and imported varieties. The assumption of product differentiation permit the model to match
bilateral trade with cross-hauling of trade and avoids unrealistically strong specialization
effects in response to exogenous changes in trade (tax) policy. Bilateral trade flows are
subject to export taxes, tariffs and transportation costs and calibrated to the base year 1995.
Carbon abatement
GHGs and related gases have direct radiative forcing effects in the atmosphere. The
various gases result from industrial production, fossil fuel consumption and household
activities. The Kyoto Protocol includes carbon dioxide (CO2), methane (CH4), nitrous oxide
(N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulphur hexafluoride (SF6)
as gases subject to control. We do not consider the abatement of a complete basket of GHG
emissions from all energy-related sources as in the Kyoto Protocol but focus on carbon
dioxide abatement from fossil fuel consumption given that it constitutes the bulk of the
contribution to global warming. Carbon emissions are associated with fossil fuel consumption
in production, investment, government and private demand. Carbon is treated as a Leontief
(fixed coefficient) input into production and consumption activities. Each unit of a fuel emits
a known amount of carbon where different fuels have different carbon intensities. The applied
carbon coefficients, which are assumed to be constant across regions, are 25 MT carbon per
EJ for coal, 14 MT carbon per EJ for gas and 20 MT carbon per EJ for refined oil.
Carbon policies are introduced via an additional constraint that holds carbon
emissions to a specified limit. The solution of the model gives a shadow value on carbon
associated with this carbon constraint. This dual variable or shadow price can be interpreted
as the price of carbon permits in a carbon permit system or as the CO2 tax that would induce
the carbon constraint in the model. The shadow value of the carbon constraint equals the
marginal cost of reduction. It indicates the incremental cost of reducing carbon at the carbon
constraint. The total costs represent the resource cost or dead-weight loss to the economy of
imposing carbon constraints. Carbon emission constraints induce substitution of fossil fuels
with less expensive energy sources (inter-fuel fuel switching), fuel-non-fuel substitution or
employment of less expensive manufacturing and production techniques (energy savings). On
the consumption side, higher energy prices imply a change in the consumption mix which
results in a loss of welfare (consumer surplus). The only means of abatement are hence inter-
fuel and fuel-non-fuel substitution and a reduction of intermediate and final consumption.
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