Economic Modelling Approaches to Cost Estimates for the Control of Carbon Dioxide Emissions

This article gives an assessment of the relative strengths and weaknesses of a variety of economic modelling approaches commonly used for cost estimates of limiting carbon emissions. The approaches discussed include the ad hoc approach, dynamic optimization approach, input-output approach, macroeconomic approach, computable general equilibrium (CGE) approach, and the hybrid approach. It illustrates how these economic approaches are able to shed light on different aspects of the control of carbon emissions. Main conclusions can be drawn as follows. First, if focus is placed primarily on technological solutions to carbon emission problems, dynamic optimization models are very useful. Moreover, in order to prioritize investments in carbon abatement technologies, specific cost-effective analysis of these technologies is helpful. Second, of a variety of economic models discussed in the article, none contains more sectoral detail than input-output models. Therefore, if interest centers mainly on the consequences of a carbon tax for the economic structure, input-out models are generally considered an appropriate tool for such a purpose. Third, the transitional impacts of a carbon tax on inflation and unemployment can best be captured in macroeconomic models. Thus, if focus is placed on an estimation of transitional adjustment costs in the short-run, we can rely on macroeconomic models. Fourth, CGE models are an appropriate tool for analyzing the economic effects of great changes in the demand and/or supply structure of an economy and those questions of long-run nature. If we want to shed light on long-run aspects of a high tax imposed for achieving a substantial cut in carbon emissions, CGE models are called for. Finally, given the relative strengths and weaknesses of bottom-up models and top-down models, it is worthwhile linking them together, thus shedding light on both economic and technological aspects of the control of carbon emissions