MPE 781 Economics For Managers

Table of Contents


Assignment Overview: This assignment is based upon an article published in The Economists Voice entitled ‘Global Climate Change. A Challenge to Policy’. It was written by Kenneth J., a Nobel laureate.

Arrow, in 2011.

Ensure that the reader reads the article.

Arrow says it is better to take action to reduce CO2emission than to ignore the challenge and risk losing our lives.

Please explain his reasoning based on the article and your research.

What are the sources of market failure?

This problem of global warming can be solved in abstract terms.

The consumption discount rate is denoted with. It can be de ned as = +g in this article.

What does g and the terms denote?

Explain the logic behind this equation.

One critic suggests that any uncertainty about g could lower the value for.

Are you in agreement or disagreement with this critique?

How does it affect the economy if there is a decrease in the value of when global warming is human-induced?

Adam Morton’s article, Energy crisis: Wholesale Power Prices Have Doubled Since the Carbon Tax Was Abolished” published in Sydney Morning Herald (9 March 2017). He argues that this dramatic rise is largely due to soaring gas prices, investment uncertainty, and the decision of which power plants to build when the old coal generators are shut down.

What does this mean for Australia’s value?

Assume that the equation = +g is determined by a social planner’s action.

Take the example of the U.S. withdrawal from the Paris Climate Accord, June 1, 2017.

What does this mean for the global value of the Paris Climate Accord?


Global warming and drastic climate changes have been one of the most disturbing and troubling issues over the past few decades.

Global warming simply means that the average global temperature is rising faster than usual.

Although this phenomenon is not widely accepted, it has been an issue of great concern for global leaders and environmentalists around the world. It poses both short-term and long-term threats.

Long-term threats include large changes in global temperature which may lead to an overall change of the environment and demography that could endanger the lives of humans, plants, and animals (Fankhauser 2013, 2013).

Many believe that global warming is caused by human activities.

Uncontrolled greenhouse gas emissions, such as carbon dioxide and methane, have been the most damaging of all these activities. They have increased to an alarming extent over the past century.

This report, which is based on Kenneth J. Arrow’s article on Global Climate Change (Arrow 2007, 2007), gives a comprehensive account of the issue. It also attempts to analyze and find answers to many important questions.

The article by Kenneth J. Arrow has been critically evaluated and discussed. It discusses the positive and negative effects of global warming on the earth.

This article discusses the possible costs that will be borne not only by humans but all life forms on Earth due to the rapid pace of global warming.

There have been many debates and confusions about the cost of global warming and when it should be paid.

However, the author attempts to show that global warming is real with the aid of the empirical evidences available.

He also discusses the need to reduce carbon dioxide emissions to huge levels to avoid future catastrophes (Arrow, 2007, 2007).

Global temperature rise is largely due to trace gases in the earth’s atmosphere.

These trace gases consist primarily of water vapor, carbon dioxide, and methane. They also have the property of absorbing low-frequency radiations and thereby heating up.

Even post Industrial Revolution, the proportion of CO2 has increased steadily. This is in addition to increasing the global mean temperature. It also has significant (mostly negative) impacts on sea levels, crops, vegetations and climate.

This article uses the cost-benefit approach to calculate the impacts of restricting CO2 emissions in the near future (Trenberth and al., 2014).

In this article, the author advocates that immediate measures be taken to curb uncontrolled greenhouse gas emissions, mainly carbon dioxide, as they are currently being done by humans all around the globe, particularly in industrialized countries.

According to the author, these measures are mandatory to prevent the devastating effects of global warming. This is largely due to uncontrolled greenhouse gas emissions.

Arrow suggests that the implications can be both short-term and long-term.

In the next section, the author elaborately discusses the reasons for his suggestions.

Over the years, scientists, environmentalists, and global leaders have all agreed that global warming is caused by the man-made as well as natural greenhouse gas emissions, particularly carbon dioxide. This has been true since the inception of life on Earth.

These greenhouse gases are one of the components of trace gases and have increased the number of trace gases in the earth’s atmosphere (Seinfeld & Pandis 2016, 2016).

Because trace gases have the unique ability to absorb radiations at low frequencies, they have contributed to the earth’s heating.

The major source of carbon dioxide emissions has been human activities. They have contributed significantly to carbon dioxide’s atmospheric concentrations in the earth’s atmosphere, particularly over the past few centuries.

Since the Industrial Revolution began, the levels have risen dramatically.

These levels have significantly increased over time after the Industrial Revolution (Lau, Lee, & Mohamed 2012).

The graph below shows how carbon dioxide is emitted over time.

Figure 1: Global Carbon Dioxide Emissions

As can be seen, the above figure shows that carbon dioxide emissions have increased significantly since the Industrial Revolution period. The emissions rose significantly starting in 1851 and then increasing rapidly after 1951.

By the end of the century, carbon dioxide emissions reached an alarming level of 8000,000,000 metric tons (Bondyrev Davitashvili and Singh, 2015).

The massive rise in CO2 levels has contributed to an abnormally high global temperature over the past few centuries. This created a greenhouse effect on the earth’s environment (O’Neill et. al., 2012).

This figure shows the direct correlation between an increase in CO2 levels and an increase in global temperature.

Figure 2: Relationship between temperature and CO2 over time

The above illustration clearly shows that the variables have a positive correlation. This supports the author’s theories.

Arrow’s article demonstrates that the concern is based on this data. Therefore, it is imperative to take corrective actions (Friedlingstein and al., 2013).

This aspect has received substantial research and the shocking results are incontestable. The levels of CO2 emissions have risen from 280ppm (parts/million) during the period prior to the Industrial Revolution, to 430ppm since the beginning of the revolution.

Reports predict that these levels will rise to as high as 550ppm (2035) if current activities continue at their current pace.

These projected emissions levels are almost twice as high as the levels before industrial activity began.

If they are received, the levels will be the first to reach that level in the last few millions of years.

If these threatening statistics are not controlled and reduced, they pose a grave threat to humanity’s future existence (Cook et. al., 2014).

This article and substantial support from other research suggests that these steadily increasing levels of carbon dioxide emissions have significant and direct implications on the global average temperature.

In the very near future, the global average temperature will rise by at least 2oC due to the projected increase in these emissions.

If this emission pattern is maintained, it poses a risk of five degrees increase in global temperature, with fifty percent probability, at the beginning of 2100.

The melting glaciers is one of the negative effects of global warming and greenhouse gas emissions on the environment. This can lead to an increase in sea level as shown in the graph below:

Figure 3: Overtime changes in sea levels

Sea levels have been rising rapidly since the 15th century. This is especially true if global warming and glacier melting continue.

This poses a credible risk of wiping out large areas of landmasses and low-sea level countries such as Bangladesh.

Other cities, such as Manhattan, are also at risk of disappearing completely from the global geographic map.

The melting of two major glaciers in Greenland, West America, could lead to even greater catastrophe and significant property and human loss (Hansen 2016, 2016).

Global warming will also have a direct effect on the global climate.

Global warming’s current pace is likely to alter the pleasant climate conditions in Europe and other countries similar to Greenland.

Over time, the frequency and intensity of tropical storms is expected to increase, creating problems for humanity.

A decrease in glacier reserves and rapid melting of large ones can cause a shortage of water worldwide in the near future (Bondyrev Davitashvili, Singh, 2015).

These consequences collectively pose a threat to the survival of all life forms on Earth in the future.

These projections have caused great concern and tensions all around the globe and are likely to cause catastrophe.

The creation and implementation of appropriate adaptive and corrective measures at a global scale has become an urgent priority. This is what the author discusses in this article (Pachauri and al., 2014).

Market Failure:

A market failure is a situation in which the welfare of society as a whole is not maximized within a specific market structure.

This issue is relevant in this instance.

As can be seen in the statistics and data from various studies and research conducted around the world, the rate of carbon dioxide emissions has increased significantly since the beginning of the Industrial Revolution.

The few highly developed countries that were on the upward trajectory of the revolution period during the industrial revolution have seen the most positive effects of the revolution (Rezai Foley & Taylor 2016, 2016).

As can be seen, the Industrial Revolution fueled the economic growth, social welfare, and overall development of these countries and set them on a path to sustainable growth.

These countries’ economic growth came at the expense of their uncontrolled emissions of carbon dioxide. This was due to a lack of awareness and appropriate restrictions (Emanuel 2012).

These activities are borne by the generations that follow.

The advanced countries prospered and grew at the expense of the poorer countries. These countries were subject to anti-growth policies and restrictions in order to reduce greenhouse gas emissions.

They suffered a severe blow to their economic success, making them less developed and poor.

It is clear that the economic costs of growth in developed countries weren’t borne primarily by them, but by those less developed nations who are most often faced with the tradeoff between global growth and well-being.

This could be viewed as a source for market failure in this area of the global scenario (Rezai Foley & Taylor 2016, 2016).

Global Warming Solutions:

There are several ways to reduce global warming, or at least to limit it to the current level.

These are some of the options:

a) Replacing traditional, high-carbon-emitting energy sources like coals with natural gas can dramatically reduce carbon emissions (Emanuel 2012).

b) Global warming can be attributed to the massive deforestation that has occurred over the years, mostly by humans.

Trees are a great way to reduce CO2 levels, and should be planted everywhere in the world to combat global warming (Pachauri and al., 2014).

c) Energy Consumption – Reducing production techniques and innovation are essential and should be applied worldwide to lower energy consumption.

This innovation and its implementation should be taken seriously by both the developed and recent developing nations (Seinfeld & Pandis 2016, 2016).

d) The industrial revolution has had a significant impact on the developed nations.

It is their responsibility to take appropriate steps to reduce carbon emissions and control them so that others can follow their lead (Lau, Lee, & Mohamed 2012).

To understand the inter-temporal preferences for consumption, the article uses the following equations:

d = r+ge

This equation shows the consumption discount rate.

If the individual chooses to consume in the current period, this is the rate at which he or she will discount future losses.

This shows the overall preference pattern of an individual for current over future.

This term is higher if the individual prefers to consume more during current than future (Sen, 2013).

In this equation, the term r is the rate at which time preference is preferred.

Higher values indicate that an individual is more likely to choose current welfare over future welfare.

The term g indicates the expected growth rate for average consumption, while e indicates the social weight that will change due to changes in consumption.

This economic concept is called marginal utility when there is an increase of consumption (Goulder & Williams III, 2012).

Figure 4: Global Discount Rate and Social Cost of Carbon (2010)

Economic intuition:

This equation indicates that two factors contribute to the consumption discount rate.

As people place more importance on future consumption than they do on present consumption, the rate has a positive relationship with the time preference variable.

Ge is the change in d’s value due to an increase of the consumption rates. Keep in mind that e decreases with g (Sen, 2013).

Critics argue that uncertainty in the values g causes a decrease in the consumption discount rate’s value.

However, this may not be true as high uncertainty in consumption growth rates can lead to current consumption being more important than future consumptions.

The critique suggests that the relationship suggested by the critique may not hold in a generalized context (Cropper and al., 2014).

The following scenario shows that a country with a low consumption discount rate would indicate that it prefers future consumption to be significantly higher than its current preference rate.

This means that future consumption is important to the country’s residents.

Given the potential danger of aggravated global heating and its possible negative effects, this economy is expected to take proactive measures to reduce CO2 emissions to ensure their future welfare.

They can be expected and encouraged to lead the way to sustainable development.

Adam Morton’s article argues that power prices in Australia have risen dramatically and almost doubled since the removal of carbon taxes.

Many evidences support their findings, which are consistent with the same phenomenon.

This has led to an increase in electricity consumption.

This is due to both the constantly rising prices of gas and the uncertainty surrounding the power sector’s investment.

This is due to investor doubts and speculations about the future of power plants.

These plants will replace the coal factories in the future, but investors are concerned about their credibility and prospects ( 2017).

This article shows that although the country recognizes the need for carbon dioxide reduction for future welfare, due to the current crisis within the power sector, the country has stopped pursuing its ambitious goal of reducing non-renewable energy resource use to fifty percent.

Indirectly, this means that the Australian population’s consumption discount rate will increase due to the dramatic rise in electricity prices.

This dynamic has the immediate consequence that residents won’t agree to sacrifice their current welfare in order to gain the future benefit of rising gas prices.

The current price trends could continue to increase the demand for traditional, non-renewable resources (Meng, Siriwardana, & McNeill 2013, 2013).

Figure 5: The price of electricity has changed in Australia

As discussed, the trend can be understood in terms of the general behavior patterns of human beings. They value current welfare more than future well-being because there are greater uncertainties about future consumption and welfare levels than they do current welfare.

Except for a few exceptions, people are naturally risk-averse.

This suggests that this type of behavior trend could be observed in this instance.

As can be seen, the uncertain prospects and profits of these plants may explain the uncertainty in investment in the power sector.

These can all lead to people reverting to non-renewable carbon emission energy sources even if it means future welfare ( 2017).

The term r in the article denotes the tradeoff between future and current preferences.

The preference for future consumption over current consumption is greater than the variable’s values.

A high time preference for a country will result in an increase of the discount rate for consumption, which means that the country cares more about the current welfare than it does the future welfare (Friedman 2016, 2016).

The withdrawal of the United States of America in the Paris Climate Accord is a case that can be compared to the previous discussion. It is expected to have significant impacts on global environmental conditions (Bodansky 2016,).

Table 1: Average Discount Rate Over the Years

The USA is still the world’s largest emitter of carbon dioxide.

The USA contributes nearly 25% of global carbon dioxide emissions. This indirectly means that the strategy and behavior of the country directly determines the fate and rise of global carbon emissions.

This context may suggest that the country’s withdrawal from the Climate Accord could mean that less restrictions and limitations will be imposed on it regarding carbon emissions (Friedman 2016, 2016).

This could increase the value of the rate, since residents will naturally choose future welfare over current welfare.

This could increase the consumption discount rate in the country, which can directly impact the global rate. It also creates upward pressure.

If the global value of d increases due to the USA’s influence, it can lead to more global warming threats (Raupach and al., 2014).

Refer to

Hidden Costs: Trump’s Campaign To Erase Carbon’s Social Cost – Center for American Progress.

Center for American Progress.

The challenge of global climate change policy.

The Economists Voice, 4(3).

A new hope: The Paris climate agreement.

American Journal of International Law 110(2), 288-319.

Global Warming and Climate Change.

The Geography of Georgia (pp.

Springer International Publishing.

A Study Shows a Dramatic Acceleration in Sea Level Rise

Global warming and 21st-century drying.

Climate Dynamics, 43(9-10), 2607–2627.

The American Economic Review, 54(5), 538-543.

Climate change: What we know.

MIT Press.

The economics of the greenhouse: Valuing climate changes.

Consistent increase in CO2 emissions and implications to achieving climate targets.

The theory of the consumption function.

Pickle Partners Publishing.

Goulder L. H. & WILLIAMS III R. C. (2012).

The selection of a discount rate to evaluate climate change policy evaluation.

Climate Change Economics, 3 (04), 1250024.

Ice melt, sea-level rise, and superstorms: Evidence from paleoclimate data and climate modeling that 2 C global warming may be dangerous.

Atmospheric Chemistry and Physics 16(6), 3761–3812.

Global warming mitigation and development of renewable energy policies from the Kyoto Protocol to Copenhagen Accord–A Comment

Renewable and Sustainable Energy Reviews 16(7), 5284-5284.

The economic and environmental impact of the carbon tax on Australia.

Environmental and Resource Economics, 1-20.

Demographic change and carbon dioxide emission.

The Lancet, Vol. 380 (9837), 157-163.

Climate change 2014: Synthesis report.

Contribution of the Working Groups I to II and III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (p.

Global warming: What is the challenge?

C. Nature Climate Change 3(1), 4.

A quota for cumulative carbon emissions.

Nature Climate Change, 4 (10): 873.

Global warming and economic externalities.

The Economics of the Global Environment (pp.

Springer International Publishing.

Climate Science Denied in Multiple Dimensions.

Atmospheric Chemistry and Physics: From air pollution to climate changes.

John Wiley & Sons.

The Choice of Discount Rates for the Social Bene?t-Cost Analysis: Approaches

Discounting Time and Risk in Energi’Policy 325-53

Since the repeal of the carbon tax, wholesale power prices have increased by two-thirds.

The Sydney Morning Herald.

Global warming and drought changes.

Nature Climate Change, 4(1): 17-22.

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