I did start to wonder what sort of cardigan induced haze had descended when it was claimed that the solution to global climate change, at least from an economic standpoint, was to "internalise the externality". Obviously. Stick with me here because in the end, it should hopefully make more sense.
Externalities are by-products of processes we value but are not included in the cost to the consumer. Carbon dioxide emissions are a classic example of an externality - they are a by-product of common processes such as energy generation or transportation which are essential to the way we currently live.
Our lecturer, being a good classically trained economist, was a huge fan of a diagram. In his honour, please find one inserted below so I can illustrate where I'm going with this.
For the purposes of this exercise we'll make some assumptions (welcome to economics);
(1) Carbon dioxide emissions cause environmental damage (of x value)
(2) The price you pay for your electricity is Pmarket (determined by the point where MPC intersects with MB)
(3) The price you pay for electricity magically excludes infrastructure and other crazy real world costs which gets electricity from the generator to your house
Working on the above assumptions you are only paying for your electricity and not any environmental damage (like carbon dioxide emitted during the process which is accumulating in the atmosphere and influencing climate change).
When you put an estimate of the environmental cost (ED) into the overall cost suddenly you have the marginal social cost (MPC + ED) and, in this case a magical new red line heading to the top right hand corner of the page.
If you now recalculate the price - where the MSC line intersects with MB, and read off Pext, the new price (including the externality) is higher.
Congratulations, you now understand what will happen when the Australian Government puts a price on carbon on 1 July 2012. They have estimated that the shadow price is $23/tonne and are working on the fact that this increase in price will mean that you as a consumer will reduce the quantity of electricity you use (NB the red dashed line on the quantity axis indicates a smaller quantity). Ideally, this should mean that people are incentivised to do something about the way they use electricity and wherever possible decouple their electricity use from carbon emissions. After all, the above diagram doesn't apply if quantity of electricity does not correlate with quantity of emissions produced e.g. if your solar powered hot water system meets your household needs without additional fossil fuel boost then there is no corresponding emissions with every shower you have.
There is method in this madness.
It would be great if everyone considered whether we really have Economic hypochondria currently in Australia as we yell increasingly louder about how we can not possible afford, as one of the wealthiest nations on earth, to do something about our contribution to climate change.
Business knows they need to do something about the mega forces expected in the future, of which climate change is only one. The suite includes climate change, fuel and energy, material resource scarcity, water scarcity, population growth, urbanisation, wealth, food security, ecosystem decline and deforestation as recognised in KPMG's latest offering to the business world. Maybe we all need to Expect the unexpected.
Externalities are by-products of processes we value but are not included in the cost to the consumer. Carbon dioxide emissions are a classic example of an externality - they are a by-product of common processes such as energy generation or transportation which are essential to the way we currently live.
Our lecturer, being a good classically trained economist, was a huge fan of a diagram. In his honour, please find one inserted below so I can illustrate where I'm going with this.
For the purposes of this exercise we'll make some assumptions (welcome to economics);
(1) Carbon dioxide emissions cause environmental damage (of x value)
(2) The price you pay for your electricity is Pmarket (determined by the point where MPC intersects with MB)
(3) The price you pay for electricity magically excludes infrastructure and other crazy real world costs which gets electricity from the generator to your house
When you put an estimate of the environmental cost (ED) into the overall cost suddenly you have the marginal social cost (MPC + ED) and, in this case a magical new red line heading to the top right hand corner of the page.
If you now recalculate the price - where the MSC line intersects with MB, and read off Pext, the new price (including the externality) is higher.
Congratulations, you now understand what will happen when the Australian Government puts a price on carbon on 1 July 2012. They have estimated that the shadow price is $23/tonne and are working on the fact that this increase in price will mean that you as a consumer will reduce the quantity of electricity you use (NB the red dashed line on the quantity axis indicates a smaller quantity). Ideally, this should mean that people are incentivised to do something about the way they use electricity and wherever possible decouple their electricity use from carbon emissions. After all, the above diagram doesn't apply if quantity of electricity does not correlate with quantity of emissions produced e.g. if your solar powered hot water system meets your household needs without additional fossil fuel boost then there is no corresponding emissions with every shower you have.
There is method in this madness.
It would be great if everyone considered whether we really have Economic hypochondria currently in Australia as we yell increasingly louder about how we can not possible afford, as one of the wealthiest nations on earth, to do something about our contribution to climate change.
Business knows they need to do something about the mega forces expected in the future, of which climate change is only one. The suite includes climate change, fuel and energy, material resource scarcity, water scarcity, population growth, urbanisation, wealth, food security, ecosystem decline and deforestation as recognised in KPMG's latest offering to the business world. Maybe we all need to Expect the unexpected.
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