Applied Analysis of the Carbon Price Mechanism in Australia - Case Study Example

Applied Analysis of the Carbon Price Mechanism in Australia Name: Course: Instructor: Institution: City & State: Date: Applied Analysis of the Carbon Price Mechanism in Australia Due to the changing world climate and adverse climatical conditions in the Australian continent, the government adopted a policy for clean energy. This policy will significantly cut pollution and drive investments hence ensuring Australia’s economic prosperity (Australian Government, 2011). Carbon price refers to the tariff charges by the government to all firms that release carbon emissions to the atmosphere. These tariffs are meant to discourage firms from utilizing energy sources that are harmful to the environment. The carbon price will generate financial incentives which will flow through the economy. Households will be cushioned against price increases through tax cuts, higher family payments and increases in pensions and benefits to meet costs passed through by businesses. Although the households are cushioned against price increases, rational consumers will be forced to make rational decisions regarding their consumption patterns as occasioned by changes in prices due to the effect of the carbon prices. The idea here is that, the consumer chooses a vector of goods to maximize utility subject to budget constraint. The carbon price is meant to change Australia’s electricity generation by encouraging investment in pure renewable energy like wind, solar power and natural gas which will enhance utilization of cleaner energy as observed by Anderson (1995). This paper examines the effects of carbon price reduction scheme on Australian households. The energy price increase due to introduction of carbon tax is likely to affect most households and businesses. This will lead to serious economic effects to the citizens since the tax levied on carbon emission will have far reaching effects on goods and services which are reliant on fuel for their production. Households which are exposed to vulnerability from even small price increases in the cost of basic commodities should be shielded from price increases caused by carbon price mechanism. Markandya and Halsnaes (2002) observed that many of such households are dis-savers, that is, they spend more than they earn. To cushion low income earners from the adverse effects of introduction of carbon price (tax), the government agreed to give financial assistance just to ensure that it does not distort the market operations. Putting in to consideration house hold assistance program under the carbon price mechanism, it is assumed that the taxation and transfer system operate concurrently. Any price increase above and beyond the model leads to cost of living increases, and it is paid and maintained as contemplated under the carbon pollution reduction scheme. The key household measure was the promise to lift all pensions and allowances by 2.5 % from the initiation of the carbon pricing mechanisms program. However, the drive to produce clean energy has led to some negative effects on the consumer due to the impact of taxation levied. Electricity price has nearly doubled over the years, driven by changes across the supply chain, from generation through transmission and distribution and by policy measures (De Nocker, Saez, & Linarez, 1999). This has been exacerbated by the carbon price changes. Fuel prices are real issues in the Australian community. Price rises from carbon price and other factors may have an effect of increasing the number of households experiencing energy hardships and the number of disconnections. Carbon price scheme will also have social impacts which stem from employment, real wage and income impacts (ACIL Tasman, 2011). Workers will be forced to adjust their wages demands and move to where jobs are in a more or less costless fashion. Social costs will flow from the process of economic adjustments to consequent dislocations of economic activities. Dislocations can lead to stagnation or to the worst closure of businesses with many workers facing a choice between unemployment and a change of occupation if not geography. Loss of jobs and reduced income earning translates to adjustments in living conditions. Burniaux, Martin and Oliveira-Martins (1992) observed that many workers will lose their jobs upon stagnation or closure of firms and this will lead them to adjust from their current living styles to ones that match their incomes. Diagram-1: shows effects of tax on demand, supply and price. S1 P1 e2 S Pe e1 P2 A D Q1 Qe Q (Quantity Demanded) The imposition of tax has an effect of rise in commodity prices shifting the supply curve from supply curve S to Supply curve S1. At supply curve S, quantity Qe is produced. Due to increase in commodity prices, the supply curve shifts upwards and new equilibrium is achieved at e2. At this equilibrium point, quantity Q1 is produced which in real sense is lesser than the original quantity demanded at equilibrium Q1. This shows that introduction of taxes leads to rise in commodity prices which in turn reduces the quantity demanded by the households. Therefore, firms will be forced to cut their production due to decrease in quantity demanded. However, this will translate in to firms scaling down their labor force and reduction in staff remuneration costs to keep pace with the reduced business activity. The impact of carbon price mechanism may have its effects on wealth of households. The scheme will have effects on the value of companies by increasing or decreasing their values. These changes in values will ultimately flow to the owners of the firms. Considering that individual households may hold diversified wealth, the value of some of their assets may increase while the value of others may decrease in response to the introduction of the scheme. The rise in prices of traditional sources of energy leads to focus on utilization of the available substitutes. The government encourages people to utilize environment friendly sources of energy such as wind and solar energy. Also, the government heavily invests in new technological developments that will lead to emergence of carbon free sources of energy. Vehicles with significantly reduced or zero emissions has been developed and more incentives are availed to encourage mass production. The upsurge in mass production of electric vehicles has allowed Australia to avoid shocks that they would have otherwise experienced in their heavy reliance on fuel viewed from Crikey blog. Imposition of carbon tax has brought about changes in household consumption patterns. The rising carbon price has reinforced some trends that are already taking place, such as reduction of use of private cars particularly among the young generation. There is an argument that if government compensates households for increase in prices as a result of carbon price, the incentive effect of the tax would be cancelled out. However, even though the carbon tax will have a significant impact on aggregate emissions of carbon, mainly through its impact on electricity generation and energy use by business, the average household will barely notice this. Carbon price targeted energy producing firms and being that these firms eventually pass the tax burden to the final consumer; the government utilize the revenue generated to cushion the households against the raise in commodity prices (Larsen and Shah, 1992). The government decision to give cash to households has a positive impact since many people will be able to maintain if not increase their consumption treads in light of increase in cash receipts upon retirement. Household’s budgets will be maintained since the effects of the commodity prices increase will be offset by the cash receipts from the governments (Australian Government, 2011). Many households prefer present consumption rather than future consumption. Therefore, monies earned today will be subjected to present consumption and due to increase in monies set aside for pensions then the households will not be obliged to set aside huge amounts for future consumption. However, households may consider other sources of energy which are environmentally friendly since it is a government directive to use energy sources that are not harmful to the environment. Also, due to carbon price burden, some firms may switch from carbonized sources of energy that are harmful to the environment to greener sources hence the end users will have no option other than using such green friendly form of energy (Crickey.com, 2011). Though the government, give the household cash to cushion them against rise in commodity prices, this may not in real sense offset the total budget that the households faces. Tax imposition does not itself translate to the equal burden that rests on the shoulders of the households. In addition, cash may reach the households as pension payments; this may have adverse effects on the wellbeing of the households since they will be forced to cough more for the increase in commodity prices presently (Anderson & Mckibbin, 1997). The cash receipt from the government will not serve the short term effects of the high commodity prices since the amount to cushion these high prices will be received later on as pension payments Introduction of carbon tariffs has an adverse effect on the economic system. It is evident that these dynamic tariffs may distort the operations of the market despite their intended purpose of helping in protecting the environment from carbon emissions. Therefore, the government should devise means of countering the effects of the tariffs levies on the household decision in order to ensure that the market operations remain at equilibrium. However, these tariffs have great impacts on the economy since they lead to use of greener sources of energy, collect revenue for the government which can in turn be redirected to other sectors of the economy and also cushion the households against increases in commodity prices. References ACIL Tasman, 2011. Briefing Note: Clean Energy Future Package – High level impacts on Victorian energy markets. Victorian Department of Primary Industry, p.9. Australian Government, 2011. Strong Growth, Low Pollution: Modelling a Carbon Price. Table 5.6, p.93. Andersen, T. and McKibbin, K., 1997. Reducing Coal Subsidies and Trade Barriers: Their Contribution to Greenhouse Gas Abatement, Seminar Paper 97-07, Centre for International Economic Studies, University of Adelaide, Australia. Anderson, P., 1995. The Political Economy of Coal Subsidies in Europe, in Energy Policy. Journal of Energy, 23 (6), pp. 2-6. Burniaux, J. M., Martin, J. P. and Oliveira-Martins, J., 1992. The Effect of Existing Distortions in Energy Markets on the Costs of Policies to Reduce CO2 Emissions: Evidence from GREEN, OECD Economic Studies No. 19. Crickey.com, 2011. Viewed from< Http//www.crikey.com.au/2011/07/15/> > (Accessed on 28th August 2011). De Nocker, S. and Linarez, P., 1999. Energy Source (online). Available at: (Accessed on 28th August 2011). Larsen, P. & Shah, T., 1992. World Energy Subsidies and Global Carbon Emissions. London: World Bank Research Paper 1002. Larsen, P. & Shah, T., 1995. World Fossil Fuel Subsidies and Global Carbon Emissions. In Bovenberg and Cnossen (Eds), Public Economics and the Environment in an Imperfect World. London: World Bank Research Paper 1002. Markandya, T. & Halsnaes, G., 2002. Climate Change and Sustainable Development. London: Earthscan. Read More