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Economics of Climate Change and Carbon Emissions

Paper Type: Free Assignment Study Level: University / Undergraduate
Wordcount: 1853 words Published: 9th Nov 2020

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Climate change is a burning issue which is plaguing the world. From Greta Thunberg who calls for a climate emergency to Donald Trump tweeting it out as a hoax, experts and notable persons from every field have their unique opinion on climate change. Climate change is often viewed through the lens of science, ignoring the diversity of its effects on the world, making the debate narrow and one dimensional as it focuses on the effects of climate change and how it can be reduced but often fails to recognise the costs it might incur to apply the technology and policies.  Economists, on the other hand, have always contributed to the smooth and efficient running of the economy by applying the principles of economics and its theories and subsequently benefitting producers and consumers. In sharp contrast to experts of physical sciences, economists focus on the less researched areas of costs and benefits that these technologies might incur and providing solutions of these ignored issues.

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As a species, we still hesitate to recognize our impact on the Earth, ignoring the magnitude of damage we have caused. (Costanza et al 2007a, as cited in Costanza et al 2017). Climate change has been observed since the late 19th century, as since then the global mean surface temperature has risen by around 1.0°C, with the increase rising after 1980 (Wuebbles 2017, referred in Hsiang and Kopp 2018). Warming over land was also significantly faster than the sea: between 1880–1900 and 1997–2017, the land averaged 1.4 ° C (2.5°F) while the oceans grew around 0.6°C (1.1°F) (GISTEMP Team 2018, cited by Hsiang and Kopp 2018). A warmer climate will accumulate more water vapour, increasing the average precipitation overall (rainfall and snowfall). Precipitation in the mid-latitude northern hemisphere has been rising since the 1950s. Since 1900, the global mean sea level has risen by about 18–21 cm, with the growth frequency 2–2.5 times faster since about 1990 than in the previous nine decades. (Sweet et al. 2017, cited by Hsiang and Kopp 2018) As the CO2 concentration in the atmosphere increases, some of this CO2 dissolves into ocean water, producing carbonic acid and increasing ocean acidity.

Another great factor of climate change are waste emission stock like nuclear wastes, various chemicals, toxic gases and so on. The excessive stock of greenhouse gasses, mainly CO2, in the atmosphere is one of the leading contributors of global warming. Most of our energy used for economic production come from carbon-based fuel sources. It is a widely accepted fact that the temperature of the atmosphere can only go up to a maximum of 2oC to stay within normal. British economist, Nicholas Stern argued that a target of 440 ppm (parts per millions or mg/L) of CO2e[1] was ideal, even though it has a 6% change of exceeding the 2oC limit (Stern 2007, cited by Costanza et al 2017) However, NASA climatologist. James Hansen, argued that 350 ppm was the maximum accepted level, without specifying whether it was for CO2 levels or CO2e (Hansen et al 2008, cited by Costanza et al 2017). Currently the stocks of CO2 stand at 414.7 ppm, not just being the highest level in 61 years of observation, but also the highest in human history (NOAA, 2019).

But is reducing carbon emissions cost efficient?

The cost of reducing carbon emissions are not without its challenges. Programs in support for biodiesel or energy efficient subsidies often seem cost-effective to the general public but under scrutiny of economists, it shows that they can be significantly more expensive than shown. The opposite also holds true, for example the Clean Power Plan, which would have reduced carbon emissions significantly for a fraction of the cost as compared to the plans already in place. Another factor is that most of the carbon emission reduction plans rely on the static cost of CO2, which do not include the dynamic consequences which, in-turn, may lead to significant long-term costs. Climate change is dynamic and thus research and cost assumptions should include the dynamic factors as well. Putting a price on carbon might not seem politically justified but in the long-term consideration, it needs to be incorporated in the short-term trade-offs. Economists recognise that with the right incentives, not even the rapid technological progress to combat climate change can be surprising any more. (Gillingham and Stock, 2018)

Moreover, scientists fail to understand or factor the socio-economic damages which occur as a result of climate change. Climate change is the biggest threat to the economics of resource management and requires focus on long-term solutions, one of them being sustainable development. Sustainable development is a way to deal with the growing rates of climate change and its impact on the scarcity of resources. In the scope of climate change research, the term “Damage Function" applies to translating climate into economic outcomes — essentially what is generally referred to as a "dose response function" (Auffhammer 2018). Economists have come up with ways to quantify economic damages, the two most important ones being:

  • The Ricardian Cross-Sectional Approach: Mendelsohn, Nordhaus and Shaw (1994) have tried to estimate a damage function which tries to measure the impact of climate on farmers and their crops by estimating the profits from the yield and its market value. But since there are other factors, (for example, farmer’s self-reported values, rainfall) some regression must be included to make the data as unbiased as possible. The results vary from season to season and climate to climate.
  • The Panel Data Approach: Auffhammer, Ramanathan and Vincent (2006) and Deschênes and Greenstone (2007) proposed to use year-to-year variations in agricultural outcomes, temperature and precipitation to estimate the damage function (as cited by Auffhammer 2018). The regression formula regresses outcomes of interest on contemporary climate measurements (instead of historical weather long-term averages). If the climate parameter on the right side enters the regression linearly, the predicted response was often described as a short run/heat/no response to adaptation. In this simplest version of the model, econometric identification arises from within unit year to-year changes in weather and the outcome of interest.

The prevailing frontier is probably best described by using the "Ricardo meets panel data" method, which is a combination of the abovementioned two approaches. The idea here is that if a large number of units (counties, families, or firms) are observed over a significant period covering a region with high climate heterogeneity, separate response functions for subgroups of individual units can be calculated using observed short-term weather fluctuations. Through accounting for unit-and time-fixed effects, it is possible to obtain realistic estimates of regional short-term dose response functions. One can then either correlate the slopes of the dose response to the environment across subgroups in a second step, or calculate how the slope of the dose response function differs across regions with different climates, incomes, and other observables that vary across space. (Auffhammer 2018)

Economists understand that the world needs sustainable development, especially after quantifying economic damages arising from climate change. Sustainable development suggests harmony with nature and resources, ensuring that future generations are much better off than we are right now. They understand to achieve such a goal, harsh steps must be taken, like stabilizing the population, revamping the financial and taxing systems, sharing of resources, in short, a complete overhaul of the current economic and social system. Ecological sustainability refers to the understanding that natural and social capital cannot be replaced with human and constructed capital and there are clear biophysical limits and boundaries for the expansion of an economy, the biggest limit being climate change.

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The standard economic model, though aimed at lowering poverty rates, has assumed that growth of GDP is the best way for expanding the economy. However, in an empirical study by Wilkinson and Pickett (2009) (referred in Costanza et al 2017) showed that there was a strong connection between income inequality in countries belonging to the Organization for Economic Co-operation and Development (OECD) and a range of health and social issues. To achieve real economic efficiency, where all resources that affect sustainable development, the current market-forced resource allocation needs to change to a new, sustainable economic model that includes natural and social capital in much effective ways.

By being able to make estimations on the price of carbon, quantifying economic damages and proving sustainable development not only benefits economically and socially, but also aims at being ecologically sustainable, economists have faced the challenges thrown by climate change head on. Scientists are attempting and debating on how to prevent or slow the march of climate change, and on the other hand, though ignored from these debates, economists have accepted the reality of the situation and adapted their strategy accordingly, proving that they do, in fact, deserve to be included in the debate of climate change.   


  • Auffhammer, M. (2018). Quantifying Economic Damages from Climate Change. In: The Journal of Economic Perspectives, 32(4), pp 33-52. Retrieved from https://www.jstor.org/stable/26513495
  • Costanza R. et al. (2017). Building a Sustainable and Desirable Economy-in-Society-in-Nature. In: Shmelev S. (eds) Green Economy Reader, Lectures in Ecological Economics and sustainability. Studies in Ecological Economics, vol 6, pp 376-454. Springer, Cham.
  • Gillingham, K., & Stock, J. (2018). The Cost of Reducing Greenhouse Gas Emissions. In: The Journal of Economic Perspectives, 32(4), pp 53-72. Retrieved from https://www.jstor.org/stable/26513496
  • Hsiang, S., & Kopp, R. (2018). An Economist's Guide to Climate Change Science. In: The Journal of Economic Perspectives, 32(4), pp 3-32. Retrieved from https://www.jstor.org/stable/26513494
  • Stein, T. (2019). Carbon dioxide levels hit record peak in May, National Oceanic and Atmospheric Administration Research News. Retrieved from https://research.noaa.gov/article/ArtMID/587/ArticleID/2461/Carbon-dioxide-levels-hit-record-peak-in-May

[1] Carbon Dioxide Equivalent, it is the standard unit of measuring carbon footprints.


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