energy
oil and natural gas
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supply 62% all energy consumed worldwide
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how to transition to new sources?
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use until mc of further use exceeds mc of
substitute resources
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More abundant coal
Or renewable solar
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transition should be smooth
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have allocations been efficient?
natural gas

huge shortages on 1974-75. why?
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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
the effect of price controls

price ceiling reduces MUC (higher future prices no
longer possible), decreasing total mc curve
(supply)
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consumers better off today (gained BC)
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producers not better off:
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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)
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when mc reaches price ceiling, QS=0
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but demand is not zero at that price: shortages
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suppliers willing, demanders willing, but price control will
not allow
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overallocation to current consumers, underallocation to
future consumers
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losses to future consumers/producers are greater than
gains to current consumers
oil

similar price control problems

second source of misallocation: OPEC
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restrict supply, raise prices

why OPEC so effective?
1.
price elasticity of demand for oil
•
2.
income elasticity of demand for oil
•
3.
inelastic, substitutes exist but are expensive
income grows, demand grows
supply responsiveness of non-OPEC members
•
OPEC produces 2/3; only Mexico may have influence
oil: national security problem

excessive dependence on imports
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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
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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
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horizontal because each individual supplier has no effect on
world price
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market allocation
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demand Q5
Q1 domestically produced
Q5-Q1 imported
efficient allocation
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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
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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
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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)
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Efficiency loss (shaded triangle): because foreign mc
is lower than domestic mc (supply)
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loss between Q2 and Q4 (where domestic mc > foreign mc)
still better to import
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vulnerability premium lower than cost of
self sufficiency
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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)?
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energy conservation, e.g. gas tax
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subsidize domestic supply
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reduces consumption, but no affect on share of
imports
reduce imports, but not consumption
tariff on imports (P1-P0) or quota on
imports (Q4-Q2)
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price rises to P1, consumption falls to Q4,
imports Q4-Q2
transition fuels

how to transition to renewables?
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fuels receiving most attention: coal, uranium
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coal: abundant
uranium: not abundant with current reactors
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technology is changing this
biggest issue btw these: environmental
impact
transition fuels: environmental problems
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coal: air pollution (sulfur, particulates,
CO2)
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uranium:
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nuclear accidents
storage of radioactive waste
energy conservation
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significant role: defer capacity expansion
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cost increases are substantial
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by reducing demand for electricity, delay
new plants, delay rate increases
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current pricing systems rely on AC pricing,
lower than true MC of new units
utilities invest in conservation when
cheaper
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rebates for conservation measures in
homes
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incentives for solar water heaters
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energy audits
load management
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peak period imposes 2 costs on utilities
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requires firing up special generators during
those periods (higher MC)
growth in peak period demand => capacity
expansion
peak load pricing
the long run: renewables
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hydro: flowing water
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biomass: burning
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solar energy: heat to drive turbines
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solar into electricity: photovoltaics
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wind energy: drive turbines
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hydrogen: fuel cars / furnaces
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geothermal: from deep in the earth