General Equilibrium Theory for Climate Change

TL;DR

This paper introduces two general equilibrium models for climate policy—quota and emission tax equilibria—highlighting their existence, equivalence, and conditions for Pareto optimality, with implications for designing effective climate regulations.

Contribution

The paper develops and analyzes two novel general equilibrium models for climate policy, establishing their existence, equivalence, and conditions for Pareto optimality.

Findings

Quota equilibrium exists and impacts welfare distribution.

Quota equilibrium constrained Pareto Optimal when externality is from total net emissions.

Emission tax equilibrium may not always exist or be unique.

Abstract

We propose two general equilibrium models, quota equilibrium and emission tax equilibrium. The government specifies quotas or taxes on emissions, then refrains from further action. Quota equilibrium exists; the allocation of emission property rights strongly impacts the distribution of welfare. If the only externality arises from total net emissions, quota equilibrium is constrained Pareto Optimal. Every quota equilibrium can be realized as an emission tax equilibrium and vice versa. However, for certain tax rates, emission tax equilibrium may not exist, or may exhibit high multiplicity. Full Pareto Optimality of quota equilibrium can often be achieved by setting the right quota.