1. Optimal climate policy
Prof. Dr. Carsten Vogt
Bochum University of Applied Sciences
Summer term 2013

2. Optimal climate policy
Weighing of costs and benefits from climate policy
Need for quantifying benefits and costs
Moreover: we need to take into account the timing of climate policy
Abatement today is more costly than abating emissions in the future (technical progress)
In short: We need a model.

3. Optimal climate policy: DICE (Nordhaus)
DICE: Dynamic Integrated model of the Climate and the Economy
Contains the important links between economic activity and climate system
Is a daynamic optimization model
i.e. it allows for calculating the optimal abatement path over time

4. DICE (2007): model architecture
Welfare
Population
Utility
carbon
abatement
consumption
capital
emissions
output
Labour force
Global temperature
damages

5. DICE: Equations Welfare: Depends on:
Utility from consumption
Population size (the more people, the more suffer from climate change)
DICE: maximizes the sum of discounted utilities
Obvious: core parameter of the model: discount rate
Note: DICE approach is purely anthropocentric and utilitarian

6. DICE: economic equations
Utility:
Depends on: per capita consumption
Population size L
Utility function is neoclassical (increasing and concave in consumption

7. DICE: economic equations
Capital rate of return:
r: capital rate of return
𝜌: social rate of time preference
𝛼: elasticity of marginal utility
g: annual growth rate of per capita consumption

8. DICE: economic equations
Capital rate of return:
Important: assumptions about rho, alpha and g determine r !
Note: r defines the discount rate on goods markets!
Thus: r gives the opportunity costs of climate policy.
DICE: sets r=4.1%
heavily influences current value of climate damages!

9. DICE: economic equations
Example: future damage due to climate change 1 trillion €
r=1%: Current value is 370 billions €
R=4%: CV decreases to merely 20 billions!
What is the right number?
Society faces different choices:
We can invest in: Climate Policy
But also, e.g., in: capital accumulation
Investment into capital gives a rate of return of about 4% (long run rate of return on capital markets)

10. DICE: economic equations
When is an investment in climate mitigation economically justified?
If it gives at least a return as high as capital investment!
Climate investment has to cover at least the opportunity costs.
Otherwise, society could earn higher returns by investing into capital formation, formation of human capital etc…
Note: This is an important question particularly for developing and emerging countries!

11. DICE: economic equations
Output:
Standard neoclassical production function
Showing decreasing returns to capital and labour
: Climate damage factor
Climate damages:
Increasing in T
And convex.

12. DICE: economic equations
Climate damages: what is contained?
Based on data from 12 world regions (e.g. US, China, Europe, Africa, Latin America …)
Damages from decreased crop yields in agriculture
Damages from sea level rise at coastal lines
Increased morbidity
Empirically estimated in order to give a best fit to the damage data reported in the current literature

13. DICE: economic equations
Abatement costs:
Increasing and convex in emissions reduction
Output: divides into consumption and investment:
Per capita consumption:
Capital accumulation:
Industrial emissions:
Core parameter: carbon intensity 𝜎

14. DICE: geophysical equations
Carbon cycle model:
Describes exchanges of carbon between the atmosphere, the upper and the lower layers of the oceans

15. DICE: geophysical equations
Radiative forcing:
Describes total incoming energy captured in the atmosphere
Depends on: exogeneous amount of energy
Depends also on: atmospheric concentration of carbon in the atmosphere relative to its preindustrial level
Temperature:

16. DICE: Results Four scenarios: Baseline: no abatement policy at all
Intertemporal Optimum („Optimum“): Efficient abatement suited to maximize social welfare
2 degrees: Policy (often advocated in the political arena) aiming at stabilizing temperature increase at 2°C
„Stern“: Scenaio adopting a very low discount rate (as has been used in the Stern-Review)