Overview of the basic concepts, theories, and frameworks related to the economics of climate change, including the role of market failures, externalities, and the need for policy interventions.
Introduction to Climate Change Economics
Key concepts, mechanisms, and policy tools
1. Why Study the Economics of Climate Change?
| Economic Reason |
Explanation |
| Scarcity of Resources |
Fossil‑fuel reserves are finite; their extraction and use have external costs. |
| Intergenerational Equity |
Current emissions affect the welfare of future generations. |
| Market Failure |
Climate impacts are negative externalities not reflected in market prices. |
| Global Public Good |
A stable climate benefits everyone, but individual nations may under‑invest in mitigation. |
| Risk & Uncertainty |
Long‑run climate outcomes are uncertain, creating challenges for optimal investment. |
2. Core Economic Concepts
| Concept |
Definition |
Relevance to Climate |
| Externalities |
Costs/benefits affecting third parties not captured by market prices. |
CO₂ emissions impose health, agricultural, and disaster costs on society. |
| Social Cost of Carbon (SCC) |
Monetary value of the incremental damage caused by emitting one extra ton of CO₂. |
Guides carbon pricing, regulation, and project appraisal. |
| Discounting |
Reducing the present value of future costs/benefits. |
Determines how heavily we weigh future climate damages versus present costs. |
| Pigouvian Tax |
A tax equal to the marginal external damage. |
Carbon tax is a classic example. |
| Cap‑and‑Trade (Emissions Trading System, ETS) |
Sets a total emissions cap and allows trading of permits. |
Creates a market price for emissions while guaranteeing a quantity limit. |
| Co‑benefits |
Positive side effects of climate actions (e.g., reduced air pollution). |
Increases net economic returns of mitigation projects. |
| Adaptation vs. Mitigation |
Adaptation: adjusting to climate impacts. Mitigation: reducing GHG emissions. |
Both require resources; economics helps allocate them efficiently. |
3. Modeling Climate–Economy Interactions
| Model Type |
Main Features |
Typical Use |
| Integrated Assessment Models (IAMs) |
Combine climate system equations with economic modules (e.g., DICE, PAGE). |
Estimate SCC, evaluate policy pathways, cost‑benefit analysis. |
| Computable General Equilibrium (CGE) Models |
Capture sectoral linkages, trade, and factor markets. |
Assess macro‑economic impacts of carbon taxes or ETS. |
| Partial‑Equilibrium Models |
Focus on a single market (e.g., electricity). |
Study specific policy instruments like renewable subsidies. |
| Damage Functions |
Relate temperature rise to economic loss (GDP, health, agriculture). |
Input for IAMs and cost‑benefit studies. |
Key Insight: Models are simplifications; results depend heavily on assumptions about climate sensitivity, technology progress, and discount rates.
4. Policy Instruments
| Instrument |
Mechanism |
Advantages |
Limitations |
| Carbon Tax |
Direct price on CO₂ emissions. |
Simple, predictable price signal, revenue‑generating. |
Politically sensitive; may need complementary measures for equity. |
| Cap‑and‑Trade |
Fixed emissions cap, tradable permits. |
Guarantees quantity, flexible compliance. |
Permit allocation can be contentious; price volatility. |
| Regulation / Standards |
Mandates (e.g., fuel‑efficiency standards). |
Guarantees minimum performance. |
May be less cost‑effective, rigid. |
| Subsidies & Feed‑in Tariffs |
Financial support for clean tech |
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