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From system to firms

Watch Frank Krysiak explaining the three standard building blocks for capturing firm behaviour used in environmental and energy economics.

In general, many economic models consist of a small number of standard building blocks. These standard building blocks are parts of a model that are well understood and that have been found to be useful in a wide range of settings.

For example in environmental economic models, we tend to focus on describing emissions and environmental policy. As emissions are often caused by firms, the first building block is the most important one for us.

For describing firm behaviour, you can choose among three standard models:

  • The Emission Choice Model (ECM) describes how much a firm emits of a pollutant given an environmental policy. The firm maximises its benefit from emitting, such as gaining profits, minus the costs induced by the regulation, like a tax that has to be paid for emissions.

  • In the Output Abatement Choice Model (OACM), a firm chooses how much it produces and how carefully it produces.

  • The Input Choice Model (ICM) describes how a firm chooses between different inputs when it is subject to an environmental regulation. The typical example is agricultural production, where a firm needs to choose how much labour, how much equipment, and how much fertiliser is to be used in production.

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Exploring Possible Futures: Modeling in Environmental and Energy Economics

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