Muller Testimony Vermont ?· Testimony to State of Vermont House Committee on Natural Resources and…

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  • Testimony to State of VermontHouse Committee on Natural

    Resources and Energy:Carbon Management

    March 30th, 2016.Nicholas Z. Muller, MPA, PhD

    Associate Professor of EconomicsMiddlebury College

    1

  • My Background

    Associate Professor of Economics at Middleburysince 2007.

    MPA Indiana University Bloomington.

    Ph.D. Yale University

    Research cited ~1,475 times. Science (2x), American Economic Review (3x).

    Research used directly: USEPA, USDOJ, UNEP,USBOEM, US NAS.

    Current member USEPA SAB

    2

  • My Background

    Associate Professor of Economics at Middleburysince 2007.

    MPA Indiana University Bloomington.

    Ph.D. Yale University

    Research cited ~1,475 times. Science (2x), American Economic Review (3x).

    Research used directly: USEPA, USDOJ, UNEP,USBOEM, US NAS.

    Current member USEPA SAB

    3

    Last 5 years, 8 peer-reviewed articleson climate change economics

    and CO2 policy.

  • Outline of Testimony

    Markets. Supply and Demand.

    Market Equilibrium.

    Motivation for Government Intervention. Market Failure.

    Externality.

    Hidden subsidy.

    Policy Instrument Design. Taxes versus command and control.

    Calibration of the tax.

    4

  • Markets

    Markets are a means to allocate resources.

    5

  • Markets

    Markets are a means to allocate resources.

    Quotas.

    Limits, bans.

    6

  • Markets

    Markets are a means to allocate resources.

    Quotas.

    Limits, bans.

    Prices act as rationing mechanism.

    Importance of scarcity in price formation.

    7

  • Markets

    Markets are a means to allocate resources.

    Quotas.

    Limits, bans.

    Prices act as rationing mechanism.

    Importance of scarcity in price formation.

    If there are many consumers and firms, pricesreveal a good estimate of societys value ofgoods and services.

    8

  • 9

    Markets

    Markets are a means to allocate resources.

    Quotas.

    Limits, bans.

    Prices act as rationing mechanism.

    Importance of scarcity in price formation.

    If there are many consumers and firms, pricesreveal a good estimate of societys value ofgoods and services.

    Under certain circumstances markets efficient.9

  • $

    Q(energy)

    10

  • $

    Q(energy)

    S = cost/unit produced

    11

  • $

    Q(energy)

    D = benefit/unit consumed

    S = cost/unit produced

    12

  • $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    13

    D = benefit/unit consumed

  • 14

    Total cost

    14

    $

    Q(energy)

    S = cost/unit produced

    14

  • 1515

    $

    Q(energy)Qmarket

    15

    D = benefit/unit consumed

    Total benefit

  • 16

    $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    16

    D = benefit/unit consumed

    Markets are efficient:Net Benefit (Total Benefit Total Cost)

    Maximized at (Pmarket, Qmarket)

  • Why do governments intervene inmarkets? Market failure.

    Many examples of market failure:

    17

  • Why do governments intervene inmarkets? Market failure.

    Many examples of market failure:

    Information: the market for used cars (lemonlaws).

    18

  • Why do governments intervene inmarkets? Market failure.

    Many examples of market failure:

    Information: the market for used cars (lemonlaws).

    Public goods: governments provide for parks andopen space, national defense.

    19

  • Why do governments intervene inmarkets? Market failure.

    Many examples of market failure:

    Information: the market for used cars (lemonlaws).

    Public goods: governments provide for parks andopen space, national defense.

    Externality: two agents engage in markettransaction, a third party(ies) incur a cost forwhich they are not compensated.

    20

  • Why do governments intervene inmarkets? Market failure.

    Many examples of market failure:

    Information: the market for used cars (lemonlaws).

    Public goods: governments provide for parks andopen space, national defense.

    Externality: two agents engage in markettransaction, a third party(ies) incur a cost forwhich they are not compensated.

    21

  • $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    22

    D = benefit/unit consumed

  • S = social cost/unit consumed

    23

    $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    23

    D = benefit/unit consumed

  • 24

    S = social cost/unit consumed

    24

    $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    24

    D = benefit/unit consumed

    Difference is cost borneby 3rd party/unit produced.

  • Implications of Externality

    Costs that firms faces are too low.

    Raw materials, labor, capital, land, insurance etc.

    25

  • Implications of Externality

    Costs that firms faces are too low.

    Raw materials, labor, capital, land, insurance etc.

    Firms do not face impacts on 3rd party(ies).

    26

  • Implications of Externality

    Costs that firms faces are too low.

    Raw materials, labor, capital, land, insurance etc.

    Firms do not face impacts on 3rd party(ies).

    Market prices are, likewise, too low.

    27

  • Implications of Externality

    Costs that firms faces are too low.

    Raw materials, labor, capital, land, insurance etc.

    Firms do not face impacts on 3rd party(ies).

    Market prices are, likewise, too low.

    Equilibrium quantity is too high.

    Consumers face a price for goods that does notreflect the full cost of production.

    28

  • Implications of Externality

    Costs that firms faces are too low. Raw materials, labor, capital, land, insurance etc.

    Firms do not face impacts on 3rd party(ies).

    Market prices are, likewise, too low.

    Equilibrium quantity is too high. Consumers face a price for goods that does not

    reflect the full cost of production.

    Markets cannot yield socially optimaloutcome.

    29

  • Implications of Externality

    Costs that firms faces are too low. Raw materials, labor, capital, land, insurance etc.

    Firms do not face impacts on 3rd party(ies).

    Market prices are, likewise, too low.

    Equilibrium quantity is too high. Consumers face a price for goods that does not

    reflect the full cost of production.

    Markets cannot yield socially optimaloutcome.

    30

  • 31

    Implications of Externality

    Costs that firms faces are too low. Raw materials, labor, capital, land, insurance etc.

    Firms do not face impacts on 3rd party(ies).

    Market prices are, likewise, too low.

    Equilibrium quantity is too high. Consumers face a price for goods that does not

    reflect the full cost of production.

    Markets cannot yield socially optimaloutcome.

    31

    Can government interventionfacilitate a more efficient outcome?

  • 32

    S = social cost/unit consumed

    32

    $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    32

    D = benefit/unit consumed

    Market Equilibrium

  • 3333

    S = social cost/unit consumed

    33

    $

    Q(energy)

    S = cost/unit produced

    Psocial

    Qsocial

    33

    D = benefit/unit consumed

    Socially Optimal Equilibrium

  • 34

    How can a government induce the optimal outcome?

    3434

    S = social cost/unit consumed

    34

    $

    Q(energy)

    S = cost/unit produced

    34

    D = benefit/unit consumed

    Tax set to cost borneby 3rd party/unit produced.

    Psocial

    Qsocial

  • 3535

    How can a government induce the optimal outcome?

    3535

    S = social cost/unit consumed

    35

    $

    Q(energy)

    S = cost/unit produced

    Ptax

    Qtax

    35

    D = benefit/unit consumed

    Tax set to cost borneby 3rd party/unit produced.

    Tax revenue.

  • 3636

    $

    Q(energy)

    S = cost/unit produced

    Pmarket

    Qmarket

    36

    D = benefit/unit consumed

    Markets are efficient:Net Benefit Maximized

  • 3737

    $

    Q(energy)

    S = cost/unit produced

    Qmarket

    37

    D = benefit/unit consumed

    Qsocial

    S = social cost/unit consumed

    Inefficiency fromtax

  • 38

    $

    Q(energy)

    S = cost/unit produced

    Qmarket

    38

    D = benefit/unit consumed

    Qsocial

    S = social cost/unit consumed

    Avoided external costfrom tax

  • How to evaluate corrective tax?

    Compare loss ( ) to gain ( ).

    Since gain > loss, net benefits with thecorrective tax outweigh net benefits withoutthe tax.

    Avoided external costs exceed distortion fromthe tax.

    39393939

  • Externality: an involuntary subsidy.

    Production and consumption produces waste.

    40

  • Externality: an involuntary subsidy.

    Production and consumption produces waste.

    Pollution (carbon) emissions are free wastedisposal.

    41

  • Externality: an involuntary subsidy.

    Production and consumption produces waste.

    Pollution (carbon) emissions are free wastedisposal.

    If this was solid waste, polluters would pay feefor disposal. Why?

    42

  • Externality: an invol