Relative Prices and Climate Policy: How the Scarcity of Nonmarket Goods Drives Policy Evaluation

Abstract

Climate change not only impacts production and market consumption but also the relative scarcity of nonmarket goods, such as environmental amenities. We study fundamental drivers of the resulting relative price changes, their potential magnitude, and their implications for climate policy in Nordhaus’s Dynamic Integrated Climate-Economy (DICE) model, thereby addressing one of its key criticisms. We propose plausible ranges for these relative prices changes based on best available evidence. Our central calibration reveals that accounting for relative prices is equivalent to decreasing pure time preference by 0.6 percentage points and leads to a more than 50 percent higher social cost of carbon. (JEL D61, H43, Q51, Q54, Q58)