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Is the price right?

This article was written by Dave Heatley, Principal Advisor, Productivity Commission.

Prices affect firm decisions. Government policy affects prices, and in doing so indirectly affects those decisions.

My previous post explored the role of policy in changing the prices faced by firms when they are choosing the mix of inputs to most profitably produce goods and services. Governments affect the prices that firms pay for their inputs in a multitude of ways. Sometimes this impact on prices is deliberate, sometimes it occurs by omission, and sometimes it’s the unplanned outcome of other choices.

One example of prices being affected by omission can be seen in climate change policy. Prices for things in demand should reflect their scarcity. If something is in hot demand but there’s little of it around, it’s usually expensive. If it’s abundant, it will be cheaper.

We now know that the capacity of the Earth’s atmosphere to absorb greenhouse gases is a scarce resource, yet the use of the atmosphere to get rid of gases as a by-product of production processes is virtually free in some countries and significantly under-priced in others. In other words, firms (and the consumers of their products) are not paying enough for their use of the atmosphere.

An emissions trading scheme (ETS) creates a market for emissions. The resulting price is what emitters pay for each unit of gas they release into the atmosphere.

The price reflects the costs arising from the contribution of emissions to global warming. New Zealand has an ETS but it has not worked very well to date. Some emissions and some emitters are not exposed to prices under the scheme, and it was possible to buy international credits of questionable quality to offset NZ emissions. The Productivity Commission recommended reforms to the NZ ETS in its report into how New Zealand can transition to a low-emissions economy.

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