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Tipping Points and Ambiguity in the Economics of Climate Change

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  • Derek M. Lemoine
  • Christian P. Traeger

Abstract

We model welfare-maximizing policy in an infinite-horizon setting when the probability of a tipping point, the welfare change due to a tipping point, and knowledge about a tipping point's trigger all depend on the policy path. Analytic results demonstrate how optimal policy depends on the ability to affect both the probability of a tipping point and also welfare in a post-threshold world. Simulations with a numerical climate-economy model show that possible tipping points in the climate system increase the optimal near-term carbon tax by up to 45% in base case specifications. The resulting policy paths lower peak warming by up to 0.5°C compared to a model without possible tipping points. Different types of tipping points have qualitatively different effects on policy, demonstrating the importance of explicitly modeling tipping points' effects on system dynamics. Aversion to ambiguity in the threshold's distribution can amplify or dampen the effect of tipping points on optimal policy, but in our numerical model, ambiguity aversion increases the optimal carbon tax.

Suggested Citation

  • Derek M. Lemoine & Christian P. Traeger, 2012. "Tipping Points and Ambiguity in the Economics of Climate Change," NBER Working Papers 18230, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:18230
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    Citations

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    Cited by:

    1. Elizabeth Kopits & Alex L. Marten & Ann Wolverton, 2013. "Moving Forward with Incorporating "Catastrophic" Climate Change into Policy Analysis," NCEE Working Paper Series 201301, National Center for Environmental Economics, U.S. Environmental Protection Agency, revised Jan 2013.
    2. Li, Xin & Narajabad, Borghan N. & Temzelides, Theodosios, 2014. "Robust Dynamic Optimal Taxation and Environmental Externalities," Finance and Economics Discussion Series 2014-75, Board of Governors of the Federal Reserve System (U.S.).
    3. Hjort, Ingrid, 2016. "Potential Climate Risks in Financial Markets: A Literature Overview," Memorandum 01/2016, Oslo University, Department of Economics.
    4. Geoffrey Heal & Antony Millner, 2013. "Uncertainty and Decision in Climate Change Economics," NBER Working Papers 18929, National Bureau of Economic Research, Inc.
    5. Fisher, Anthony, 2014. "Climate Science and Climate Economics," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt746627gz, Department of Agricultural & Resource Economics, UC Berkeley.
    6. Anderson, Evan W. & Brock, William & Sanstad, Alan H., 2016. "Robust Consumption and Energy Decisions," 2017 Allied Social Science Association (ASSA) Annual Meeting, January 6-8, 2017, Chicago, Illinois 250117, Agricultural and Applied Economics Association.
    7. David Comerford, 2013. "A balance of questions: what can we ask of climate change economics?," ESE Discussion Papers 216, Edinburgh School of Economics, University of Edinburgh.
    8. Yongyang Cai & Kenneth L. Judd & Thomas S. Lontzek, 2013. "The Social Cost of Stochastic and Irreversible Climate Change," NBER Working Papers 18704, National Bureau of Economic Research, Inc.
    9. Christian Traeger, 2014. "A 4-Stated DICE: Quantitatively Addressing Uncertainty Effects in Climate Change," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 59(1), pages 1-37, September.
    10. Mark Kagan, 2012. "Climate Change Skepticism in the Face of Catastrophe," Tinbergen Institute Discussion Papers 12-112/VIII, Tinbergen Institute, revised 29 Sep 2014.
    11. Derek Lemoine & Christian Traeger, 2014. "Watch Your Step: Optimal Policy in a Tipping Climate," American Economic Journal: Economic Policy, American Economic Association, vol. 6(1), pages 137-166, February.
    12. Duncan Foley & Lance Taylor, 2013. "The Social Cost of Carbon Emissions," SCEPA policy note series. SCEPA's main areas of research are macroeconomic policy, inequality and poverty, and globalization. 2013-2, Schwartz Center for Economic Policy Analysis (SCEPA), The New School.
    13. Łukasz Balbus & Kevin Reffett & Łukasz Woźny, 2015. "Time consistent Markov policies in dynamic economies with quasi-hyperbolic consumers," International Journal of Game Theory, Springer;Game Theory Society, vol. 44(1), pages 83-112, February.
    14. Fisher, A. C & Le, P. V, 2014. "Climate Policy: Science, Economics, and Extremes," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt6tj3j4jb, Department of Agricultural & Resource Economics, UC Berkeley.
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    16. Vale, Petterson Molina, 2016. "The changing climate of climate change economics," Ecological Economics, Elsevier, vol. 121(C), pages 12-19.
    17. Antony Millner & Simon Dietz & Geoffrey Heal, 2013. "Scientific Ambiguity and Climate Policy," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 55(1), pages 21-46, May.
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    More about this item

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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