Tipping Points and Ambiguity in the Economics of Climate Change

40 Pages Posted: 14 Jul 2012

See all articles by Derek Lemoine

Derek Lemoine

University of Arizona - Department of Economics

Christian P. Traeger

University of California, Berkeley; University of Oslo - Department of Economics (ESOP); ifo Institute - Leibniz Institute for Economic Research; University of Oslo - Ragnar Frisch Centre for Economic Research

Date Written: July 2012

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

Lemoine, Derek and Traeger, Christian P., Tipping Points and Ambiguity in the Economics of Climate Change (July 2012). NBER Working Paper No. w18230. Available at SSRN: https://ssrn.com/abstract=2105975

Derek Lemoine (Contact Author)

University of Arizona - Department of Economics ( email )

McClelland Hall
Tucson, AZ 85721-0108
United States

HOME PAGE: http://www.dereklemoine.com/

Christian P. Traeger

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

University of Oslo - Department of Economics (ESOP) ( email )

Moltke Moes vei 31
Oslo, 0851
Norway

ifo Institute - Leibniz Institute for Economic Research ( email )

Poschinger Str. 5
Munich, 81679
Germany

University of Oslo - Ragnar Frisch Centre for Economic Research ( email )

Gaustadalleen 21
N-0317 Oslo
Norway

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