Tag: marginal social cost

25 January 202531 January 2025

Trump to withdraw the USA from the Paris climate agreement

On the day he came to office, President Trump signed a series of executive orders. One of these was to set in motion the process of withdrawing from the UN Paris climate agreement. Section 3(a) of the order reads:

The United States Ambassador to the United Nations shall immediately submit formal written notification of the United States’ withdrawal from the Paris Agreement under the United Nations Framework Convention on Climate Change.

The Paris Agreement is an international treaty on climate change. It was adopted on 12 December 2015 and came into force on 4 November 2016, 30 days after the point was reached when at least 55 countries accounting for at least 55% of global emissions had ratified the treaty.

Currently, all UN countries are signatories to the agreement and only Iran, Libya and Yemen are yet to ratify it. The agreement commits countries to limiting global warming to well under 2°C above pre-industrial levels and preferably to no more than 1.5°C. This would involve reducing greenhouse gas emissions and/or taking carbon absorbing measures.

Since 2020, each country has been required to submit its own emission-reduction targets, known as ‘nationally determined contributions’ (NDCs), and the actions it will take to meet them. Every five years each country must submit a new NDC more ambitious than the last.

Rich countries are expected to provide finance to low-income countries. This is required to help poor countries adopt green technologies and to adapt to the harmful effects of climate change (e.g. through irrigation schemes and flood defences).

Countries set target dates by which emissions would be fully offset by carbon absorption measures (‘net zero’). The UN’s goal is to reach global net zero by 2050. According to the UN Climate Action site:

As of June 2024, 107 countries, responsible for approximately 82 per cent of global greenhouse gas emissions, had adopted net-zero pledges either in law, in a policy document such as an national climate action plan or a long-term strategy, or in an announcement by a high-level government official. More than 9000 companies, over 1000 cities, more than 1000 educational institutions, and over 600 financial institutions have joined the Race to Zero, pledging to take rigorous, immediate action to halve global emissions by 2030.

The Paris Agreement has helped to cut emissions or slow their rate of growth in most countries. Although net zero by 2050 may be unlikely, warming will be less than without the agreement.

The USA and the Paris Agreement

In April 2016 the USA signed the Paris Agreement. As stated above, the Paris Agreement came into effect on 4 November 2016.

President Trump came to office for the first time in January 2017. In June 2017, he signed an executive order in which he announced that the USA would withdraw from the agreement, arguing that it undermined the US economy and put it at a competitive disadvantage. He claimed that global warming is a hoax concocted by China designed to undermine the competitive power of the USA.

However, despite Trump’s intention to withdraw from the agreement, its terms did not allow a country to begin a withdrawal procedure for at least three years after the agreement was ratified (i.e. not before 4 November 2019) and then a year’s notice has to be given. This notice was given on 4 November 2019. In the meantime, the USA had to abide by the terms of the treaty. During this period, US representatives at COP meetings used the opportunity to promote fossil fuels. Withdrawal took place on 1 November 2020, just one day after the presidential election and just over two months before the end of Trump’s first term of office.

On 20 January 2021, his first day in office, President Biden signed an executive order to rejoin the agreement, which took place on 19 February 2021. He committed to cutting total greenhouse gas emissions by at least 50% by 2030. To achieve this, his administration adopted a number of emissions-reducing measures, for example requiring all new passenger vehicles sold after 2035 to be emissions free, giving tax credits for clean electricity generation, providing federal funds for smart agriculture and setting greener appliance and equipment standards.

But, as we have seen, newly elected President Trump for the second time announced that the USA would withdraw from the Paris agreement and would prioritise fossil fuel production, under the mantra, ‘drill, baby, drill’.

The economics of climate change

Climate change is directly caused by market failures. One of the most important of these is that the atmosphere is a common resource: it is not privately owned; it is a global ‘commons’. Individuals and firms use it at a zero price. If the price of any good or service to the user is zero, there is no incentive to economise on its use. Thus for the emitter there are no private costs of using the atmosphere in this way as a ‘dump’ for their emissions and, in a free market, no incentive to reduce the climate costs.

And yet when firms emit greenhouse gases into the atmosphere there are costs to other people. To the extent that they contribute to global warming, part of these costs will be borne by the residents of that country; but a large part will be borne by inhabitants of other countries.

These climate costs are external costs to the firm and are illustrated in the figure. It shows an industry that emits CO₂. To keep the analysis simple, assume that it is a perfectly competitive industry with demand and supply given by curves D and S, which are equal to the marginal private benefits (MPB) and marginal private costs (MPC), respectively. There are no externalities on the demand side and hence MPB equals the marginal social cost (MSB). Market equilibrium is at point a, with output at Q_pc and price at P_pc. (Click here for a PowerPoint.)

Assume that the emissions create a marginal cost to society equal to MEC_c. Assume that the MEC increases as output and total emissions increase. The MEC_c line is thus upward sloping. At the market price of Q_pc, these external climate costs are equal to the purple vertical line. When these external climate costs are added to private costs, this gives a marginal social cost given by MSC = MPC + MEC_c. The gives a socially optimal level of output of the product of Q* at a price of P*, with the optimum point of c.

In other words, other things being equal, the free market overproduces products with climate externalities. If the output is to be reduced to the social optimum of Q*, then the government will need to take measures such as those advocated in the Paris Agreement. These could include imposing taxes on products, such as electricity generated by fossil fuels, or on the emissions themselves. Or green alternatives, such as wind power, could be subsidised.

Alternatively, regulations could be used to cap the production of products creating emissions, or caps on the emissions themselves could be imposed. Emissions permits could be issued or auctioned. Only firms in possession of the permits would be allowed to emit and the permits would cap emissions below free-market levels. These permits could be traded under a cap-and-trade scheme, such as the EU’s Emissions Trading Scheme. Again, such schemes are advocated under the Paris Agreement.

Effect of the USA’s withdrawal from the Paris Agreement

Withdrawal from the Paris Agreement and promoting fossil fuels will increase US emissions. Scientific consensus is that this will have a negative effect on climate change. Only part of these climate costs will be borne by the USA, although the severity of recent fires in California, fanned by strong Santa Ana winds, and more violent hurricanes are two examples of costs of climate change to the USA itself.

A bigger worry is whether the USA’s withdrawal will encourage other countries, such as Argentina, to do likewise. Then the climate costs of US withdrawal will be greater.

But all is not bad news. The transition to green energy is well advanced and the costs of solar and wind power are decreasing. Global investment in clean energy has increased by 60% since 2015. China is investing heavily in renewable energy technology, which is giving it a significant trade advantage. The EU has taken significant actions to promote green energy and technology. Similarly, industrial processes that economise on emissions are developing apace and it is becoming increasingly profitable for private companies to make climate-friendly investments without subsidies. In the USA itself, many Democratic states and local governments, and even some Republican ones, will continue to adopt climate-friendly policies.

In this environment, the Trump administration does not want to fall behind in the development of new technologies and markets. And with Elon Musk having a significant influence on Donald Trump, the USA’s investment in EVs and battery technology is likely to continue. This will help to reduce the price of green energy and transport.

Videos

Trump takes US out of Paris climate agreement, doubles down on fossil fuels • FRANCE 24 English

France 24 on YouTube (20/1/25)

Did Trump Make the Right Choice Leaving the Paris Accord?

The News9 Plus Show of India on YouTube (21/1/25)

‘A truly unfortunate development’ – Trump pulls US out of Paris Agreement

euronews on YouTube (22/1/25)

Articles

Trump vows to leave Paris climate agreement and ‘drill, baby, drill’

BBC News, Matt McGrath (20/1/25)

What is the Paris climate agreement and why has Trump withdrawn?

BBC News, Esme Stallard and Mark Poynting (21/1/25)

Six Trump executive orders to watch

BBC News (21/1/25)

The real message behind Trump’s withdrawal of US from the Paris climate agreement

Sky News, Tom Clarke (21/1/25)

Trump signs order to withdraw US from Paris climate agreement for second time

The Guardian, Dharna Noor (20/1/25)

Explained: how Trump’s day one orders reveal a White House for big oi

The Guardian, Oliver Milman and Dharna Noor (22/1/25)

Donald Trump can’t stop global climate action. If we stick together, it’s the US that will lose out

The Guardian, Bill Hare (6/11/24)

Trump to pull US from Paris climate agreement: What could this mean for the environment?

ITV News, Martin Stew (21/1/25)

10 reasons why US president-elect Donald Trump can’t derail global climate action

The Conversation, Wesley Morgan and Ben Newell (8/11/24)

Trump has rejected the Paris agreement again, but game theory shows how other countries can still lead by example

The Conversation, Renaud Foucart (27/1/25)

Information

Putting America First in International Environmental Agreements

Whitehouse Executive Order (20/1/25)

The Paris Agreement

United nations Climate Change

United States and the Paris Agreement

Wikipedia

Tracking Progress: Climate Action Under the Biden Administration

World Resources Institute, Dan Lashof (30/7/24)

Questions

Summarise the Paris Agreement.
Using a diagram similar to that above, illustrate how the free market will produce a sub-optimal amount of solar power because the marginal social benefit exceeds the marginal private benefit.
How might game theory be used to analyse possible international decision making in the context of US climate policy?
Is it in America’s interests to cease investing in green energy and green production methods?
Go through each of the reasons (not specific to Australia) given in The Conversation article linked above why ‘Donald Trump can’t derail global climate action’. To what extent do you agree with each one?

6 November 2019

Are carbon taxes a solution to the climate emergency?

With the growing recognition of the global climate emergency (see also), attention is being increasingly focused on policies to tackle global warming.

In the October version of its journal, Fiscal Monitor, the IMF argues that carbon taxes can play a major part in meeting the goal of achieving net zero carbon emissions by 2050 or earlier.

As the blog accompanying the journal states:

Global warming has become a clear and present threat. Actions and commitments to date have fallen short. The longer we wait, the greater the loss of life and damage to the world economy. Finance ministers must play a central role to champion and implement fiscal policies to curb climate change. To do so, they should reshape the tax system and fiscal policies to discourage carbon emissions from coal and other polluting fossil fuels.

The effect of a carbon tax on production

The argument is that carbon emissions represent a massive negative externality, where the costs are borne largely by people other than the emitters. Taxes can internalise these externalities. The effect would be to raise the price of carbon-emitting activities and reduce the quantity consumed and hence produced.

The diagram illustrates the argument. It takes the case of carbon emissions from coal-fired electricity generation in a large country. To keep the analysis simple, it is assumed that all electricity in the country is generated from coal-fired power stations and that there are many such power stations, making the market perfectly competitive.

It is assumed that all the benefits from electricity production accrue solely to the consumers of electricity (i.e. there are no external benefits from consumption). Marginal private and marginal social benefits of the production of electricity are thus the same (MPB = MSB). The curve slopes downwards because, with a downward-sloping demand for electricity, higher output results in a lower marginal benefit (diminishing marginal utility).

Competitive market forces, with producers and consumers responding only to private costs and benefits, will result in a market equilibrium at point a in the diagram: i.e. where demand equals supply. The market equilibrium price is P₀ while the market equilibrium quantity is Q₀. However the presence of external costs in production means that MSC > MPC. In other words, MEC = b – a.

The socially optimal output would be Q* where P = MSB = MSC, achieved at the socially optimal price of P*. This is illustrated at point d and clearly shows how external costs of production in a perfectly competitive market result in overproduction: i.e. Q₀ > Q*. From society’s point of view, too much electricity is being produced and consumed.

If a carbon tax of d – c is imposed on the electricity producers, it will now be in producers’ interests to produce at Q*, where their new private marginal costs (including tax) equals their marginal private benefit.

Assessing the benefits of carbon taxes

The diagram shows the direct effect on production of electricity. With widespread carbon taxes, there would be similar direct effects on other industries that emit carbon, and also on consumers, faced with higher fuel prices. In the UK, for example, there are currently higher taxes on high-emissions vehicles than on low-emissions ones.

However, there are other effects of carbon taxes which contribute to the reduction in carbon emissions over the longer term. First, firms will have an incentive to invest in green energy production, such as wind, solar and hydro. Second, it will encourage R&D in green energy technology. Third, consumers will have an incentive to use less electricity by investing in more efficient appliances and home insulation and making an effort to turn off lights, the TV, computers and so on.

People may object to paying more for electricity, gas and motor fuel, but the tax revenues could be invested in cheaper clean public transport, home insulation and public services generally, such as health and education. This could be part of a policy of redistribution, with the tax revenues being spent on alleviating poverty. Alternatively, other taxes could be cut.

The IMF estimates that to restrict global warming to 2°C (a target seen as too modest by many environmentalists), large emitting countries ‘should introduce a carbon tax set to rise quickly to $75 a ton in 2030’.

This would mean household electric bills would go up by 43 per cent cumulatively over the next decade on average – more in countries that still rely heavily on coal in electricity generation, less elsewhere. Gasoline would cost 14 percent more on average.

It gives the example of Sweden, which has a carbon tax of $127 per ton. This has resulted in a 25% reduction in emissions since 1995, while the economy has expanded 75% since then.

Limits of carbon taxes

Although carbon taxes can make a significant contribution to combatting global warming, there are problems with their use.

First, it may be politically popular for governments not to impose them, or raise them, with politicians arguing that they are keen to help ‘struggling motorists’ or poor people ‘struggling to keep their homes warm’. In the UK, successive governments year after year have chosen not to raise road fuel taxes, despite a Fuel Price Escalator (replaced in 2011 by a Fuel Duty Stabiliser) designed to raise fuel taxes each year by more than inflation. Also, governments fear that higher energy prices would raise costs for their country’s industries, thereby damaging exports.

Second, it is difficult to measure the marginal external costs of CO₂ emissions, which gives ammunition to those arguing to keep taxes low. In such cases it may be prudent, if politically possible, to set carbon taxes quite high.

Third, they should not be seen as a sufficient policy on their own, but as just part of the solution to global warming. Legislation to prevent high emissions can be another powerful tool to prevent activities that have high carbon emissions. Examples include banning high-emission vehicles; a requirement for coal-fired power stations and carbon emitting factories to install CO₂ scrubbers (filters); and tougher planning regulations for factories that emit carbon. Education to encourage people to cut their own personal use of fossil fuels is another powerful means of influencing behaviour.

A cap-and-trade system, such as the European Emissions Trading Scheme would be an alternative means of cutting carbon efficiently. It involves setting quotas for emissions and allowing firms which manage to cut emissions to sell their surplus permits to less efficient firms. This puts a price pressure on firms to be more efficient. But the quotas (the ‘cap’) must be sufficiently tight if emissions are going to be cut to desired levels.

But, despite being just one possible policy, carbon taxes can make a significant contribution to combatting global warming.

Articles

Fiscal Policies to Curb Climate Change

IMF blog, Vitor Gaspar, Paolo Mauro, Ian Parry and Catherine Pattillo (10/10/19)

Energy bills will have to rise sharply to avoid climate crisis, says IMF

The Guardian, Larry Elliott (10/10/19)

Huge global carbon tax hike needed in next 10 years to head off climate disaster, says IMF

Independent, Chris Mooney and Andrew Freedman (11/10/19)

World urgently needs to quicken steps to reduce global warming – IMF

Reuters, Lindsay Dunsmuir (10/10/19)

The Case for a Goldilocks Carbon Tax

Forbes, Roger Pielke (13/9/19)

The world needs a massive carbon tax in just 10 years to limit climate change, IMF says

Washington Post, Chris Mooney and Andrew Freedman (10/10/19)

People like the idea of a carbon tax – if the money is put to good use

New Scientist, Michael Le Page (18/9/19)

The IMF thinks carbon taxes will stop the climate crisis. That’s a terrible idea.

The Guardian, Kate Aronoff (12/10/19)

Firms ignoring climate crisis will go bankrupt, says Mark Carney

The Guardian, Damian Carrington (13/10/19)

How central banks can tackle climate change

Financial Times, The editorial board (31/10/19)

World Economic Forum: Climate change action needed to avoid societal ‘collapse’ says minister

The National, UAE, Anna Zacharias (3/11/19)

Riots and trade wars: Why carbon taxes will not solve climate crisis

Recharge, Leigh Collins (31/10/19) (Part 1)

The plethora of effective alternatives to carbon pricing

Recharge, Leigh Collins (31/10/19) (Part 2)

Are these the real reasons why Big Oil wants a carbon tax?

Recharge, Leigh Collins (31/10/19) (Part 3)

Do we need carbon taxes in an era of cheap renewables?

Recharge, Leigh Collins (31/10/19) (Part 4)

Report

How to Mitigate Climate Change

IMF Fiscal Monitor, Ian Parry (team leader), Thomas Baunsgaard, William Gbohoui, Raphael Lam, Victor Mylonas, Mehdi Raissi, Alpa Shah and Baoping Shang (October 2019)

Questions

Draw a diagram to show how subsidies can lead to the optimum output of green energy.
What are the political problems in introducing or raising carbon taxes? Examine possible solutions to these problems
Choose two policies for reducing carbon emissions other than using carbon taxes? Compare their effectiveness with carbon taxes.
How is game theory relevant to getting international agreement on cutting greenhouse gas emissions? Why is there likely to be a prisoners’ dilemma problem in reaching and sticking to such agreements? How might the problem of a prisoners’ dilemma be overcome in such circumstances?

21 October 201321 October 2013

Do bus lanes increase congestion?

Demand and supply analysis can be applied to a multitude of markets. When there is a disequilibrium in a market, prices will tend to adjust to eliminate any shortage or surplus. But, what of road space? There is a demand and a supply of road space and when there are too many cars for the road space available, congestion is the consequence.

When an additional car enters the road network, there is a cost and a benefit to the driver. However, there are not only costs/benefits to the driver, but there are also costs/benefits to other road-users. When one car drives on the M25 it adds to the number of cars on the road. Once we reach the point where there are too many cars given the road space and thus the flow of cars per minute begins to fall, congestion starts to build up. There is a negative externality involved here – the actions of one person (the driver) impose an additional cost on other drivers (the congestion). It takes every other road user a little bit of extra time to get from A to B the more cars there are on the road.

Congestion is a problem in many parts of the country and various solutions have been suggested. Policies to reduce demand will help the congestion problem by reducing the number of cars on the road. Numerous strategies have been tried, such as restrictions on parking; improvements in public transport; an integrated transport policy; higher parking charges; work place parking levies; higher taxes on petrol, higher car taxes and congestion charging schemes.

Alternatively, building more roads will directly increase the supply of road space, but this can (and has) simply led to more cars using the additional road space and thus the problem of congestion remains. Bus/taxi lanes are in use across the country and allow the users of public transport to benefit from faster journey times, thus encouraging them to forgo their cars and use buses. However, does this add to the congestion for other people?

In Liverpool, a nine month trial is taking place, where bus lanes will be removed to find out if they have a positive effect on reducing congestion. By increasing the amount of road space available to all road users, Liverpool City Council will be able to see if directly increasing the supply of road space will help to meet the existing demand. The possibility, however, is that by increasing the supply of road space, more individuals will choose to use their cars, thus fuelling demand. Many argue that this trial is a step backwards and will add to congestion, reduce the appeal of travelling by bus and impose further costs on the environment. The following articles consider the debate surrounding congestion.

Liverpool City Council will scrap bus lanes for nine months BBC News (27/9/13)
Liverpool bus lanes plan criticised by government Liverpool Daily Post (9/10/13)
Calls for single 30% income tax rate BBC News (21/5/12)
Liverpool scraps bus lanes in trial BBC News (including video) (21/10/13)
Government warning over Liverpool council plans to axe bus lanes in the city Liverpool Echo (9/10/13)

Questions

Explain why congestion is a negative externality. What other externalities exist with regard to car usage?
Using a diagram, show the point at which congestion occurs and explain why there is a difference between the marginal private and marginal social cost.
What will happen to the difference between the marginal private and social cost curves before and after congestion sets in?
Think about the different solutions to the problem of congestion. In each case, explain whether it is a demand-side or supply-side solution and how it will aim to combat congestion. You should also consider whether it is a short or long term solution and how feasible it actually is.
How will the abolition of bus lanes aim to reduce congestion?
There are supporters for bus lanes and supporters for the abolition of them. Justify the arguments on each side of the debate. You should consider the wider implications as well as the impact on congestion.