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Masaaki Kijima, Katsumasa Nishide and Atsuyuki Ohyama Tokyo Metropolitan University Yokohama National University NLI Research Institute
Optimal Environmental Policy
1. Model setup : A real options approach 2. Thresholds for stopping and restarting
III. Why Does the Kuznets Curve Present ?
1. 2. 3. 4. Model setup : Alternating renewal processes Transition density of the pollution level The inverse-U-shaped pattern as expected pollution level Numerical example
Barro (1991). Inequality Income per Capita t 4Page. etc. Moran (2005). Deininger and Squire (1996). but then starts decreasing to settle down – Kuznets (1955，1973)；Robinson (1976).What is the Kuznets Curve ? • The Kuznets Curve reveals that Income differential first increases due to the economic growth. .
Literature Review • Environmental Kuznets Curve Similar curves are observed in various pollution levels 【Empirical studies】 – Grossman and Krueger (1995) – Shafik and Bandyopadhyay (1992) – Panayotou (1993) Many other empirical studies. while just a few theoretical research 【Theoretical studies】 – Lopez (1994) – Selden and Song (1995) – Andreoni and Levinson (2001) 5Page. .
Itaru Yasui. Trondheim. 2007 NTNU.Symposium on Sustainability in Norway and Japan: Two Perspectives. "Environmental Transition . April 26.A Concept to Show the Next Step of Development“ . . Norway 6Page.
r.Lopez (1994) Macroeconomic model (no uncertainty) .the production is affacted by the level of pollution . pollution is U-shaped w. the agent switches the strategy when the pollution touches a certain level. . Selden and Song (1995) Representative agent in a dynamic setting (no uncertainty) . the production.t.utility from consumption and disutility from pollution . 7Page.if the abatement function satisfies some property.in the optimal path.
・ macroeconomic effect is not examined as the aggregation of microeconomic behavior. 8Page.Andreoni and Levinson (2001) Representative agent in a static setting (no uncertainty) . ・ uncertainty is not considered.utility from consumption and disutility from pollution . the agent pays a more amount of abatement cost as his income becomes larger.r. .t.if the elasticity of pollution w. the abatement effort is large enough. In the previous literature.
… – How will stock pollutants change in time？ – How about expected stock pollutants in total ? Alternating renewal processes Macro’s perspective An inverse-U-shaped pattern (＝Environmental Kuznets Curve) 9Page.Purpose • Our purpose is to present a simple model to explain the inverse-U-shaped pattern using a real options model. As a result. . Micro’s What is the optimal management of stock pollutants? perspective A real options approach Derive the thresholds of regulation and de-regulation.
B D 0 System on System off System on System off t 10Page. etc.Two Ingredients • Real Options Approach (strategic) switching model under uncertainty – Dixit and Pindyck (1997). Chapter 7) and Wirl (2006) • Alternating renewal processes Switchings produce ‘on’ and ‘off’ alternately with iid lifetimes A C – Ross (1996). . We use the same framework as Dixit and Pindyck (1994. etc.
.Optimal Environmental Policy 11Page.
it is possible to switch the regimes. Of course. . we analyze each country i • Stock Pollutants : where k represents each regime as shown below. 12Page. • Cost of external Effects： • Benefit in regime k : u k • Government chooses alternative regimes for an environmental policy: one under regulations L and the other under de-regulations H (including no regulation).Model Setup: A Real Options Approach • From the micro’s perspective.
the value function is where B is a constant. 13Page.• The country i’s problem • Under the de-regulation regime. . • Under the regulation regime. the value function is where A is a constant.
. the two thresholds . Smooth-pasting Condition These equations have four unknowns. we can obtain the solution at least numerically.Thresholds for Stopping and Restarting • We derive two thresholds: one for starting regulation and the other for de-regulation . and the coefficients and . Value-matching Condition . i. Therefore. . 14Page.e.
.Why Does the Kuznets Curve Present ? 15Page.
【Assumption】 i i Instead of Pt . . we consider the following stochastic process. we investigate the shape of log Pt . and then. Therefore. 16Page. illustrate the inverse-U-shaped pattern. We calculate the transition density of the pollution level using the theory of alternating renewal processes.Model Setup: Alternating Renewal Process Suppose that countries execute optimally the switching options for regulating and de-regulating pollutions in time.
are independent and identically distributed (iid) except . . Suppose that 【Thresholds】 i i H 0 L . off Regulation De-regulation on off on off off on on off 17Page. Let . . be the sequences of durations to switch the states. The sequences .＜＜Alternating Renewal Process＞＞ Consider a system that can be in one of two states: on (regulation) or off (de-regulation).
we omit the superscript i for a while.The transition probability density for country i: To simplify our notation. 【Definition of the hitting times】 with and also 18Page. .
The sequence renewal process. we denote Density Function n 1.Since and Duration are independent. n 2. .3. is called a (delayed) alternating 19Page. Also. we denote where is the convolution operator.2.
【Delayed renewal processes】 【Renewal functions】 ＜＜Renewal densities＞＞ By the definition. . 20Page.
following the basic renewal theory.Also. . we obtain Laplace Transform Laplace Transform Inverse Laplace Transform Inverse Laplace Transform via numerical inversion 21Page.
In this case.Renewal Functions: . after Time=300. Time . then Time State Equal Time 22Page.
because S 0 H . we define and denote These transition densities are known in closed form for the case of geometric Brownian motions. . we have 23Page. Also. we denote the regime at time t by . Note that.Transition Probability of the Pollution Level 【Notation】 In order to calculate .
we consider the following three cases】 Case 1： Case 2： that is. that is. and and These 3 cases are mutually exclusive and exhaust all the events. .【To calculate the transition probability density. 24Page. Case 3： that is. .
the event to hit at some time s has occurred.【Case 1】 【Case 2】 In this case. 25Page. .
【Case 3】 Transition density is given by State Density 26Page. Time .
as .From the basic renewal theory. when and L 0 . we have Hence. we obtain 27Page. .
.The Inverse-U-Shaped Pattern 【A Model for the Aggregated Level】 Consider the sum of each country’s log-stock pollutant where with subject to the switching at xi x i 28Page.
The switching thresholds over the countries. . are the same 29Page.e. The uncertainties (Brownian motions) are mutually independent. so that it is plausible to assume the parameters to be the same over countries. its initial stock pollutant is distinct over countries. i.【Assumptions】 Because each country’s economic scale is different. technological transfers are smoothly performed. Because environmental problems are the world-wide issue. because each country executes environmental policy non-cooperatively.
we can calculate the transition probability density of However. when N is sufficiently large. and we are interested in the mean (or the variance) of . as the first approximation. That is. we consider y wi y i i 1 30Page. Moreover. Hence. the effect from the law of large numbers (or the central limit theorem) becomes dominant. N . is a weighted average of independent replicas with different initial states. in principle.Under these assumptions.
.Numerical Examples We are interested in the shape of with respect to t with 31Page.
.Monte Carlo Simulation 32Page.
33Page. .The Environmental Kuznets Curve E[log Pt ] E[log GDPt ] An inverse-U-shaped pattern GDP per capita also grows in average exponentially in time.
We describe a simple real options (switching) model to explain why the environmental Kuznets curve presents for various pollutants when each country executes its environmental policy optimally. The assumption of GBM can be removed as far as the constant switching thresholds and the Laplace transform of the first hitting time to the thresholds are known. 35Page. As a future work. our model can be applied to estimate when the peak of the curve will present. The transition probability density of the pollution level is derived using the alternating renewal theory. its mean is calculated numerically to show the inverse-U-shaped pattern. In particular. .
Thank you for your attention 36Page. .
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