Economics and Climate Applications: Exploring the Frontier

1. Economics and Climate Applications: Exploring the Frontier Debra J. Rubas Harvey S.J. Hill James W. Mjelde

2. Economics is about choice

3. Modeling Decision Making • Decision Theory • General Equilibrium Modeling • Game Theory • Mechanism Design

4. Decision Theory • One decision maker • At least one decision • Fixed rules • Decisions of others are fixed

5. Decision Theory in Climate Applications I • Decision maker makes choices to maximizes an objective (generally profit) • Without a forecast, decision maker uses prior knowledge of climate conditions to make decisions • Climate occurs and payoff is received

6. Decision Theory in Climate Applications II • With a forecast, decision maker uses the forecast to make decisions • Climate occurs and payoff is received • The value of the forecast is the difference between the payoff with a forecast and the payoff without a forecast

7. Decision Theory Examples I • Decision theory used most of four approaches • Most studies assume away price effects (o.k. if one decision maker but inappropriate if many decision makers) • Most give a dollar value for climate forecasts

8. Decision Theory Examples II • Meza and Wilks - $5 - 22 / ha for potato farmers in U.S. • Jones et al. – $13 / ha for maize producers in Tifton, Georgia and $15 /ha for maize producers in Pergamino, Argentina • Hamlet et al. - $153 million revenue increase for hydroelectric dam management

9. Game Theory • At least two decision makers • At least one decision • Fixed rules • Decisions of others are not fixed

10. Game Theory in Climate Applications • Decision maker makes choice to maximize objective given what he knows about other players’ objectives • Forecast value is the difference between the payoff when using the forecast and not using the forecast (as in decision theory)

11. Game Theory Example • Players: Australia, U.S., and Canada • Decision: Use climate forecast or not in planting wheat • Result: All countries use climate forecasts Mean Percentage Changes in Producer Surplus Over 20 Years for 1000 Simulations

12. General Equilibrium Modeling • All decision makers • All decisions • Fixed rules • Decisions of others are not fixed

13. General Equilibrium Modeling in Climate Applications • True general equilibrium modeling has not been used due to huge informational requirements • Would have every decision maker maximize an objective containing all possible decisions given the objectives of all other decision makers • Value of climate forecast would be determined as before

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

15. Partial Equilibrium Examples II • Chen and McCarl and Chen, McCarl, and Adams – societal welfare increases due to increases in consumer surplus; producer surplus decreases • Adams et al. (2001) – US $10 million annually for Mexican agriculture • Hill et al. (2004) producer surplus and consumer surplus increase worldwide

16. Mechanism Design • All decision makers plus a “principle” • At least one decision • Rules not fixed—chosen by principle • Decisions of others are not fixed

17. Mechanism Design in Climate Applications • Mechanism design theory has not been used to our knowledge • “Principle” could choose best set of rules to maximize value of forecast use • Decision makers make choices as before but now they also include rules set by the “principle” in the objective they are maximizing • Value of forecast determined as before

18. Tradeoffs Game Theory Decision Theory Mechanism Design General Equilibrium Modeling

19. Publishing Trends I • ISI Web of Knowledge Search • “Climate” and “Forecast” • “Climate,” and “Forecast” and “Value” • Shows applications • Disciplines where published

20. Publishing Trends II Number of Published Articles Using ISI Web of Knowledge Search Engine for Searches of “Climate and Forecasts” and “Climate and Forecasts and Value”

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

22. Reasons Climate Forecasts Seen as Applied Issue in Social Sciences • Lag between advance in one discipline and use in other disciplines • Funding originates from sources that do not typically fund social science research • Lack of communication between the disciplines

23. Resource/Environmental Economics • Pollution Trading • Natural Disaster Mitigation • Climate Change

24. Seasonal Forecast Use • Technology Adoption • Educational Applications • Integrated Research

25. Conclusions • Traditionally, climate forecast applications have involved decision theory and have been published in non-social science journals • There are many exciting opportunities for studies using climate applications to contribute to the economics of information, especially using game theory and mechanism design • This would increase our ability to accurately value climate forecasts in different settings and would contribute to economic theory