In the days before Pampers, babies wore cloth nappies. Mums would put a pair of elastics over the nappy to keep things dry. Economically speaking, elasticity gave protection against liquidity events. Today, better exploitation of elasticity could help stave off the ultimate liquidity event – the melting of the polar ice caps.

We have emission trading or carbon taxes because we want to make it more expensive for people to do things which emit greenhouse gases. The idea is that if a product or service is more expensive, then you are less likely to buy it. And if it is cheaper, then you are more likely to buy it.[1] So we think: let’s jack up the CO2 price, and we’ll get there.

This overlooks an important feature of economics: price sensitivity.

Some companies are very sensitive to the price of fuel. You increase fuel prices by 20% and power stations start looking for ways of improving their efficiency. But people at the wheel are insensitive to the price of fuel. You hear it said that we would have to increase the price of petrol at the pumps by five or ten times to get the cars off the road.

How you respond to carbon prices depends on what it is that you want to do and who you are. A €50 carbon price is a killer for a coal-fired power plant, but a cake crumb for Mr and Mrs Tesco. Given that time is short, we should be looking urgently for every opportunity to target people with precision, just at the point where it starts to make them wince. That probably means one carbon price for power plants, but a much higher carbon price for Mr and Mrs Tesco.

Each population has a different demand curve. Some have neat, firm ones. Others have fat saggy ones. The sum of all the demand curves is a relatively smooth line. Effective policy would disaggregate the smooth line. Could this lead to arbitragers screwing the system? Unlikely that a pensioner in Aberdeen could persuade anyone that she is a cement plant in Indonesia. She might wear a grey coat and puff herself out a bit; she could perhaps even put on a funny walk. But the accent would give it away.

There is a further point. We tend to see price elasticity as something which is fixed over time. Meaning that people will react to a €50 carbon price today in the same way as they will at some time in the future. I think, however, that price elasticity and the shape of the demand curve can actually be changed, made steeper at the point where the price settles, i.e. you can increase people’s sensitivity to the carbon price. This would make them respond quicker and you would not need to increase petrol prices by ten times. The demand curve is, after all, a function of psychological factors – “willingness” or “readiness” to pay for things. And people’s psychologies are changed everyday by education and the media.

Emissions policy should not just be about finding the right price for carbon. It should also be about changing the shape of the demand curves, so that we simply want it less.

[1] This is patently absurd. Anyone with any self-respect has quite the opposite view on life. If you have a choice between spending £9.99 on a pair of Hush Puppies or £150 on a pair of Grensons, you don’t think twice. But as Marie Antoinette learned, not everyone would agree. Laws are made for the majority.

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1 Response to Elastics

  1. Kingsley says:

    I see another point to stimulating this change that solves the demand issue. Finding a price of carbon leads to innovation, as demand switches to cheaper forms of fuels. We will see many forms of new renewable energy emerge as oil becomes increasingly expensive. Innovation and progression is forced as prices go up. Demand will shift, it will decrease in oil and be devided among the alternative fuels. Your argument is a good one, but one that is naturally resolved through emissions caps.

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