The Global Price of Carbon Determining by the Forces of Demand and Supply - Assignment Example

Economics Student’s Name Institutional Affiliation Question 1 The introduction of fixed price on emissions of carbon dioxide and greenhouse equivalent, which was set at approximately $24/tonne, was aimed at reducing the Australia emissions to five percent level by 2020. This fixed carbon emission tax is likely to increase the production cost of producing electricity in Australia (Johnston 2006). This is because; most of Australia’s electricity is generated from burning coal, which emits carbon dioxide and other greenhouse gasses. The increased cost of production will affect both the demand and the supply of Electricity in the country; increased costs of production will raise the price units of electricity consumed by the household. The high cost of electricity will also have negative impacts on all other sectors of the economy. The curve below shows the equilibrium price and demand in a free economy. Supply (cost) Equilibrium P Demand (private Q In this case, Marginal Private Benefit is equal to Marginal Private Cost (MPB = MPC). The fixed price of carbon emission will increase the cost of producing electricity. Price of Electricity Social cost Cost of production Supply (private cost) Pm Po Equilibrium Qm Q0 Q (optimum) Q(market) Increased price of production will be shifted to the household through pricing, thereby increasing the price of electricity consumed. This will consequently reduce the amount of electricity demanded by the household. Price will increase from P1 to P2, leading to reduction of quantity demanded from Q1 to Q2 P P p2 p1 q2 q1 Q The high price of electricity after subsequent increase in the cost of production will reduce the quantity supplied at a given price. However, the supply may increase with an increase in cost of production if it is possible to the burden of tax the consumer through pricing. Price of electricity P supply curve p2 p1 q1 q2 Q This strategy of fixed price on carbon emission increases the overall price of energy (electricity), hence having a negative impact on other producing firms. The burden will be unevenly distributed, with the household carrying the highest burden of the increased cost of production. Relative prices of products manufactured using coal electricity will increase, leading to consumption of alternative products with lower costs of production owing to their low costs. Conversely, industries will shift to alternative sources of energy, such as solar energy, which are costly to implement. This will lead to reduced national supply of goods, thereby reduced G.D.P. Question 2 The fixed price of carbon emission imposed by the Australian Government is an example of pigovian tax. Pigovian taxes are those levies that are structured to internalize negative externalities. The government has dictated that carbon emitting firms should pay a fixed charge of approximately $24/tonne. Higher pigovian tax will has higher impact on the prices of electricity and helps in reducing pollution arising from carbon emission. The fixed price of emission is also a mean of earning government revenue and encourages electricity producers to adopt cleaner methods of generating electricity. However, the Australian fixed price on carbon emission is relatively higher compared to other floating price schemes operating elsewhere, such as in the European Union (the EU ETS), which makes the charge detrimental. The fixed price charge on carbon emitted (pigovian tax) is unevenly distributed, and much of the burden is borne by the household (consumer) rather than the suppliers. The ability to transfer the tax burden is dependent on the price elasticity of demand, and the price elasticity of demand Incidence of the tax falls on the group with inelastic price elasticity of demand since they respond less to any price change (Helfand et al 2003). In Australia, the household has an inelastic price elasticity of demand, and the demand curve is more elastic than the supply curve; hence the burden of the increased costs of production is passed on to the consumer. Since electricity producer can pass most of the burden to the consumer, he can continue supplying exact quantity of electricity since the burden of the tax is lesser. Price of electricity Inelastic PED curve Quantity demanded Consumers PED However, if the household has an elastic price elasticity of demand, it would respond more to slight changes in the prices of electricity. This would make it impossible to shift the burden of the imposed tax on the consumers since they would adopt alternative sources of fuel. Price of electricity P Elastic PED curve Quantity demanded Consumers PED Question 3 Demand for electricity The price of externalities has a direct impact on costs of production of different commodities, with higher price leading to higher costs. Higher cost of production leads to high prices of goods as producers shift the burden of the price of externality to the consumers, leading to reduced demand. As such, the set price of carbon emission has increased the cost of generating electricity in Australia, which has led to lower demand for electricity generated from coal. If the price of carbon emission is halved, the cost of production will be reduced, hence reducing the price of electricity. This increases the demand for electricity. The price of electricity to consumers Consumers of electricity in Australia have an inelastic price elasticity of demand; hence the suppliers shift much of the tax burden to consumers through pricing. High price of carbon emission translates to higher price of electricity and vice-versa. As such reduction in the fixed price of carbon emission will reduce the price of electricity to consumers. • Government revenue The Australian Government generates much of its revenue through selling permits/units, which translates to higher revenue since Australia highly relies on electricity generated from coal. Reducing the price of carbon emission will reduce the revenue generated by the Government. Question 4 If the electricity producers opt for renewable energy sources, government revenues from the perspective of the fixed price scheme will reduce. This ensures lesser carbon emissions to the environment and the Government will not benefit from the issue of permits to the electricity producing firms. This will result into the net efficiency gain on the society. This results from the use of marginal social benefits (MSB) and marginal social costs (MSC) in determining the price of electricity, as opposed to the use of marginal private costs (MPC) and marginal private benefits (MPB). The revenue for the electricity producing firm will increase, and the government revenue will decrease. Efficiency gain Price MSC=MPC+MEC p Ps MPC = S MEC D = MPB + MSB Qs Qs Quantity Price, P S = MPC = MSC Ps Pc MSB = MPB + MEB MEB MPB = D Qc Qs Question 5 Introduction The introduction of fixed price on carbon emissions will have the tendency of augmenting the production cost. In order for firms to continue making profits, they may slightly increase prices per unit of production so as to accommodate costs that are incurred due to higher production. In Australia, nearly 80% of the electricity consumptions are generated from coal-fired generators. Recent studies indicate that coal generators emit more carbon to the environments as compared to any other kind of electricity generation. The overall effect of introduction of price on emissions will have an effect on the supply, demand, as well as on the government revenue. The emission trading coupled with a fixed price per unit is a component of emission trading scheme. However, the price of the carbon emission is determined by the price of permits that are issued by the government at the end of each year to internalize the externality. In the recent past, the Government issued free permits to the firms and sold them the reminder at a fixed price which is estimated to be $24 per tonne in the last year. The sale of permits leads to the increase of the government revenue which is equivalent to the imposition of tax on production to minimize the effects of pollution on the environment. However, the price per emission of carbon will be determined by demand and supply forces for the permits. On the other hand, the supply of permits is determined by the Government as the issuer while the demand is created by interested parties who include the production firms willing to buy the permits to cater for the pollution as a result of carbon emissions. The overall effect of the introduction of emission tax/ fixed price on carbon emissions will increase the production cost for the electricity by the generating firms (Intergovernmental Panel on Climate Change (IPCC) 2005). The level of carbon emission may also be minimized by the government through regulating the number of permits issued. Under this circumstance, as indicated in the diagram below, the price of carbon emission will be determined by the demand curve. The price of pollution will be determined by the interplay of the demand curve and the quantity of electricity produced by the firm determined by the pollution permits. Price of pollution Supply for pollution rights P Demand for pollution rights Quantity of pollution Q Electricity producing firms through the use of coal-fired generators are some of the manufacturing industries that enormously contribute to carbon emissions. In such a scenario, the social cost is higher than the private cost. Nonetheless, in a free competitive market the social cost will not be put into consideration when determining the price for the electricity. This may have a tendency of bringing about social inefficiency due to overproduction of electricity whose price is determined by the private costs, as opposed to social costs. In the event where the negative externality emanating from carbon emissions is not internalized it may lead into a market failure when determining the price for electricity to be charged at the consumer level. Price of MSC=MPC1=PMC2+MP 1 ton of SC=MPC1 coal po t=MD Qo Q1 In the above diagram, the externality is internalized through the use of taxes on per unit production leading to the emission of carbon into the atmosphere. A tax of $ 24 per tonne of coal produced which is equivalent to the marginal damage caused by the carbon emission shifts the private marginal cost curve from PMC1 to PMC2. This equates to the social marginal cost curve (SMC). This in turn decreases the unit of electricity generated, from Q1 to Q2, which is considered as the socially optimal level of production. However, the price every unit of electricity generated remains fixed. Therefore, the impact of production tax/ fixed price helps to internalize the externality as a result of carbon emission (Convery et al 2007). Conclusion However, for a scheme that permits unlimited units based on international trade, the prices of carbon at domestic level would be equivalent to those at the international level. The global price of carbon will be determined by the forces of demand and supply. This implies that, increasing the carbon price reduces global pollution. References Convery, F., S. McDonnell and Ferreira S. 2007, “The most popular tax in Europe? Lessons from the Irish plastic bags levy”, Environmental and Resource Economics, Vol. 38, No. 1 (September), pp. 1–11. Helfand, G., P. Berck and Maull T. 2003, “The theory of pollution policy”, in K.-G. Mäler and J. R. Vincent (eds.), Handbook of Environmental Economics, Vol. 1, Amsterdam: North Holland Elsevier. Intergovernmental Panel on Climate Change (IPCC) 2005, Carbon dioxide capture and storage, New York: Cambridge University Press. Johnston, A. 2006, “Free allocation of allowances under the EU emissions trading scheme: legal issues”, Climate Policy, Vol. 6, No. 1, pp. 115–36 OECD.2006. The Political Economy of Environmentally Related Taxes, Paris: OECD Read More