1. Economics of Energy Policy Monday, March 21

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. Quantity of coal mined $ D S=MPC only qmqm pmpm S=MPC + MSC q* P* External costs of extracting coal

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

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

7. Quantity of gasoline used by automobiles $ D qmqm pmpm External costs of gasoline use in automobiles MC Total MC qeqe

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. $ Quantity of petroleum Domestic Supply SDSD Domestic Demand International Supply SISI PwPw QdQd S D2 QtQt Q d2 At S D : ratio = (Q t – Q d )/Q t At S D2 : ratio = (Q t – Q d2 )/Q t

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. $ Quantity of gasoline D S Price control PmPm QmQm QsQs QdQd Price controls (consumers’ price was set) in the 1970s resulted in shortages 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. Miles of driving $ D MC qmqm pmpm Changes in fuel efficiency standards so cars use less gasoline: MC ‘ Impact on use of gasoline in cars depends upon the elasticity of demand for driving.

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