A Third Wave in the Economics of Climate Change

J. Doyne Farmer; Cameron Hepburn; Penny Mealy; Alexander Teytelboym

doi:10.1007/s10640-015-9965-2

Environmental and Resource Economics

October 2015, Volume 62, Issue 2, pp 329–357

A Third Wave in the Economics of Climate Change

Authors
Authors and affiliations

J. Doyne Farmer
Cameron HepburnEmail author
Penny Mealy
Alexander Teytelboym

Article

First Online:: 01 October 2015

Accepted:: 21 August 2015

DOI: 10.1007/s10640-015-9965-2

Cite this article as:: Farmer, J.D., Hepburn, C., Mealy, P. et al. Environ Resource Econ (2015) 62: 329. doi:10.1007/s10640-015-9965-2

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Abstract

Modelling the economics of climate change is daunting. Many existing methodologies from social and physical sciences need to be deployed, and new modelling techniques and ideas still need to be developed. Existing bread-and-butter micro- and macroeconomic tools, such as the expected utility framework, market equilibrium concepts and representative agent assumptions, are far from adequate. Four key issues—along with several others—remain inadequately addressed by economic models of climate change, namely: (1) uncertainty, (2) aggregation, heterogeneity and distributional implications (3) technological change, and most of all, (4) realistic damage functions for the economic impact of the physical consequences of climate change. This paper assesses the main shortcomings of two generations of climate-energy-economic models and proposes that a new wave of models need to be developed to tackle these four challenges. This paper then examines two potential candidate approaches—dynamic stochastic general equilibrium (DSGE) models and agent-based models (ABM). The successful use of agent-based models in other areas, such as in modelling the financial system, housing markets and technological progress suggests its potential applicability to better modelling the economics of climate change.

Keywords

Climate changeIntegrated assessment modelsAgent based modelsDSGE modelsUncertaintyTechnological innovationHeterogeneityDamage function

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J. Doyne Farmer
- 1
- 2
- 3
Cameron Hepburn
- 1
- 4
- 5
Email author
Penny Mealy
- 1
- 4
Alexander Teytelboym
- 1
- 4

1.Institute for New Economic Thinking at the Oxford Martin SchoolUniversity of OxfordOxfordUK
2.Santa Fe InstituteSanta FeUSA
3.Mathematical InstituteUniversity of OxfordOxfordUK
4.Smith School of Enterprise and the EnvironmentUniversity of OxfordOxfordUK
5.Grantham Research InstituteLondon School of Economics and Political ScienceLondonUK

A Third Wave in the Economics of Climate Change

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