Carbon emissions do respond to policy

In Australia it is common to come across both climate change deniers and those who deny that policy measures to reduce global warming will be effective. Often the claim is made that the policy measures do too much harm to people's livelihood's now to be worth the benefits later (dingos kidneys obviously).

The story below from the BBC reports on a record fall in UK coal use and as a result carbon emissions. It is a story that suggests when policy is properly applied it can have a significant impact.

In the case of the UK (and here you can read a combination of EU and UK policy) thare are a raft of complementary policies that have driven lower emissions.

Briefly the UK policy includes:

• Setting a carbon budget - a proposed limit to carbon emissions that falls over time
• Taxing carbon emissions, including a minimum tax on carbon.
• Subsidizing renewable energy.
• Promoting and funding a shift away from coal to cleaner fuels (move to low-carbon technologies)
• Funding public information of the dangers of global warming and ways to reduce carbon emissions.
• Subsidizing home improvements and strict regulation on new building standards e.g. insulation standards such as compulsory double glazing.

The message here is that one policy alone is not really that effective, but a combination of policies that raise the price and shift the demand curve to the left do have a significant effect.

One point to note is that serious attempts in UK policy on this issue began in 1990. While policy has intensified since 2006 there has been a fairly sudden change recently, as the article notes. Initially policy met an inelastic response to price changes and only minor changes that could be said to have moved the demand curve left. 

Now the policy has reached the 'tipping point'. We are observing an elastic response to price (see article) and behaviour has been changed. Economists knew this point would be reached, but predicting how much pressure needed to be applied to reach it was never clear.

David Pearce, you were right. I'm sorry you never lived to see it.

The BBC article is here

Road pricing in Melbourne - excellent idea

Infrastructure Victoria today issued a 200+ page interim report on future transport infrastructure planning in Melbourne. There is much in it that makes sense, including a cost-benefit analysis report showing which projects will yield more benefits than costs.

One of their proposals (and it is only an option) is to charge motorists $5 to enter the CBD. The aim is to reduce congestion by making people time their journeys differently and to move others on to public transport. The report suggests that 20% of journeys taking between 7am and 9am could be moved to other times.

This proposal is founded on the experience of many other cities. London, Singapore and Stockholm all have well developed charging schemes, although they are not all the same. London charges one amount between 7am and 6pm while Singapore varies the charge according to the time of day and level of congestion.

Road pricing schemes are highly effective when combined with other measures, such as improved public transport and subsidies of that system, park and ride schemes, car sharing schemes and high car parking charges for example. Without additional measures the price elasticity of demand is too inelastic for road pricing to make a significant difference, due to the essential nature of transport generally and the sheer convenience of driving your own vehicle.

Both major parties in Victoria rejected the proposed charges on the morning the report was published. So much for well considered long-term policy making. I have sent a letter!

The Age covers the story here

The ABC coverage is here

This article has some relevance to VCE as it deals with market failure (the negative externalities of using a car and congesting a road) and the price mechanism. IB students are much better equipped to investigate this topic using their knowledge of market failure and policy. (Good EE topic?)

A small charge for plastic shopping bags leads to massive fall.

England introduced a 5p (about 10c) charge for plastic bags in supermarkets. After six months there has been up to a 90% fall in plastic bags used.

The motive is to reduce negative externalities of consumption which have led to market failure. Not only were the bags unnecessarily up scarce resources, they are made from oil so there are negative externalities associated with production too. Also the disposal of the bags has to be in landfill because they cannot be recycled.

This example is an excellent one of regulation (it's not a tax) that internalises the externality. People are forced to consider the costs of the resources used by the imposition of a price. The PED is actually very difficult to determine as the price was originally zero, however we might at this stage suggest that there has been a highly elastic response!

The story is covered here

This is a great example for IB students and for VCE students it also illustrates the effect of using prices to correct market failure. It is unusual as it is a regulation rather than  tax, but clearly a 5p tax would have the same effect (while raising virtually no money).

Sugar tax - flawed thinking?

As IB students approach their first IA I'm posting this story to remind you about the UK 'Sugar tax'.

The article focuses on a group, "The Taxpayers Alliance", who oppose the tax (very Australian - any tax is a bad tax attitude). They point out that the tax is not being applied to all drinks with high sugar content.  They also suggest that the tax is regressive.

A sugar tax intends to address a negative externality of consumption and was dealt with in a post on 19th February. However the economics of it is shown in the diagram below. People don't understand how their consumption of the good is not as good for society (and them) as their perceived private benefit.

The first point made by the group is that the tax is not being applied to other sugary drinks. This is a fair point in some respects. Perhaps those who drink fizzy sugary drinks will switch to untaxed drinks due to the change in relative prices. This expose an important flaw in taxation policy, and suggests that applying the tax across a wider range of goods might be advisable.

However the criticism miss the point. Young people (and some older ones) can drink litres of fizzy drinks, but are unlikely to drink litres of hot chocolate. The problem is not the sugar content per 100ml, but the amount consumed. So if people swap a litre of fizzy drink for a hot chocolate then less sugar is consumed.

The second point made is that the tax is regressive. This means that the poorer households pay a higher proportion of their income in tax than richer households. This is usually true of specific indirect taxes. Should we be worried about this? In short, probably not. The sugar tax is designed to change behaviour. If households buy fewer fizzy drinks then they don't pay the tax and that's what the government wanted. If they carry on buying fizzy drinks then they are paying more towards their medical treatment.

Maybe the Taxpayers Alliance should have claimed the elasticity of demand was not conducive to reducing consumption instead?

The BBC article is here

This article is more relevant to IB students because of its international nature. However VCE students should be aware of the impact of, justification for and limitations of indirect tax.

Coping with air pollution

Pollution is a well known market failure. The negative externalities imposed by, say, driving cars are significant and the market has no way of applying a price to these effects. Therefore governments must intervene to mitigate against the worst effects.

There are several possible ways to deal with this. In order of effectiveness, least to best:

Do nothing
Ban the activity
Regulate the activity
Impose a tax or subsidy
Create a tradeable permit scheme

When it comes to pollution caused by traffic there are many difficulties. The 'do nothing' approach has been tried (usually this leads to building more roads which cause more congestion and pollution) and bans on certain vehicles at certain times is also used in some places (such as no lorries allowed 7.30am to 9am).

The article below explains a British scheme to impose charges on high polluting vehicles in certain areas. The aim is to discourage there use in those areas, it is, in effect, a tax. Will it work? Well that depends on the Price Elasticity of Demand for road use by the vehicles operators and whether they simply operate elsewhere simply redistributing the pollution.

The article below discusses some wider issues, but it is clear that when it comes to coping with the negative externality of pollution, or carbon emissions, a comprehensive policy is required. Not only geographically comprehensive but a policy that integrates with transport policy across all modes of transport.

The BBC covers the issue here

This article is relevant to both VCE and IB students. The methods of dealing with environmental problems is the key for VCe students whereas IB students should consider the alternative methods and their merits. My list suggests tradeable permits are the most efficient method, but why?

The carbon tax worked. Proof of what economists always knew.

Australia is a pariah for its callous disregard of the global warming crisis. While it is fashionable within Australia to believe that the government is acting in the best interests of Australia's standard of living the rest of the world looks on them as bigots.

An example of the extraordinary behaviour of Australia is the repeal of the carbon tax. Various reasons were given including 'it didn't work'. (The other reasons are beyond the scope of the space we have.)

Taxes work by raising the price of a good and so changing the relative price of the good. As a result some consumers move to relatively cheaper substitutes and consumption of the taxed good falls.

The practical difficulties of taxing a good like carbon are significant. Demand for energy is price inelastic and so small rises in price have only a very small effect on demand. Demand is inelastic partly due to the lack of substitutes, the fact that energy is a necessity and it takes a long time to be able to switch to alternatives. Therefore the effect of the carbon tax was difficult to detect.

The chart below shows the changes in electricity generation, coal's share of that generation and emissions. Notice this shows percentage changes in totals, not absolute amounts. This is much more useful in tracking the effect of the policy changes.

 

The chart clearly shows that coal's share of electricity generation falls after the carbon tax was introduced in 2012 and that emissions fell even faster. Since the carbon tax was scrapped in 2014 coals share of generation has risen and so have emissions.

It is important to concentrate on the economics rather than the politics of this policy. Taxes do work (a Pigovian tax - see a post form last month) because changing relative prices will alter the allocation of resources. The problem is that it does take time to work.

The Guardian Australia covers the story here

As an extra here is a chart of how each state was generating their electricity on 7th April 2016.

 

Brown coal is the dirtiest fuel in terms of CO2 emissions. 

This article is relevant to both VCE and IB students. It can be used as an example for IB students and an Australian environmental policy is required knowledge for VCE.

New minimum wage rates - good or bad for the British economy?

The UK today introduced a new 'National Living Wage' which is effectively a minimum wage. The UK already has a minimum wage, but that's 50p less an hour.

There is a great deal of support for this move, but also a great deal of opposition.

Those who support the 'Living Wage' argue that the present minimum wage is insufficient to provide workers and their families with a reasonable standard of living. This is where the term 'Living wage' comes from.

Those who oppose the move say that many workers will lose their jobs or be forced to accept shorter hours as employers cannot afford the higher wage rate. They suggest that the market won't support the employment levels currently enjoyed at the higher wage rate.

The economics of this can can complex, but the diagram below shows the most basic analysis.

 In the diagram above the free market wage rate is 0W* and 0N* hours of labour are hired by firms. Suppose that the National Living Wage (NLW) is introduced at 0WH. As this new NLW is above the market rate the effect on employment will be detrimental with hours of labour employed falling to 0Nd. Those who remain in work will, of course, be better off, but this is cold comfort for those who loose their jobs.

If the new NLW is imposed at 0WL then there is no effect on employment at all. Workers will continue to be paid the higher open market rate.

The BBC article below shows the situation is far from this simple. Here are a few considerations.

* There are people earning less than the new NLW. How could they be earning less than the free market rate (0W*) at present? Possibly because of an imbalance of power between employer and employee meaning the employer can exploit the weak position of such workers (perhaps in a non-unionised industry). In this case the employers are being forced to pay a fairer wage rate.

* If the new NLW is above the market rate how many workers might lose their jobs? This will depend on the elasticity of demand for labour and this in turn depends on the elasticity of demand for the product they produce (derived demand).

* Looking at the BBC article shows that different regions of the UK will see different proportions of the workforce affects receiving pay rises. The distribution of gains between regions will be very different therefore on real incomes and hours worked. Overall their may be an improvement in the equality of the distribution of income, this can be measured by the gini-coefficient.

* In the short run there may be job losses due to the higher NLW. In the long run the improved standard of living may result in high overall benefits to society (lower government spending, improved productivity etc.) 

There are many aspects of the introduction of the NLW to consider. Issues are rarely as simple as they first appear and further consideration often draws us to a different conclusion.

The BBC article is here  

 This article is more likely to be useful to IB students than VCE. However VCE students can still look at it as an application of demand and supply analysis. For IB students the evaluation of a measure is very important and this needs to be based on analysis (explaining using theory). Ther are numerous ways the initial demand and supply analysis could be developed.

The effect of a poor crop, applying demand, supply and elasticity

It will surprise many to learn that the second most expensive spice by weight in the world is Vanilla (Saffron is the most expensive). And there was a poor crop of vanilla last year.

The article linked below shows that in Madagascar the vanilla crop has fallen by up to 700 tonnes from 2000 tonnes a year. Madagascar produces the best vanilla and is favoured by ice cream makers.

The result has been a rise in price from £59 to £144 a tonne and this is being passed on to ice cream makers. While your favorite ice cream flavour might not be vanilla it is the biggest selling ice cream.

The diagram below shows the effect on the vanilla market.

Although the fall in vanilla production is 35% the rise in price is 144%. This gives us a Price Elasticity of Demand (PED) of (-) 0.24. That is very inelastic. Should we be surprised by the result? Well not really, vanilla has few substitutes and those that exist are regarded as being of lower quality. Also vanilla represents a fairly small proportion of household expenditure, despite it's high price per kg. Could we regard it as a necessity? Well for some products yes, although this argument isn't as clear cut. Whatever the PED tells us demand is inelastic!

Notice also that the income of vanilla farmers has shot up, from £118,000 to £187,200. This is what we expect to see in primary product markets and inelastic demand.

What will be the consequence for ice cream prices? Well not as big a price hike as there was for vanilla. The article tells us that 'customers would notice' a rise in vanilla ice cream prices compared to other ice cream. This is suggesting that ice cream flavours are substitutes for each other (they have a high cross-price elasticity of demand, XPED) and there are also alternatives to icecream. So manufacturers are likely to absorb the rise in vanilla price this year and hope for a larger crop in 2016.

The diagram below shows what happens if the ice cream manufacturers passed on the full rise in vanilla prices. Because demand for vanilla ice cream is elastic the price rises from 0P1 to 0P2, but there is a large fall in quantity demanded (Q1 - Q2). So we are likely to see a smaller rise in ice cream price than (P2 - P1) due to competition between ice cream makers and the high XPED between ice cream flavours.

The Guardian article is here

IB students will be able to apply elasticity concepts to this article and use it as an example of primary product markets. It is th stuff good IA's are made of. VCE students will see it as an application of demand and supply analysis and PED.