Ch 7
Energy: The Transition from
Depletable to Renewable
Resources
1
•
Energy is one of our most critical resources
• Currently, many industrialized countries depend on oil and
natural gas for the majority of their energy needs.
According to the International Energy Agency (IEA), these
resources together supply 59 percent of all primary energy
consumed world- wide.
•
Adding coal, another fossil fuel resource, increases the
share to 86 percent of the total.
2
• Fossil fuels are depletable, non-recyclable
sources of energy. Crude oil proven reserves
peaked during the 1970s and natural gas peaked
in the 1980s in the United States and Europe, and
since that time, the amount extracted has
exceeded additions to reserves.
3
• Even if we cannot precisely determine when the
fuels on which we currently depend so heavily will
run out, we still need to think about the process of
transition to new energy sources..... Why?
•
According to depletable resource models, oil and
natural gas would be used until the marginal cost
of further use exceeded the marginal cost of
substitute resources—either more abundant
depletable resources such as coal, or renewable
sources such as solar energy
4
•
Read Ex 7.1 p.141
• In this chapter we shall examine some of the
major issues associated with the allocation of
energy resources over time and explore how
economic analysis can clarify our understanding
of both the sources of the problems and their
solutions.
5
Natural Gas: Price Controls
•
In the United States, during the winter of 1974 and early
1975, serious shortages of natural gas developed.
Customers who had contracted for and were willing to
pay for natural gas were unable to get as much as they
wanted.
•
The shortage amounted to two trillion cubic feet of natural
gas in 1974–1975, which represented roughly 10% of the
marketed production in 1975.
•
In an efficient allocation, shortages of that magnitude
would never have materialized. What happened?
6
•
The source of the problem: Government controls
over natural gas prices.
•
The increasing importance of the automobile for
transportation created a rising demand for gasoline,
which in turn stimulated a search for new sources of
crude oil.
• This exploration activity uncovered large quantities
of natural gas (known as associated gas), in
addition to large quantities of crude oil
•
As natural gas was discovered, it replaced
manufactured gas in the geographic areas where it
was found. natural gas became an important
source of energy for the United States.
7
•
The regulation of natural gas began in 1938 with the
passage of the Natural Gas Act and it extend price
control regulations to the producer... Price Ceiling
•
What was the effect of this regulation?
•
The P ceiling would prevent prices from reaching their
normal levels.
•
Since price increases are the source of the incentive to
conserve, the lower prices would cause more of the
resource to be used in earlier years.
•
Consumption levels in those years would be higher
under price controls than without them.
8
•
Effects on the supply side are also significant.
Producers would produce the resource only when
they could do so profitably.
•
Once the MC rose to meet the price ceiling, no
more would be produced, in spite of the large
demand for the resource at that price.
•
Thus, as long as price controls were permanent,
less of the resource would be produced with
controls than without.
•
Furthermore, more of what would be produced
would be used in the earlier years.
9
•
The combined impact of these demand-and-supply
effects would be to distort the allocation
significantly
•
While a number of aspects differentiate this
allocation from an efficient one, several are of
particular importance:
(1) more of the resource is left in the ground,
(2) the rate of consumption is too high,
(3) the time of transition is earlier, and
(4) the transition is sudden, with prices suddenly
jumping to new, higher levels
10
•
The first effect means we would not be using all of
the natural gas available at prices consumers
were willing to pay.
•
Because price controls would cause prices to be
lower than efficient, the resource would be
depleted too fast.
•
These two effects would cause an earlier and
abrupt transition to the substitute possibly before
the technologies to use it were adequately
developed.
11
•
The discontinuous jump to a new technology,
which results from price controls, can place quite
a burden on consumers.
•
Attracted by artificially low prices, consumers
would invest in equipment to use natural gas, only
to discover—after the transition—that natural gas
was no longer available.
12
• Price controls may cause other problems as well.
•
Price controls are permanent; they can change
unpredictably at the whim of the political process.
• The fact that prices could suddenly rise when the
ceiling is lifted also creates unfortunate
incentives.
• If producers expect a large price increase in the
near future, they have an incentive to stop
production and wait for the higher prices. This
could cause severe problems for consumers.
13
• in Figure 7.2: An efficient market allocation would
result in Q* supplied at P *.
•
The net benefits received by the country would be
represented by areas A and B.
•
Of these net benefits, area A would be received
by consumers as consumer surplus and B would
be received by producers as a producer surplus.
14
P
S0
A
P*
B
Q
Q*
15
•
Suppose now that a price ceiling were established. This
ceiling would reduce the marginal user cost because
higher future prices would no longer be possible.
•
This has the effect for current producers of lowering the
perceived supply curve, due to the lower marginal user
cost.
•
As a result of this shift in the perceived supply curve,
current production would expand to Qc and price would
fall to Pc.
•
Current consumers would unambiguously be better off,
since consumer surplus would be area A + B + C instead
of area A. They would have gained a net benefit equal to
B + C.
16
•
What about the producer?
• It may appear that producers could also gain if D > B, but
that is not correct because this diagram does not take
into account the effects on other time periods.
• Since producers would be overproducing, they would be
giving up the scarcity rent they could have gotten without
price controls.
•
Area D measures current profits only without considering
scarcity rent. When the loss in scarcity rent is
considered, producers unambiguously lose net benefits.
17
•
Future consumers are also worse off. As the resource
was depleted, the supply curve for each subsequent year
would shift up, thereby reflecting the higher marginal
extraction costs for the remaining endowment of the
resource.
•
When the marginal extraction cost ultimately reached the
level of the price control, the amount supplied would drop
to zero.
•
Extracting more would make no sense to suppliers
because their cost would exceed the controlled price.
18
•
Since the demand would not be zero at that price,
a shortage would develop.
•
Although consumers would be willing to pay
higher prices and suppliers would be happy to
supply more of the resource at those higher
prices (if they were not prevented from doing so
by the price control), the price ceiling would keep
those resources in the ground.
19
•
Over the long run, price controls end up harming
consumers rather than helping them.
•
Scarcity rent plays an important role in the allocation
process, and attempts to eliminate it can create more
problems than solutions.
•
Scarcity Rent: The marginal OC imposed on future generations by
extracting one more unit of a resource today. Scarcity rent is one of two costs
the extraction of a finite resource imposes on society. The other is marginal
extraction cost--the OC of resources employed in the extraction activity.
Scarcity rent is the cost of "using up" a finite resource because benefits of
the extracted resource are unavailable to future generations. Efficiency is
achieved when the resource price--the benefit society is willing to pay for the
resource today--is equal to the sum of marginal extraction cost and scarcity
rent.
20
P
S0
A
P*
Si
B
C
PC
D
Q
Q*
Q
21
C