Interactions Between Climate Policies in the Power Sector - Green Energy and Efficiency: An Economic Perspective - page 277

ciency. 15 Alternatively, a Pigouvian
subsidy on avoided carbon emissions could have equivalent effects: by subsidising
emission reductions (from a pre-speci

the emissions externality and thus restoring ef

ed benchmark), the global optimal might
also be restored. 16 Both instruments, under certain circumstances, lead to the same
outcome.
In principle, a carbon price through the setting of a system of tradable

17

“ black ”

(CO 2 ) quotas such as the EU ETS or through carbon taxes should be suf cient to

abate emissions and restore optimality. A carbon price provides a price signal to

rms which is incorporated into their production and investment decisions and
allows them to adopt the most ef cient decision on how and by how much to reduce

their carbon emissions.
In the absence of any policy, the electricity mix would be such that the marginal
costs of the fossil-fuelled generation and the non-emitting sector are equal, i.e.
c 0 2 ðq 2 Þc 0 1 ðq 1 Þ¼

0.
In our simple model, the existence of a carbon market (and no renewable sub-
sidies) would be equivalent to setting r = 0 (and R = 0). Producing one more unit of
electricity through fossil-fuelled technologies would imply incurring the production
costs and the emissions costs. This would increase the demand for carbon permits
which would cause an increase in the emissions price. Therefore, the marginal cost
of producing one more unit of electricity through fossil-fuelled technologies would
be higher than in the absence of a carbon price. This would promote non-emitting
generation.
Under this scenario, the electricity mix would be such that marginal costs of both
technologies are equalised, i.e. c 0 2 ðq 2 Þc 0 1 ðq 1 Þp e f 0 ðq 1 Þp 0 e f 0 ðq 1 Þ 0. Now, the

marginal cost of the fossil-fuelled technology would be higher (since it would
internalise the emission costs). A carbon market would therefore be suf cient to

restore optimality.
Thus, a carbon market would suf

ce in principle to solve the emissions exter-
nality. Setting an optimal price for carbon would provide economic agents covered
by the carbon market with a signal to reduce their emissions. Such a signal could
trigger investments in renewable energies. The decision to invest in renewable
energy will be driven by the relative cost of producing non-emitting energy versus
the cost of producing fossil-fuelled energy once the emissions externality has been
internalised. A carbon market does not necessarily entails the development of a
renewables sector since economic agents might decide to reduce their emissions
through clean investments in other sectors where the abatement costs might be
lower.

15 For a discussion of the role and determination of the carbon price see Bowen [ 7 ]. In the US,
there is no carbon price so the internalisation of GHG emission costs corresponds to renewables
support mechanisms. See Joskow [ 18 ].
16 Note however that such a subsidy would not justify different subsidies to different non-emitting
technologies.
17 B ö hringer and Rosendahl [ 5 ].