energy

oil and natural gas  supply 62% all energy consumed worldwide  how to transition to new sources?  use until mc of further use exceeds mc of substitute resources More abundant coal Or renewable solar  transition should be smooth  have allocations been efficient?

natural gas  huge shortages on why? rise of automobile rise of demand for gasoline search for new sources of crude oil uncovered large quantities of natural gas  in the 50’s gov’t put price ceilings

the effect of price controls

 price ceiling reduces MUC (higher future prices no longer possible), decreasing total mc curve (supply)  consumers better off today (gained BC)  producers not better off: Overproducing giving up scarcity rent could have gotten without price controls (area D only measures current profit)

the effect of price controls

consumers also lose in the future  as resource depleted, supply curve shifts up (reflecting higher extraction costs)  when mc reaches price ceiling, QS=0  but demand is not zero at that price: shortages  suppliers willing, demanders willing, but price control will not allow  overallocation to current consumers, underallocation to future consumers  losses to future consumers/producers are greater than gains to current consumers

oil  similar price control problems  second source of misallocation: OPEC  restrict supply, raise prices  why OPEC so effective? 1. price elasticity of demand for oil inelastic, substitutes exist but are expensive 2. income elasticity of demand for oil income grows, demand grows 3. supply responsiveness of non-OPEC members OPEC produces 2/3; only Mexico may have influence

oil: national security problem  excessive dependence on imports national security issue dependent on countries with unstable political history actual price we pay is higher than world price  when national security is an issue market consumes too much oil domestic production is too small

the national security problem vulnerability premium

market vs. efficient allocations  vulnerability premium reflects additional national security costs caused by imports  horizontal because each individual supplier has no effect on world price  market allocation demand Q5 Q1 domestically produced Q5-Q1 imported  efficient allocation demand Q4 Q2 domestically produced Q4-Q2 imported

the national security problem vulnerability premium

what would happen during an embargo?  consume Q1 at price of P2  supply curve assumes enough time to develop the resources  if embargo hits, not enough time – in short run supply curve becomes perfectly inelastic at Q1  price rises to P2 to equate supply & demand  huge loss in CS

the national security problem vulnerability premium

self sufficiency?  domestic supply = domestic demand  net benefits from Q3 < net benefits from Q4 (efficient allocation w/imports)  Efficiency loss (shaded triangle): because foreign mc is lower than domestic mc (supply) loss between Q2 and Q4 (where domestic mc > foreign mc)

still better to import  vulnerability premium lower than cost of self sufficiency embargos not certain events possible to reduce vulnerability (strategic reserves) using more domestically incurs user costs by lowering amounts available for future  paying vulnerability premium creates more efficient balance btw present/future

the national security problem vulnerability premium

how to achieve efficient consumption (Q4 instead of Q5)?  energy conservation, e.g. gas tax reduces consumption, but no affect on share of imports  subsidize domestic supply reduce imports, but not consumption  tariff on imports (P1-P0) or quota on imports (Q4-Q2) price rises to P1, consumption falls to Q4, imports Q4-Q2

transition fuels  how to transition to renewables?  fuels receiving most attention: coal, uranium coal: abundant uranium: not abundant with current reactors  technology is changing this  biggest issue btw these: environmental impact

transition fuels: environmental problems  coal: air pollution (sulfur, particulates, CO2)  uranium: nuclear accidents storage of radioactive waste

energy conservation  significant role: defer capacity expansion  cost increases are substantial  by reducing demand for electricity, delay new plants, delay rate increases  current pricing systems rely on AC pricing, lower than true MC of new units

utilities invest in conservation when cheaper  rebates for conservation measures in homes  incentives for solar water heaters  energy audits

load management  peak period imposes 2 costs on utilities requires firing up special generators during those periods (higher MC) growth in peak period demand => capacity expansion  peak load pricing

the long run: renewables  hydro: flowing water  biomass: burning  solar energy: heat to drive turbines  solar into electricity: photovoltaics  wind energy: drive turbines  hydrogen: fuel cars / furnaces  geothermal: from deep in the earth