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Economics of Energy Policy

Economics of Energy Policy. Monday, March 20. Sources of inefficiency. Externalities (market failure) Government failure (perverse incentives). Externalities in energy production and consumption. Coal mining Electricity generation Oil extraction and refining Gasoline use in automobiles.

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Economics of Energy Policy

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  1. Economics of Energy Policy Monday, March 20

  2. Sources of inefficiency • Externalities (market failure) • Government failure (perverse incentives)

  3. Externalities in energy production and consumption • Coal mining • Electricity generation • Oil extraction and refining • Gasoline use in automobiles

  4. S=MPC + MSC P* q* External costs of extracting coal $ S=MPC only pm D qm Quantity of coal mined

  5. S=MPC + MSC P* q* External costs of electricity generation from coal $ S=MPC only pm D qm Quantity of electricity from coal-powered generation

  6. Total MC Pe Qe External costs of using oil and its derivatives – e.g. refining oil into gasoline $ S = MPC Pm D Quantity of gasoline Qm

  7. Total MC qe External costs of gasoline use in automobiles $ pm MC D qm Quantity of gasoline used by automobiles

  8. Energy policy objectives • Reduce import dependency ratio so that U.S. is less vulnerable to unstable world markets • Manage domestic prices so that high energy prices do not dampen economic activity • Shift energy use from depletable to renewable sources • Reduce energy demand overall

  9. Supply policy • Open new reserves in the U.S. • Alaskan Wildlife Reserve

  10. Qd At SD: ratio = (Qt – Qd)/Qt At SD2: ratio = (Qt – Qd2)/Qt SD Domestic Supply $ SD2 International Supply SI Pw Domestic Demand Qd2 Qt Quantity of petroleum

  11. Price policy • Strategic oil reserves • Short-term increase in domestic supply • Price controls • Temporary restrictions on prices paid by energy users (this was done in the 1970s)

  12. Price controls (consumers’ price was set) in the 1970s resulted in shortages of gasoline S $ Pm Price control D Qd Qs Qm Quantity of gasoline

  13. Alternative source development • Hydrogen cells • Much of the R&D with federal funding • Wind farms • Clean but loud • Solar power

  14. Alternative approaches to encouraging conservation of gasoline: • Make cars more fuel-efficient • Impact on gasoline use depends upon elasticity of demand for driving • Driving is less costly if cars use less gas to travel any given distance • Make gasoline more expensive • The cost of driving any distance is higher • This may increase the demand for fuel-efficiency, but not for miles driven

  15. Impact on use of gasoline in cars depends upon the elasticity of demand for driving. MC ‘ D’ Changes in fuel efficiency standards so cars use less gasoline: $ MC pm D qm Miles of driving

  16. How do we choose from among alternative energy sources? $ MCcoal MCwind D Qc Qw Energy BTUs

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