General equilibrium, electricity generation technologies and the cost of carbon abatement: A structural sensitivity analysis

Electricity generation is a major contributor to carbon dioxide emissions, and abatement in this sector is a key determinant of economy-wide regulation costs. The complexity of an integrated representation of economic and electricity systems makes simplifying assumptions appealing, but there is no evidence in the literature on how important the pitfalls may be. The aim of this paper is to provide such evidence, drawing on numerical simulations from a suite of partial and general equilibrium models that share common technological features and are calibrated to the same benchmark data. We report two basic findings. First, general equilibrium inter-sectoral effects of an economy-wide carbon policy are large. It follows that assessing abatement potentials and price changes in the electricity sector with a partial equilibrium Marshallian demand can only provide a crude approximation of the complex demand-side interactions. Second, we provide evidence that widely used top-down representations of electricity technologies produce fuel substitution patterns that are inconsistent with bottom-up cost data. This supports the view that the parametrization of substitution possibilities with highly aggregated production functions is difficult to validate empirically. The overall picture that emerges is one of large quantitative and even qualitative differences, highlighting the role of key structural assumptions in the interpretation of climate policy projections.

► We integrate a bottom-up electricity model into a top-down economy-wide model for the U.S. ► We quantify the importance of structural assumptions for carbon policy assessment. ► A partial equilibrium framework overlooks significant economy-wide demand effects. ► Top-down electricity models fail to capture bottom-up fuel substitution patterns.