5. Concluding remarks and policy implication
This paper investigates the effect of possible climate tipping events on optimal carbon taxation and energy pricing, taking into account the strategic behavior of energy consumers/producers and the uncertainty of climate tipping points through a stochastic dynamic game. The tipping probability is increasing with the rise in temperature, which can be affected by both players’ decisions (indirectly through the CO2 concentration). The consumers’ government chooses the optimal carbon taxation to maximize the social welfare with taking into account the externality of the climate change and the producers’ cartel chooses its optimal energy pricing strategy to maximize its profits. Due to the difficulties of finding the equilibrium analytically, this paper uses numerical methods to solve the model and thus to examine the effect of different factors on the outcomes of the game, from which some interesting findings and policy implications can be obtained as follows. Since the occurrence of the tipping events is stochastic, the optimal strategies of players need to take into account the potential effect of a tipping event through the players’ expected payoffs. Under the threat of possible tipping events, the carbon tax from the consumers’ government will be increasing over time while the producer (energy) price set by the producer's cartel will be decreasing over time, both at a diminishing rate. The increases in the carbon tax outweigh the decreases in the producer price, which results in the increasing consumer price over time. Once a tipping event occurs, the carbon tax will be shifted upwards significantly and stay in the new trajectory. Meanwhile, the occurrence of a tipping event will leads to a downward shift in the cartel's producer price. The overall effect of the shift in the carbon tax and that in the producer price would be a shift upward in the consumer price.
