Economics and Climate Economics and Climate Applications: Exploring the Applications: Exploring the

FrontierFrontier

Debra J. RubasDebra J. Rubas

Harvey S.J. HillHarvey S.J. Hill

James W. MjeldeJames W. Mjelde

Economics is about choiceEconomics is about choice

Modeling Decision MakingModeling Decision Making

Decision TheoryDecision Theory

General Equilibrium ModelingGeneral Equilibrium Modeling

Game TheoryGame Theory

Mechanism DesignMechanism Design

Decision TheoryDecision Theory

One decision makerOne decision maker

At least one decisionAt least one decision

Fixed rulesFixed rules

Decisions of others are fixedDecisions of others are fixed

Decision Theory in Climate Decision Theory in Climate Applications IApplications I

Decision maker makes choices to Decision maker makes choices to maximizes an objective (generally profit)maximizes an objective (generally profit)

Without a forecast, decision maker uses Without a forecast, decision maker uses prior knowledge of climate conditions to prior knowledge of climate conditions to make decisionsmake decisions

Climate occurs and payoff is receivedClimate occurs and payoff is received

Decision Theory in Climate Decision Theory in Climate Applications IIApplications II

With a forecast, decision maker uses the With a forecast, decision maker uses the forecast to make decisions forecast to make decisions

Climate occurs and payoff is receivedClimate occurs and payoff is received

The value of the forecast is the difference The value of the forecast is the difference between the payoff with a forecast and the between the payoff with a forecast and the payoff without a forecastpayoff without a forecast

Decision Theory Examples IDecision Theory Examples I

Decision theory used most of four Decision theory used most of four approachesapproaches

Most studies assume away price effects Most studies assume away price effects (o.k. if one decision maker but (o.k. if one decision maker but inappropriate if many decision makers)inappropriate if many decision makers)

Most give a dollar value for climate Most give a dollar value for climate forecastsforecasts

Decision Theory Examples IIDecision Theory Examples II

Meza and Wilks - $5 Meza and Wilks - $5 - 22 / ha for potato - 22 / ha for potato farmers in U.S.farmers in U.S.

Jones Jones et al.et al. – $13 / ha for maize producers – $13 / ha for maize producers in Tifton, Georgia and $15 /ha for maize in Tifton, Georgia and $15 /ha for maize producers in producers in Pergamino, Pergamino, ArgentinaArgentina

Hamlet Hamlet et al.et al. - $153 million revenue - $153 million revenue increase for hydroelectric dam increase for hydroelectric dam managementmanagement

Game TheoryGame Theory

At least two decision makersAt least two decision makers

At least one decisionAt least one decision

Fixed rulesFixed rules

Decisions of others are not fixedDecisions of others are not fixed

Game Theory in Climate Game Theory in Climate ApplicationsApplications

Decision maker makes choice to maximize Decision maker makes choice to maximize objective given what he knows about other objective given what he knows about other players’ objectivesplayers’ objectives

Forecast value is the difference between Forecast value is the difference between the payoff when using the forecast and not the payoff when using the forecast and not using the forecast (as in decision theory)using the forecast (as in decision theory)

Game Theory ExampleGame Theory Example

Australia Adopts Canada Adopts U.S. Adopts

Aus Can U.S. Aus Can U.S. Aus Can U.S.

Mean % 6.29 -0.15 0.06 0.06 0.59 -0.28 1.01 1.32 2.83

Std. Dev. 8.39 1.64 1.47 10.00 10.02 10.24 5.14 5.53 2.00

Canada & Australia Adopt U.S. & Australia Adopt U.S. & Canada Adopt

Aus Can U.S. Aus Can U.S. Aus Can U.S.

Mean % 6.56 0.52 -0.34 7.19 1.20 2.76 1.13 1.37 2.29

Std. Dev. 13.65 10.28 10.27 9.85 5.93 2.53 11.52 11.36 10.61

U.S., Canada, & Australia Adopt

Aus Can U.S.

Mean % 7.53 1.33 2.22

Std. Dev. 14.80 11.66 10.66

Players:Players: Australia, U.S., and Canada Australia, U.S., and Canada

Decision:Decision: Use climate forecast or not in planting wheat Use climate forecast or not in planting wheat

Result:Result: All countries use climate forecasts All countries use climate forecasts

Mean Percentage Changes in Producer Surplus Over 20 Years for 1000 Simulations

General Equilibrium ModelingGeneral Equilibrium Modeling

All decision makersAll decision makers

All decisionsAll decisions

Fixed rulesFixed rules

Decisions of others are not fixedDecisions of others are not fixed

General Equilibrium Modeling in General Equilibrium Modeling in Climate ApplicationsClimate Applications

True general equilibrium modeling has not True general equilibrium modeling has not been used due to huge informational been used due to huge informational requirementsrequirementsWould have every decision maker Would have every decision maker maximize an objective containing all maximize an objective containing all possible decisions given the objectives of possible decisions given the objectives of all other decision makersall other decision makersValue of climate forecast would be Value of climate forecast would be determined as beforedetermined as before

Partial Equilibrium Examples IPartial Equilibrium Examples I

Though general equilibrium modeling has Though general equilibrium modeling has not been attempted, there have been not been attempted, there have been attempts at partial equilibrium modeling attempts at partial equilibrium modeling (limited players and or limited decisions)(limited players and or limited decisions)All studies we found show use of climate All studies we found show use of climate forecasts to improve overall welfare, forecasts to improve overall welfare, though some show consumers to benefit though some show consumers to benefit at the expense of producers, and some at the expense of producers, and some show both to benefit.show both to benefit.

Partial Equilibrium Examples IIPartial Equilibrium Examples II

Chen and McCarl and Chen, McCarl, and Chen and McCarl and Chen, McCarl, and Adams – societal welfare increases due to Adams – societal welfare increases due to increases in consumer surplus; producer increases in consumer surplus; producer surplus decreasessurplus decreases

Adams Adams et alet al. (2001) – US $10 million . (2001) – US $10 million annually for Mexican agricultureannually for Mexican agriculture

Hill Hill et al.et al. (2004) producer surplus and (2004) producer surplus and consumer surplus increase worldwideconsumer surplus increase worldwide

Mechanism DesignMechanism Design

All decision makers plus a “principle”All decision makers plus a “principle”

At least one decisionAt least one decision

Rules not fixed—chosen by principleRules not fixed—chosen by principle

Decisions of others are not fixedDecisions of others are not fixed

Mechanism Design in Climate Mechanism Design in Climate ApplicationsApplications

Mechanism design theory has not been Mechanism design theory has not been used to our knowledgeused to our knowledge““Principle” could choose best set of rules Principle” could choose best set of rules to maximize value of forecast useto maximize value of forecast useDecision makers make choices as before Decision makers make choices as before but now they also include rules set by the but now they also include rules set by the “principle” in the objective they are “principle” in the objective they are maximizing maximizing Value of forecast determined as beforeValue of forecast determined as before

TradeoffsTradeoffs

Decision Theory

General Equilibrium Modeling

Game Theory

Mechanism Design

Publishing Trends IPublishing Trends I

ISI Web of Knowledge SearchISI Web of Knowledge Search

““Climate” and “Forecast”Climate” and “Forecast”

““Climate,” and “Forecast” and “Value”Climate,” and “Forecast” and “Value” Shows applicationsShows applications

Disciplines where publishedDisciplines where published

Publishing Trends IIPublishing Trends II

0 0 0 0 0 0 2 25

2 3 52 3 5

1013 12

1518

2 1 2 1 16

28

21 2327

5249 50

62

52

8084

108

123

97

0

20

40

60

80

100

120

140

1985 1988 1991 1994 1997 2000 2003Year

Nu

mb

er

Climate and Forecast and Value

Climate and Forecast

Number of Published Articles Using ISI Web of Knowledge Search Engine for Searches of “Climate and Forecasts” and “Climate and Forecasts and Value”

Publishing Trends IIIPublishing Trends III

0

10

20

30

40

50

60

70

80

90

Subject Matter Category

Pe

rce

nta

ge 1985-1990

1990-1994

1995-1999

2000-2004

Percentage of Published Articles by Journal Subject Matter Type Using ISI Web of Knowledge Search Engine for Search of “Climate and Forecasts”

Reasons Climate Forecasts Seen Reasons Climate Forecasts Seen as Applied Issue in Social Sciencesas Applied Issue in Social Sciences

Lag between advance in one discipline Lag between advance in one discipline and use in other disciplinesand use in other disciplines

Funding originates from sources that do Funding originates from sources that do not typically fund social science researchnot typically fund social science research

Lack of communication between the Lack of communication between the disciplinesdisciplines

Resource/Environmental Resource/Environmental EconomicsEconomics

Pollution TradingPollution Trading

Natural Disaster MitigationNatural Disaster Mitigation

Climate ChangeClimate Change

Seasonal Forecast UseSeasonal Forecast Use

Technology AdoptionTechnology Adoption

Educational ApplicationsEducational Applications

Integrated ResearchIntegrated Research

ConclusionsConclusions

Traditionally, climate forecast applications have Traditionally, climate forecast applications have involved decision theory and have been involved decision theory and have been published in non-social science journalspublished in non-social science journals

There are many exciting opportunities for studies There are many exciting opportunities for studies using climate applications to contribute to the using climate applications to contribute to the economics of information, especially using game economics of information, especially using game theory and mechanism designtheory and mechanism design

This would increase our ability to accurately This would increase our ability to accurately value climate forecasts in different settings and value climate forecasts in different settings and would contribute to economic theorywould contribute to economic theory