Reference no: EM131968335

Assignment -

In Paris in April of 2016, a 196 countries agreed to dramatically reduce greenhouse gas emissions to curb the negative impacts of climate change. Specifically, participating countries agreed to 80% reductions in annual greenhouse gas emissions of 2005 levels by 2050. Since adhering to the goals of the Paris Agreement is voluntary, countries may do nothing if the mitigation costs to reduce those emissions are extraordinarily high. On the other hand, countries may exceed the Paris Agreement goals and attempt to completely eliminate greenhouse gas emissions by 2050. As a decision tree expert, you have been hired to analyze the economics of this global decision making process over the 2018-2050 time period.

To help with the analysis, you recently conducted a survey with 100 renowned climate scientists and binned their responses by the temperature rise the planet might see by 2050 when compared to the temperature in 1900 under three different scenarios: do nothing, meet Paris goals, no GHG emissions. Note that the planet's temperature in 2018 has already risen by 1.5^oC since 1900.

The mitigation cost for 'do nothing' is zero but the mitigation cost for meeting the Paris goals is approximately $1 trillion each year and that of eliminating GHG emissions altogether is approximately $2 trillion each year. Mitigation costs are defined here as costs borne by the global economy from switching from fossil fuel sources (e.g., coal, petroleum) to more renewable and sustainable sources (e.g., solar, wind, biofuels). Rising temperatures are expected to lead to large environmental costs. The annual environmental cost (D) of a rising temperature (T in ^oC) as a fraction of the global GDP can be modeled using the following equation:

D = 1 - (1/1+(T/18.8)²) - (1)

Environmental costs are defined here as costs linked to adverse effects such as rising sea levels, changes in precipitation, poor air quality, and more frequent extreme weather events. For equation (1), a 1.5 ^oC increase in temperature in 2018 over 1900 will result in a 0.63% decrease in annual GDP and an environmental cost of $0.63 trillion if the global GDP is a $100 trillion in 2018.

To model the global GDP between 2018 and 2050, assume the global GDP to be $100 trillion in 2018 and assume that this GDP grows by 2% every year. To model the temperature rise in a given year, assume that the temperature rise linearly changes between 2018 and 2050. Assume a discount rate of 3%.

(a) Build a spreadsheet model to calculate present values for the mitigation and environmental costs and draw a decision tree that shows the decision choices, chance nodes, and cost outcomes.

(b) What are the expected costs for the three different options: do nothing, meet Paris goals, and no GHG emissions? What would you recommend we do as a planet based on using an expected value framework?

(c) If the planet's risk tolerance is about $2 trillion, how does our recommendation change with the use of an expected utility framework?