1. Chapter 2 Energy, Markets, and Society Part A
Peter Schwarz, Professor of Economics
and Associate, Energy Production and Infrastructure Center (EPIC), University of North Carolina Charlotte

2. Chapter 2 Outline Introduction What is Different about Energy?
Efficiency
Social Welfare
Sustainability
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3. I. Introduction (1) Economics: Allocation of scarce resources
Economic Efficiency: Maximize output (size of pie) from scarce resources.
Private efficiency: The best outcome for direct participants.
Social efficiency: The best outcome for all affected parties.
Equity: Fairness, income distribution (how the pie is sliced).
Social Welfare: Maximize societal well-being, including efficiency and equity.
Society welfare function (SWF) encompasses all affected parties (one big family).
Cost-Benefit Analysis (CBA) a special type of SWF.
Equity: $ = $, no matter who receives it.
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4. Introduction (2) Energy Markets example Hummer Private interest
Bury in landfill: Society may be better off.
Introduction (2)
Energy Markets example
Hummer
Private interest
Supply and demand
Third parties
Oil depletion
Emissions
Climate change
Equity
Who bears emissions?
Environmental justice
Sale to Chinese company fell through.
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5. Introduction (3) One other criterion Sustainability
Effect on future generations
May not be considered in today’s efficiency, equity decisions
"Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”
Bruntland Commission (1987) Our Common Future
Efficiency, equity, sustainability need not coincide
Ex. China Three Gorges Dam
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6. Introduction (4): Decision Criteria
Weak
Strong
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7. II. What is Different about Energy?(1)
Widespread dissatisfaction with market solutions
Not always based on economic considerations
Running out of energy
National security
Environmental damage
Consider government
If governments fail
Choose least bad alternative
Ronald Coase
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8. What is Different about Energy?(2)
Market failures pervasive
Market power
Externalities
Public goods characteristics
Decline of coal
Carbon emissions
So substitute nuclear energy?
Radiation
Wind and solar?
Cost
Intermittency
North Carolina and 29 other states
Renewable Portfolio Standards (RPS)
European Union
Feed-in Tariffs (FITs)
Carbon pricing would be more efficient.
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9. III. Efficiency (1) Invisible Hand
Adam Smith, Wealth of Nations (1776)
Private interests coincide with social interests.
As long as certain conditions hold
Otherwise private and social interests may diverge
Inefficiency
Inequity
Market Failure
But can also have government failure
Government cure is worse than the disease.
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10. III. (In)Efficiency (2) Invisible Hand Necessary Conditions
Market Failure due to inefficiency
Monopoly
Natural Monopoly
Economies of Scale
Externalities
Public Goods
Imperfect Information
Second-best Considerations
Macroeconomic instability
Inflation, Unemployment
Other types of failures
Inequity
Unsustainability
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11. (In)Efficiency (2): Monopoly
Firm = Market (Industry)
OPEC
Extract oil for $20 or less; sell for more (as much as $150)
Economist’s objection is not higher profit, but loss in social welfare
Consumers lose more $s than producers gain.
Pm > Pc , Qm < Qc
Consumers lose
Producers gain on first Qm units, lose on Qc - Qm units
Net loss (demonstrated in next chapter) Deadweight loss (DWL)
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12. Efficiency (3) Economies of scale Declining LRAC Example: Electricity
Natural monopoly
Example: Electricity
Transmission and distribution lines
Generation?
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13. (In)Efficiency (4): Externalities
Also called third-party or spillover effects
Usually negative.
Difference between Social and Private Cost
or Social and Private Benefit
Example: Steel firm burns coal to heat furnace
Emits sulfur (S), nitrous oxides (NOx), particulate matter (PM), mercury (Hg), carbon (C)
Chooses lowest cost method of production:
Uses air for free.
So ignores emissions.
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14. (In)Efficiency (5): Public Goods Characteristics
Extreme case of (positive) externalities
Pure public good
Non-rival
Non-excludable
Taxonomy
Commons
Rival,
non-excludable
(Pure) Public
Non-rival,
Private
Excludable
Club (Quasi, impure) Public Good)
Examples: Climate change agreement
Nuclear fusion R & D
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