This chapter addresses the methodological issues that arise in the estimation of the monetary costs of climate change. The focus here is on the correct assessment of the costs of mitigation measures to reduce the emissions of greenhouse gases (GHGs). The other two areas in which cost issues arise are the estimation of the climate change impacts in monetary terms, and the assessment of measures to adapt to climate change. Working Group II (WGII) is charged with the responsibility to evaluate the impacts and adaptation measures. It is important, though, that much of the discussion in this chapter is relevant to these areas. The basic principles of cost estimation certainly apply in all three areas. Moreover, some of the key issues in cost estimation that arise in the assessment of impacts are also relevant to the estimation of the costs of mitigation. Hence, the relationship between the costs discussed by WGII and those discussed by WGIII is close.

The chapter begins by providing the background to this assessment report; by giving a summary of the Second Assessment Report (SAR) and of the developments in the literature since SAR (IPCC, 1996a, 1996b). Section 7.2 discusses the elements in any climate change cost estimation. It begins by setting out the decision-making framework for mitigation decisions. Unfortunately, this framework is complex, as it involves the application of different modelling techniques and assumptions. Important within the framework are issues of ancillary and co-benefits of climate change mitigation, evaluation techniques, the treatment of barrier removal and implementation costs, discounting, and the linkages between adaptation and mitigation. The conventional cost-effectiveness and the cost–benefit tools used for making decisions to reduce GHGs, or to select adaptation measures, provide only part of the information required by the decision maker. The extensions that are currently being discussed, and used in some cases, include the valuation of external effects, and considerations of equity and sustainability. The outline of the extended decision-making framework and its relationship to the cost methodology is discussed in Sections 7.2.1 to 7.2.5.

Section 7.3 discusses the critical assumptions made in the application of the methodology to climate change problems. The key issues are:

• different systems in which the cost analysis is carried out–project sector and macro level;
  
• determination of baselines;
  
• treatment of technological change;
  
• assessment of cost implications of including alternative GHG emission reduction options and carbon sinks; and
  
• treatment of uncertainty.

Section 7.4 covers the practical problems that arise in cost estimation, particularly relating to the linkages between the “micro” cost exercise and the broader “macro” picture. The problems covered are:

• relationship to objectives of development, equity, and sustainability (DES);
  
• income and other macroeconomic effects of mitigation and adaptation policies;
  
• issues of spillovers;
  
• treatment of equity; and
  
• treatment of future costs and sustainability issues.

Section 7.5 considers the special issues that arise in the estimation of costs in developing countries and economies in transition (EITs).

Section 7.6 discusses the relationship between the cost assessment methodology and the models used to estimate mitigation costs. Issues discussed include classification of models (Section 7.6.2), top-down and bottom-up models (Section 7.6.3) integrated assessment models (IAMs; Section 7.6.4), categorization of climate change mitigation options (Section 7.6.5), and critical assumptions (Section 7.6.6).

The links between this chapter with others is as follows. Section 7.1 overlaps with Chapter 10, Section 7.2 with Chapter 6, and Section 7.6 with Chapters 8 and 9.

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