The Opportunity Cost of Climate Policy: A Question of Reference

19 Pages Posted: 29 Nov 2011

See all articles by Armon Rezai

Armon Rezai

Vienna University of Economics and Business

Date Written: December 2011


The cost of climate policy depends on the no‐policy alternative without which the “opportunity cost” of climate action cannot be determined. This baseline path has to reflect the current failure in the market for carbon emissions. Because of a negative externality, private investment decisions are made without considering the climate damage they entail. Agents overinvest in conventional capital and underinvest in climate capital. Internalization of climate damage lowers the private return to capital, and agents reduce investment in favor of mitigation and consumption. Optimal climate policy increases the welfare of both the present and the future. A simulation of the inefficient no‐policy scenario in the Dynamic Integrated Climate–Economy model (DICE‐07) confirms this numerically.

Keywords: Climate policy, DICE, externality, intergenerational equity, market failure

JEL Classification: C61, C70, D62, E24, H23, Q54

Suggested Citation

Rezai, Armon, The Opportunity Cost of Climate Policy: A Question of Reference (December 2011). The Scandinavian Journal of Economics, Vol. 113, Issue 4, pp. 885-903, 2011, Available at SSRN: or

Armon Rezai (Contact Author)

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020

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