TU Berlin | The Economics of Climate Policy | WS 2019/2020

Homework assignment 1

Heloisa Brenha Ribeiro 408488

João Pedro Saldanha Corrêa 415023

a) Lecture

1. Climate change can be considered the greatest and widest-ranging market failure that ever
existed. It is different from other environmental problems because the excessive concentration
of greenhouse gases (GHGs) in the atmosphere, mostly due to the industrial activity and the
intensive use of fossil fuels it entails, generates externalities that are global, uncertain, long-
term, and potentially very large and irreversible. These special features set GHGs emissions
apart from other externalities, given the potential magnitude of the damage for so many
people and the involvement of almost all in causing the externality. 1 If temperature increases
beyond a certain range, climate models find thresholds in which the effects of GHGs emissions
are most likely irreversible and very difficult to predict, due to the positive feedbacks in the
carbon cycle (e.g. the release of carbon dioxide from warming soils, or of methane from
thawing permafrost). Such feedback loops mean that climate change could itself trigger
additional increases in GHGs in the atmosphere, warming up the planet even more. 2 When it
comes to assessing the costs of such unpredictable impacts, climate change demands that
economists build complex models that take into account, e.g., deep uncertainty, very long time
horizons, heavy distributional implications, non-marginal changes, and strong implications on
non-market goods.
The first economical study that framed the climate change in the terms above was the
Stern Review, a comprehensive report on the economics of climate change commissioned by
the United Kingdom and released in 2006, with great repercussion. It was elaborated by a
team headed by the economist Nicholas Stern, the first to state that “Climate change is the
greatest market failure the world has ever seen.” 3 Stern also underlined the problem is “deeply
inequitable with the rich countries having caused the bulk of current stocks of greenhouse
gases and the poor countries being hit earliest and hardest.”4

2. (i) The Kyoto Protocol was an international agreement on climate change adopted
in Kyoto, Japan, in December 1997 and entered into force in February 2005. Recognizing that
developed countries were the main responsible for the high levels of GHGs emissions in the
atmosphere, the protocol placed a heavier burden on developed nations, committing them
with internationally binding emission reduction targets.5
According to the United Nations Framework Convention on Climate Change (UNFCCC),
countries with Kyoto commitments should meet their targets primarily through national

1
Stern, Nicholas. Ethics, equity and the economics of climate change. Paper 1: Science and philosophy. Economics
and Philosophy, Volume 30, Issue 3, November 2014. doi: 10.1017/S0266267114000297, p. 22.
2
Stern, Nicholas. The Economics of Climate Change: The Stern Review. Cambridge University Press, 2007, p. 8.
3
Stern, Review, p. viii.
4
Alison Benjamin, “Stern: Climate change a ‘market failure’,” The Guardian, November 2007,
https://www.theguardian.com/environment/2007/nov/29/climatechange.carbonemissions.
5
“What is the Kyoto Protocol?,” United Nations Framework Convention on Climate Change, Bonn, Germany, 2019.
https://unfccc.int/kyoto_protocol.

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measures, but additionally by way of three market-based mechanisms: international emissions
trading, clean development mechanism (CDM), and joint implementation (JI). These allowed a
country with Kyoto commitments to implement an emission-reduction project in a developing
country (in the CDM case)6 or also in another Kyoto-committed country (JI) 7. Such projects, just
like the domestic ones, could earn saleable certified emission reduction (CER) credits, each
equivalent to one ton of CO2, which could be counted towards meeting the protocol’s targets.
These CER credits would work as a new commodity, which could be tracked and traded
like any other. In the Kyoto’s emissions trading, countries that have emission units to spare
─emissions permitted them but not “used”─ could sell this excess capacity to countries that are
over their targets.8 This scheme, still following the UNFCCC, would arguably help countries to
meet their targets by reducing emissions from the atmosphere in other parts of the word,
stimulating foreign investment and technology transfer, and encouraging developing countries
to contribute to the emission reduction efforts as well.
However, these mechanisms seemed to have failed completely, given skepticism over
its effectiveness, lack of transparency, and the whole controversy regarding Kyoto’s further
negotiations, in which the United States (the main GHGs emitter back then) withdraw from the
pact, and only a few of the first-round signatories (37 industrialized countries plus the
European Community) actually ratified the agreement. With the protocol losing its credibility,
and fossil fuels’ prices going down, what happened after the implementation was an increase
in GHGs emissions, particularly due to coal use. Despite the unwanted results, Kyoto has left
important lessons to be learned and still is a landmark in the course of global climate effort.
The Paris Agreement, in turn, seems to have overcome some of Kyoto’s difficulties by
proposing a whole new, “bottom-up” approach. For the first time, each country was able to
pledge what it was able and willing to contribute in the combat climate change. Rather than
requiring emissions reductions only from developed countries, the agreement was designed to
draw nearly-universal country action, applying to all 197 members of the UNFCCC, including
the major emerging economies, such as India and China, the current top-emitter. 9 It was signed
by 195 countries at the COP21 in Paris, in December 2015, covering later the whole UNFCCC-
membership, as Nicaragua and Syria also decided to join the accord in 2017. To this date,
187 of the 197 signatories have already ratified the accord, which entered into force in
November 2016. In June 2017, president Donald Trump proclaimed his intent to withdraw the
United States from the Paris Agreement, in a rejection of climate change that, as Michael
Greshko from the National Geographic qualified, “moves the country toward isolation on the
global stage.”10 By the rules of the accord, however, the pull-out cannot be done until 2020. 11
Before being elected, Brazilian new far-right president, Jair Bolsonaro, had also stated that he
would withdraw the country from the Paris Agreement, but later walked back those remarks. 12

6
“The Clean Development Mechanism,” United Nations Framework Convention on Climate Change, Bonn, Germany,
2019. https://unfccc.int/process-and-meetings/the-kyoto-protocol/mechanisms-under-the-kyoto-protocol/the-
clean-development-mechanism.
7
“Joint implementation,” United Nations Framework Convention on Climate Change, Bonn, Germany, 2019.
https://unfccc.int/process/the-kyoto-protocol/mechanisms/joint-implementation.
8
“Emissions Trading,” United Nations Framework Convention on Climate Change, Bonn, Germany, 2019.
https://unfccc.int/process/the-kyoto-protocol/mechanisms/emissions-trading.
9
“Paris Agreement - Status of Ratification,” United Nations Framework Convention on Climate Change, Bonn,
Germany, 2019. https://unfccc.int/process/the-paris-agreement/status-of-ratification.
10
Michael Greshko, “Map Shows How Paris Reversal Isolates U.S. From World,” National Geographic, June 2, 2017.
https://www.nationalgeographic.com/news/2017/06/climate-change-paris-agreement-map/.
11
“Paris climate accord: Syria to sign up, isolating US,” BBC, London, November 7, 2017.
https://www.bbc.com/news/world-middle-east-41904650.

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 Despite this, the Paris Agreement is often regarded as successful, especially because of
the paradigm shift it represented in terms of regulation, with a hybrid of legally binding and
nonbinding provisions. According to the UN 13, the core agreement that governs the
international process are binding on parties, while there are elements that are not part of the
legally binding agreement, but that may be binding at the national level. One of these
elements are the so-called intended Nationally Determined Contributions (iNDCs), which are
basically a plan each country voluntarily elaborates to reduce domestic emissions of GHGs
from 2020 on, therefore, contributing to the broader goal of limiting the rise of global
temperatures to a maximum of 2 degrees Celsius by 2100. These voluntary national climate
targets become a binding Nationally Determined Contributions (NDC) when the country ratifies
the Paris Agreement.14 The Paris Agreement requires each party to prepare, communicate and
maintain successive nationally determined contributions (NDCs) that it intends to achieve, but
also provides countries the opportunity to review their NDCs every five years. This adjustment
mechanism, according to the UN, will help “to avoid locking in a level of ambition that would
make the well below 2 degrees goal improbable.”15

2. (ii) The main arguments on why the Paris Agreement can and why it cannot be
called a success were well articulated by the Guardian columnist George Monbiot, who wrote
on the last day of the COP21: “By comparison to what it could have been, it’s a miracle. By
comparison to what it should have been, it’s a disaster.” 16 A “miracle”, he argues, in
comparison with the 2009 UN Climate Change Conference, also known as the Copenhagen
Summit, which ended up with an accord that only recognized the scientific case for keeping
temperature rises to no more than 2o C but did not contain commitments to emissions
reductions to achieve that goal.17 According to Monbiot, the fact that the Paris Agreement kept
“its aspirational limit of 1.5o C of global warming, after the rejection of this demand for so
many years, can be seen within this frame as a resounding victory”, which, among other
things, made the final text “stronger than most people anticipated.” However, outside the
“narrow frame within which the talks have taken place,” the Paris Agreement could also be
regarded as cynical, since “even 2o C, in view of the weak promises governments brought to
Paris, is wildly ambitious.” Disaster arises from that, as he summarizes:

A maximum of 1.5o C, now an aspirational and unlikely target, was eminently

achievable when the first UN climate change conference took place in Berlin
in 1995. Two decades of procrastination, caused by lobbying —overt, covert
and often downright sinister— by the fossil fuel lobby, coupled with the
reluctance of governments to explain to their electorates that short-term
thinking has long-term costs, ensure that the window of opportunity is now

12
Jake Spring, “Brazil states forge ahead in climate change fight despite Bolsonaro ambivalence,” Reuters, April 26,
2019, https://www.reuters.com/article/us-brazil-environment/brazil-states-forge-ahead-in-climate-change-fight-
despite-bolsonaro-ambivalence-idUSKCN1S220H.
13
“The Paris Agreement: Frequently Asked Questions,” United Nations, Sustainable Development Goals Blog,
https://www.un.org/sustainabledevelopment/blog/2016/09/the-paris-agreement-faqs/.
14
“Intended Nationally Determined Contributions (INDCs),” The World Bank Group, 2016,
http://spappssecext.worldbank.org/sites/indc/Pages/INDCHome.aspx.
15
“The Paris Agreement: FAQ,” United Nations.
16
George Monbiot, “Grand promises of Paris climate deal undermined by squalid retrenchments,” The Guardian,
December 12, 2015, https://www.theguardian.com/environment/georgemonbiot/2015/dec/12/paris-climate-deal-
governments-fossil-fuels.
17
John Vidal, Stratton, Allegra, and Goldenberg, Suzanne, “Low targets, goals dropped: Copenhagen ends in failure,”
The Guardian, December 19, 2009, https://www.theguardian.com/environment/2009/dec/18/copenhagen-deal.

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 three-quarters shut. The talks in Paris are the best there have ever been. And
that is a terrible indictment.18

This criticism resonates with last year’s IPPC Special Report on Global Warming of 1.5 o
C, in which the UN panel informed that we have only 12 more years for global warming to be
kept to a maximum of 1.5o C, beyond which even half a degree will significantly worsen the
risks of drought, floods, extreme heat and poverty for hundreds of millions of people. 19
To reply fairly to this criticism, we would probably need to address the deeply ethical
and controversial quest of separating the global efforts on mitigating climate change we made
from those we should or wished we have made. To qualify Paris Agreement as mild or rather
cynical is to forget the long process it has taken to put climate change and the environment as
priorities in the international agenda, and as major concerns in public debate. It is also to deny
the efforts and the good faith many nations, and some of their most truly-committed scientists
and representatives, in the design of their countries’ NDCs. Instead of regretting that the
climate agenda, despite all its urgency, has not advanced fast enough, maybe we could urge
for change in the political processes that seem to have been keeping it from advancing as fast
and as deep as we aim and need. Many climate activists are already doing so, worldwide.

2. (iii) The international comparability among the national goals is difficult because,
according to the Paris Agreement, each country is to write its nationally determined
contributions voluntarily, in the way it finds “fair and ambitious” and “in the light of its
national circumstances”. Therefore, the NDCs vary in scope, content, and length from nation to
nation. “They range from 3 to 57 pages, and often lack detail about stated ambitions. This
variation hinders a robust understanding of countries’ ambitions and priorities, and how they
compare among one another,” highlights by Paul et al. (2018). 20 A broad and accessible
database would be the ideal instrument to create more transparency and to compare (i)NDCs.
According to the authors, an effort in this sense is already in progress: the UNFCCC is
developing a comprehensive database, with 60 subcategories, of all current iNDCs and NDCs,
which can be accessed and visualized through the NDC Explorer, an online interactive tool.
Following the researchers, such tool can: 1) help countries to learn from each other by
comparing their projects and achievements, 2) reveal some of the weaknesses of the scope
and content of NDCs, including the omission of important mitigation sectors, for instance, 3)
support civil society to hold governments accountable for implementing NDCs, and 4) help
actors such as development banks and climate funds to check whether their climate projects
address the NDCs and to mainstream climate change in the broader project portfolio.

3. According to the IPCC AR5 WGII SPM, the key risks of climate change for Europe are
three:
(1) Increased economic losses and people affected by flooding in river basins and
coasts, driven by increasing urbanization, increasing sea levels, coastal erosion,
and peak river discharges.
18
Monbiot, The Guardian, 2015.
19
Jonathan Watts. “We have 12 years to limit climate change catastrophe, warns UN,” The Guardian, October,
2018. https://www.theguardian.com/environment/2018/oct/08/global-warming-must-not-exceed-15c-warns-
landmark-un-report.
20
Pauw, W.P., Klein, Richard J. T., Mbeva, Kennedy, Dzebo, Adis, Cassanmagnago, Davide, and Rudloff, Anna.
“Beyond headline mitigation numbers: we need more transparent and comparable NDCs to achieve the Paris
Agreement on climate change.” Climatic Change, March 2018, Volume 147, Issue 1-2, pp 23-29.
https://link.springer.com/article/10.1007%2Fs10584-017-2122-x.

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 (2) Increased water restrictions, with significant reduction in water availability from
river abstraction and from groundwater resources, combined with increased water
demand (e.g., for irrigation, energy and industry, domestic use) and with reduced
water drainage and runoff as a result of increased evaporative demand,
particularly in southern Europe.
(3) Increased economic losses and of people affected by extreme heat events, which
can impact health and well-being, labor productivity, crop production, air quality,
and increase the risk of wildfires in southern Europe and in the Russian boreal
region.

b) Tutorial

1. λ = 0.58

(1)

(2)

(3)

(2) → (1)

(3)

The equilibrium surface temperature is 277 K or 4o C, approximately.

2. Considering the new CO2 concentration C = 666 ppm, we can compare it either to pre-
industrial CO2 concentration C0 = 280 ppm or to the previous CO 2 concentration of C0 =
630 ppm. Let us calculate ΔF for both cases, then.

Case 1, with C0 = 280 ppm:

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 (1)
(2)

In this case, the increase in radiative forcing Δ𝐹 corresponds to 4.6358 W/m², and
the increase in the surface temperature Δ𝑇, to 3.7086 K.

Case 2, with C0 = 630 ppm:

In this case, the increase in radiative forcing Δ𝐹 corresponds to 0.2973 W/m², and
the increase in the surface temperature Δ𝑇, to 0.2378 K.

3. (i) Payoff matrix

Countries: {A, B}
Actions: {C – conservation; D – development}

(A, B) C D

C (900, 900) (400, 1000)

D (1000, 400) (600, 600)

3. (ii) Both countries will develop their share of the forest. Development (D) is the dominant
strategy for both countries, and (D, D) will be the Nash-Equilibrium.

3. (iii) No. Pareto optimum is an outcome from which any change in strategy necessarily
result in a loss of utility to at least one player. In this scenario, it is possible to increase the
payoff of both countries by changing their strategies.

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3. (iv) The two countries can sign an agreement to preserve the whole forest or they can
design another agreement where the country which develops its share of the forest must pay
200 million euros/year to the other country as a compensation, which would result in a new
pay-off matrix:

(A, B) C D

C (900, 900) (600, 800)

D (800, 600) (600, 600)

4. (i) A3 is a weakly dominant strategy to A. B has no dominant strategies.

4. (ii) A1 is a strictly dominated strategy to A. A2 is a weakly dominated strategy. B2 is a strictly
dominated strategy to B. B1 is a weakly dominated strategy.
4. (iii) {A1, A2, B1, B2}
4. (iv) (B3, A3)

***