Environmental Economics Climate Change

Economics of Climate Change

We need to understand the basic economic theory and some complications that arise with the problem of climate change.  At the heart of it, it is an externality, but there are significant complications arising from the fact that it has different impacts over both space and time. In addition, climate is considered as a public good.

Externalities are effects on bystanders that the market mechanism will not consider. In other words externalities are the costs or benefits imposed by consumption, production, or exchange on third parties not borne by the parties engaging in the activity. For example; Negative externalities are considered third party costs and positive externalities are third party benefits. Climate change can be considered as negative externality where the social cost of producing an emission intensive good is greater than the private cost of producing it. For example; an aluminium producer will not take into account the cost of pollution that should be borne by the society. BUT, climate change is not a typical externality because the incremental impact of a tonne of greenhouse gasses on climate change is independent of where in the world it is emitted.


Because GHG’s are diffuse in the atmosphere – We may be experiencing negative impacts of climate change due to greenhouse gasses emitted somewhere else in the world. Local climates depend on global climate system Impacts across time (with lag effects) – Lag effects mean that we are experiencing come of the impacts of CC produced by previous generations and future generations will experience the effects of what we are doing – in part this means we will never fully experience the consequences of the externality Large degree of uncertainty – Uncertainty about the potential size (last lecture); type and timing of impacts; costs of combating; so the framework used must be able to handle risk and uncertainty.

Climate is considered as a public good that has the following properties:

Non-rival – A good is non-rivalrous if one individual’s consumption does not affect the amount left for others to consume

Non-excludable – One person cannot prevent another from consuming.

This has important implications for non-contributors specifically and they cannot be excluded (free riders) from acquiring the benefits. This makes private returns from production of public goods close to zero due to every individual tries to free ride on others. Typically, public goods should be provided by the government to avoid the problem of non-excludability. Government has the advantage of being able to coerce on a large scale (to induce contributions), for example: pay taxes or impose a fine.

What does public good nature mean for climate change?

Those that do not contribute to reducing GHG emissions and thereby impacts on climate cannot be excludable from the benefits. Only a few parties will bear the burden of the costs but benefits be experienced by everyone regardless whether they have paid for it or not. This in part explains why effective international agreements are so difficult to create. However, governments are best placed to overcome the problems of climate change because they can coerce contributions and compliance.