take a hit here even in
Canada. To compensate these people for the tax, lump sum
rebates and progressive income taxes are required. The
problem is even larger on a global scale due to such great income
disparities.

– That said, income is highly correlated with greenhouse gas emissions per capita such that high income people will pay more tax. Also,
damages are expected to harm low income people more heavily than high income people (especially in global South). Hence, not doing
anything about global warming would be highly inequitable too.

124

7- Summary:

– Given our current technologies, most consumption goods provide
net private benefits (surplus) but also external costs due to
their effect upon environmental quality.

– Economists have the goal of making society a better
place and use criterion such as social efficiency and equity to
evaluate various options.

– Under the $ social efficiency criterion, economists choose
the number of consumption goods that maximizes the total
money social surplus (total social benefits of a consumption good
minus the total social costs). Social costs have two categories,
private and external costs. Social benefits are likewise private or
external.

– Markets fail to be socially efficient when there are
externalities. For example in the case of negative
externalities, the market price is too low and the market
quantity too high for social efficiency. In the case of positive
externalities, markets tend to provide too little of the good
and the price is too low.

– Since markets fail, economists want to regulate the market
to make it behave “better” according to “social welfare
criterion” such as monetary social efficiency and
equity.

– There are three basic types of policy targets, quantity, price and
quality. We looked at examples for regulating negative
externalities including a quota on output (an example of a
quantity instrument) and a tax on output (an example of a
price instrument).

– It is best to target policy along supply chain where GHGs are
released, not just on final stage.

– To regulate goods like forests which provide positive
externalities, we can use the quantity mechanism of a
floor or a price mechanism of a subsidy.

– Quality mechanisms include standards on allowable
technologies including sustainable forestry and building codes.

– We looked at policies to regulate markets guide them to
produce the socially efficient quantities and qualities
of output (TSS is maximized). The externalities are said to be
“internalized” such that the users (consumers and producers)
pay for negatives and are subsidized for positives.

– The monetary total social maximizing goal may
disproportionately harm low income people, income
redistribution policies like income tax reductions on low
and middle income people will need to be simultaneously
implemented. These may provide compensation while still
providing incentives to reduce GHGs since GHG intensive goods
will be relatively expensive.

– Economists often recommend targeting byproducts like
GHGs directly instead of goods, services (like electricity
or cars). This approach has the merits of enabling firms to find
the most cost effective methods to reduce emissions (we look at
this in the next lectures).

– However, regulating goods, services and inputs may be the
simplest regulation in some cases. For example, in the case
of cars, it is much easier to tax gasoline than GHG
emissions. Regulating goods, services and inputs can also
potentially be rapidly implemented.

“Thneeds” Residual
Byproducts

inputs services goods

Forests provide
CO2 removal
services

C
ru

d
e

– crude oil, trees
for paper and
wood, includes
technologies

– transport
to work
– trees as an
end product

Next Class, we shift our focus away from markets in GHG
intensive goods and services to the GHGs themselves.
We will develop the MAC MD framework which will allow us to
understand policies like carbon taxes, emissions standards and cap
and trade markets.

– The two basic targets are the goods, services and inputs produced in either the human production systems or the natural ones (or mixed
ones) OR the by targeting damaging residual byproducts (like the GHGs or ecosystem destruction and species extinctions.
– In this lecture, we have focused on policies which target the thneeds directly (not the byproducts).
– We will see later that there are pros and cons of either approach with ideally economists recommending that we target our policy directly at the
GHG residual byproducts. The reason is simple–if we target the thneeds, firms have no incentives to find low GHG ways to make these
thneeds. However, we can always target particular qualities of thneeds. We will look at this argument in the next lecture.

An example is targetting electricity via a Pigou tax on electricity. This approach would be foolish as firms will have no incentives to find greener
low GHG ways to make the electricity. It is better to target the GHGs as they leave the smokestacks. Firms can then focus on reducing these
GHGs as cheaply as possible. In our car example however, it will be expensive to target GHGs as they leave the tail pipe of over 800,000
automobiles. It is much simpler to tax gasoline and emissions at earlier stages along the supply chain. A possible drawback is that there is no
incentive to figure out a way to capture the emissions from the car.
http://www.cbc.ca/news/politics/story/2012/01/18/pol-keystone-xl-pipeline.html

Dr Seuss (1971), The Lorax,
Random House.

130

Appendix:

Quantity of
Thneads/
period

$ / thneed

Q m=40

20
100

100 MCexternal
=

Qse = 0

Pse > 100

MCSocial = 110 + Q

policy goal

110

Suppose that the MC
(external) is $90/ unit.
Here, the marginal social
cost of producing a good
always exceeds, the $
marginal social benefit, the
monetary social surplus is
maximized at Q = 0 at
which point TSS = 0.
The TSS loss at the market
equilibrium is equal to the
purple shaded area.

Case in which SE to ban good or service

Pm = 60

QSE = 0

$M
C
Pr

iva
te

$ MB Private
= $ MB Social

DWL

Question: What is the maximum total social surplus in this market?

Answer: 0

Quantity of
Thneads

$ /
thneed

Unregulated Supply Curve

Private MC Producer = 20 + Q

Demand Curve (Private MB
consumers and social MB)

Pm = 60
Q m=40
20
100
100

QSE=26.7

MCsocial
= 20+ 2Q

PSE
= 73.4

Regulated Supply Curve
Private MC producer + marginal tax
= 20 + Q + T

If the marginal external cost is not
constant, a constant marginal tax will
equal the vertical distance between the
unregulated supply (MC private curve)
and the socially efficient price at the
SE level of output = 73.4 – 46.7 = 26.7
(see pink arrow on graph)

Marginal cost external = Q

46.7

Case of upward sloping marginal external cost curve

References:
Pipe Dreams? Jobs Gained, Jobs Lost By Construction of
Keystone XL, Cornell University Global Labour Institute

Oil Sands, Greenhouse Gases, and US Oil Supply: Getting the
Numbers Right: IHS CERA (industry commissioned)

IPCC (2007) Transport and its Infrastructure (4th Assessment
Report, Working Group 3)
http://www.ipcc.ch/pdf/assessment-report/ar4/wg3/ar4-wg3-chapter5

Searchinger, T. et al (2008) Use of U.S. Croplands for Biofuels
Increases Greenhouse Gases Through Emissions from Land
Use Change, Science, 319, 19

Sharpe, A. et. al (2008) The Valuation of the Alberta Oil Sands,
Centre for the Study of Living Standards.

World Bank Population & cars per capita data

L6_ Practice Problems
Direct Regulation Externalities in Markets for goods, services or Inputs

Ruth Forsdyke

Regulating Negative Externalities:
1) This problem continues on from the L5 and L6 Practice Problem:
Note: Demand and Supply Curves are hypothetical but roughly intersect world demand and price
point.

QD(P) = 1

– P
QS (P) = 3P/2 – 6

The marginal external cost is: MCExternal = 25$/bbl (assumed low carbon tax of $50/tonne CO2e)

The quantity units are in millions bbl oil/day while the price units are in $US/bbl.

a) Find the marginal Pigouvian tax to regulate this market and plot on your graph. Illustrate how
this shifts the producer’s marginal cost curve.
b) Starting at the point in time immediately after the tax is imposed, explain the process by which
the market moves to the new equilibrium.
c) Use areas under curves to illustrate the following under the tax and indicate whether they rose
or fell:

i) total consumer surplus
ii) total producer surplus
iii) total external costs
iv) total social surplus
v) total tax revenue

d) Find the monetarily socially efficient crude oil quota and label on your graph.
e) Starting at the point in time immediately after the quota is imposed, explain the process by
which the market moves to the new equilibrium.
f) Use areas under curves to illustrate the changes in the following due to the quota:

i) total consumer surplus
ii) total producer surplus
iii) total external costs
iv) total social surplus
v) total quota rent (goes to firms if given away, goes to government if auctioned in
perfectly competitive market with no corruption, i.e. regulatory capture).

Variable vs Fixed External Costs:
2) Suppose that you take a return trip by Air from Halifax to Vancouver and back. The GHGs due
to combustion of the fuel used to power your trip are approximately 1 tonne of CO2e. Suppose the
price of carbon dioxide is $200/tonne CO2e. This is only part of your carbon footprint—by taking
the trip, you are also responsible for some very small fraction of the emission used during the air
plane’s product life cycle and also that of the air port. These get diluted out over many people and
so your airplane trip still has a carbon footprint of about 1 tonne. Like private costs, external costs
can be either fixed or variable. Identify some variable and fixed external costs of your trip.

Positive Externalities from Forests:
3) Consider the town of Thneedville. Their monetary marginal willingness to pay for a truffala
forest is: MWTP = 10 – Q/2 (in millions of $/hectare)
Suppose that the monetary marginal opportunity cost of the forest is cutting down the forest to
make thneeds is MCPrivate = 10Q (in millions of $/hectare)

Suppose that the forest stores 2000 tonnes of CO2e/ hectare and that it is estimated that the price of
carbon dioxide is $20,000/ tonne.

This problem is complicated in reality because it takes time to grow a forest during which carbon
dioxide is sequestered in the soil, plants and other organisms. When the forest comes into
equilibrium, there will be no net exchange of carbon dioxide with the atmosphere. For simplicity,
assume the forest grows immediately and all of the above benefits and costs are in terms of
hectares per century.

a) Find the perfectly competitive market equilibrium quantity and price of forest and plot on a
graph and label curves and equilibrium.

b) Find the marginal external benefit of forest and plot and label on your graph.
c) Find the marginal social benefit of the forest and find the socially efficient price and

quantity. Plot and label on your graph.
d) Label the total external benefit from the forest at the SE level and calculate it.
e) Label the deadweight loss (i.e. total social surplus loss from the market).
f) Suggest a quantity and price mechanism by which to regulate the forest.
g) Which of the quantity and price mechanisms is more likely to hit the quantity target?
h) Which policy would be easier for government to finance?

4) Suppose that you are considering 3 policies to regulate GHG emissions from buses. These are
1) a tax on buses, 2) a tax on gasoline and 3) a tax on tailpipe CO2 emissions from buses. Compare
pros and cons of these policies.
5) List some thneeds that produce positive GHG externalities.

Answers:
a) The marginal tax is equal to the marginal external cost of $25 at the socially efficient quantity.
The producers now pays $25/ barrel to the government increasing their private costs by $25/ barell.
The supply curve shifts up by $25/ thneed (red to dashed green). The equation of the new MC
private curve is 65 + 2Q/3 (the same as the social marginal cost curve).

$/
barrel

Crude oil (millions
barrels /day

PMarket = 100

QMarket
= 90

$MCPrivate_Old

$ MBSocial

B C

190

0
0 190

$ MBPrivate&Social

$ MCSocial = MCPrivate_New
= $ MCPrivate_Old + $t

PSE = 115

QSE
= 75

65 t =
$25/barrel
{Marg. tax
shifts
supply
curve up}
by)

b) Now, immediately after the tax is imposed, at the old market price of $100/barrel, firms are
willing to supply 52.5 million barrels which is less than the demand of 90 million barrels so there
is excess demand. The price rises causing demand to fall (move along demand curve). The new
regulated market equilibrium occurs when new supply = demand with the new price being $115
and the new quantity being 75 million barrels. This is monetarily socially efficient.

c) Use areas under curves to illustrate the following under the tax:

i) The new consumer surplus is equal to A = (190 – 115) * 75 million/2
= Total willingness to pay for 75 barrels – total expenditure on 75 barrels
= [A+B+C+D+ E+F] – [B+C+D+E+F] = A = $ 2812.5 million. The Tot. Cons. Surplus fell
relative to the unregulated market allocation at which it was (190 – 100)*90/2 = $4050 million.

ii) The new total producer surplus is equal to B+D which is equal to the producers’ total
revenue (their variable benefits) – their total production costs
= [B+C+D+E+F] – [ F + E + C] = (115 – 65) * 75/2 = $1875 million.

The old tot. prod. surplus was equal to (100 – 40)*90/2 = $2700 which is bigger than under the
tax regulation. Hence tot. prod. surplus fell. Note that tot. prod. surplus is also called “variable
profits” or “economic rent”. Producers profits fall & hence they may lobby against the tax policy.

iii) tot. external costs = C + E = $1875 (green area)
iv) tot. social surplus = ABD (note deadweight loss at market allocation is G) = $ 4687.5 million.
v) The tot. tax revenue is equal to $25/barrel * 75 million barells = $1875 million = E + C

d. Set the Quota at the SE quantity of Oil as illustrated below.

$/
barrel
Crude oil (millions
barrels /day
PMarket = 100
QMarket
= 90

$ Marginal
Private
Cost

$ Marginal
Social
Benefit

A
B C
190
40
0

0
190

$ Marginal
Private
Benefit

$ Marginal
Social Cost

PSE = 115

QSE =
75

D
E
F
H

Quota = 75
million
barrels/ day

G
I
J
90

e) The money socially efficient quota is applied at the socially efficient level of output. The new
supply curve is the same as the old supply curve for quantities lower than the quota after which it
becomes vertical at the quota (dashed crimson line). At the old market price of $100/ barrel, the
demand is 90 million barrels while the supply is 75 million barrels such that there is excess
demand. This drives the price up PSE = $100/thneed until the demand equals new supply at QSE
= $ 100 mill barrels per day.

i) $ Total Consumer Surplus
= $Total Willingness to Pay (Benefits) – $ Total Expenditure (Costs)

= [A+B+C+D+E+F] – [B+C+D+E+F]
= A = (190 – 115) * 75/2 = $ 2812.5 million

The total consumer surplus in the unregulated market is (190 – 100)*90/2 = $4050
million/ year. Hence, consumer surplus has fallen.

ii) $ Total Producer Surplus
= $Total Revenue (Benefits) – $Total Producer Costs
= [B+C+D+E+F] – F = B+C+D+E
= [$115/thneed * 75 million thneeds] – [40*75 million thneeds + (90 – 40)*75/2]
= $ 8625 mill – $ 4825 = $ 3750 million/year.

This is less than the producer surplus under the unregulated market ($ 90 * 90 mill/2 = $4050
million/ year). Hence, in our example, the total producers surplus went down –however, it is
possible that it could rise because the price they receive rises (which all else equal increases
revenue) while the amount sold falls (which all else equal reduces revenue). In our example, the
latter effect dominates the former so our total producer surplus fell.

iii) total external costs = C+E
iv) total social surplus = ABD
v) total quota rent = E+C (this is how much quotas would sell for in a perfectly competitive
auction)

Under quota giveaway, the government collects no revenue. If instead, we auctioned off the
quotas, and each quota sold for a price of 25$/bbl, the government would collect a revenue equal to
area C+E = 25 $/barrel * 75 million barrels = $1875 million. The total consumer surplus is the
same as under the quota give way while the producer surplus is equal to area B+D = (115 – 65) *
75 million/2 = $1875 million.
We can see from the small numbers I am getting for total producer surplus and so on that my
demand curve intercept is far too low (however, my x-axis is based on the data). Also, the linear
curves were employed for heuristic purposes.
Also, the demand is by oil refineries and hence, the consumer surplus is the surplus to the
refineries. There will be more surplus higher up the supply chain.

2) Fixed external costs include GHGs produced when the airplane was made and when the airport
was constructed. These do not vary with the number of flights.
Variable GHG costs is 1 tonne/flight* 200 $/tonne = $200. We can see that this carbon tax will
provide some deterrent to flying.

3) Positive Externalities from forests
a) $ MBPrivate = $ MWTP = 10 – Q/2

$ MC = 10Q
To find market equilibrium, set MBPrivate = MCPrivate
10 – Q/2 = 10Q
10 = 10Q + Q/2 = 21Q/2
QMarket = 20/21= 0.9523 hectares
PMarket = 10 – 0.9523/2 = $9.5 mill/ hectare
∴the unregulated competitive market will supply 0.9523 hectares at a price of $9.5 million
each (the price here represents the net present value over the century).

b) MBExternal = PCO2 * CO2 sequestered / hectare = $ 20,000/tonne * 2000 tonnes/hectare
= 40,000,000 $/hectare = 40 mill $/hectare

c) MBSocial = MBExternal+MBPrivate
= 40 + 10 – Q/2 = 50 – Q/2
Set equal to MCSocial to get the efficient quantity of thneeds.
We assumed no negative externalities, so MCSocial = MCPrivate
MBSocial = MCSocial
50 – Q/2 = 10Q
QSE = 4.76 & PSE = $47.62 mill $/hectare
We can see that the market fails to provide enough of the forest due to the private parties
being unable to capture the value of the externalities.

d) TBExternal = 4.76 hectares * 40 mill/hectare = $ 190.4 million.
e) See graph.
f) A quantity mechanism is a forest floor of 4.7 hectares while a price mechanism is a

marginal subsidy of $40 mill/hectare. Alternatively, if we start out with forest, we could
charge a $40 mill/hectare for cutting it down.

g) The quantity mechanism (floor on amount of forest) is more likely to hit the target than
the price mechanism (subsidy to conserve forest) because the government is unlikely to
have accurate demand and supply curve estimates and hence will have trouble knowing
how private parties will react to the tax. Quality mechanisms can also be employed. For
example, all logging must sustainable practice standards.

h) The marginal subsidy is going to be expensive to finance. If the subsidy is relative to BAU
(here the market quantity), the government is may mis-estimate this and end out paying too
much subsidy. An alternative is to use nature as the baseline and to tax all alternative uses
by $40 million/ hectare_century. The forest would generate revenue for the government
and this could be used to reduce taxes elsewhere and to finance public goods.

4 a) A tax on buses only provides an incentive to reduce the number of buses. This will lower
GHGs from buses but provides no incentive to develop low GHG buses.
b) Since gasoline produces GHGs upon combustion and since a tax on gasoline will provide
incentives to use less gasoline, this will provide an incentive for firms to produce buses that use
less gasoline and potentially less GHGs. However, we also better make sure that there is a tax on
liquefied coal because if the price of gasoline rises too much, liquefied coal may be used and this
will also cause a lot of GHGs.
c) A tax that is levied on the actual emissions from each bus would be difficult to implement
due to needing to put emissions monitors on every bus (or car). Bus companies might tamper
with the monitors to save money on the tax increasing government’s regulatory costs further.
Although directly targeting transport GHGs would however provide incentives to reduce GHGs
and might also provide incentives to invent ways to capture GHG emissions from transport
vehicles, making a target on GHGs ideal in theory, in practice, scientists do not think that it is
likely that we will be able to capture and store emissions from mobile sources such that the
expected benefits of directly targeting transport GHG emissions are not expected to outweigh the
additional regulatory costs of CO2 monitoring.

The simplest policy on transport GHGs are levies on the final transport fuel that are proportional
to the GHGs emitted when the gasoline is combusted. Taxes on GHG emissions can also be
levied further up the supply chain at refining, transport, and processing and extraction stages.
This will be an efficient way to tax gasoline and diesel as the tax will be proportionate to the
GHG’s produced along the entire lifecycle. Transport fuels from high GHG sources like Tar
Sands would be relatively expensive providing incentives to use the least dirty transport fuel
during an oil phase-out.

5. An example of thneeds, which provide positive externalities are natural ecosystems like
forests, wetlands and marine areas. A quantity mechanism to achieve socially efficient amounts
of forests is a quantity floor (ex. National and Provincial Parks) or a subsidy. Households, firms
and governments could be paid subsidies for the amount of natural ecosystems they conserve.
Green subsidies can be financed by taxes on negative externalities. Another example is replacing
high GHG energy source (ex coal) with wind turbines. The positive externality from the wind
turbine equals the savings in external costs from not combusting coal minus wind power GHGs.
Note that most of the externalities from wind are fixed external costs incurred when manufacturing
the wind turbines as well as fixed costs on site such as roads to access turbines, costs of
manufacturing computer equipment and so on.

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