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Chapter 19
Economics of Energy, the
Environment, and Global
Climate Change
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
• Characterize the basics of energy
consumption, supply and price.
• Discuss energy sustainability and
conservation.
• List the types of damage done by pollution
externalities.
• Describe different approaches to controlling
pollution.
• Explain how a market-based approach could
help mitigate global climate change.
19-2
Basics of Energy Supply
and Demand
• Since 1850, oil usage per person in
the U.S. has more than tripled.
• Since 1973, due to the energy shocks
of 1973 and 1979, energy usage per
person in the U.S. has remained
relatively constant.
• The U.S. uses more energy per person
than most other countries.
19-3
Energy Consumption
• The United States uses more energy
per person than most other countries.
• In 2008, the U.S. used 4.1 times the
world average.
• Energy consumption is growing at a
fast rate in the developing countries,
especially in China and India.
19-4
U.S. Energy Consumption per
Person
19-5
Global Energy Consumption
per Person, 2008
19-6
Energy Supply
• The most widely used energy sources are
fossil fuels, which include coal, crude oil,
and natural gas.
• The marginal cost of extraction is the
amount of money that it takes to get one
more ton of coal, one more barrel of oil, or
one more cubic foot of natural gas out of
the ground.
• This cost can vary greatly, depending on
where the resource is located.
19-7
Energy Supply
• Companies will pump oil or mine coal
where the marginal cost of
extraction is the lowest.
• Once these resources are exhausted,
companies will extract energy from
more expensive locations.
• Eventually, as the marginal cost of
extraction continues to rise, we will
shift out of fossil fuels to alternatives.
19-8
Energy Supply
• Two other main sources of energy are
renewable energy and nuclear
power.
• Renewable energy sources such as
wind and solar power have low
variable costs, but high fixed costs.
• Nuclear power also has high fixed
costs, but higher variable costs than
renewable energy sources.
19-9
Where the World’s Energy
Comes From
Energy source
Coal
Crude oil
Gas
Nuclear
Hydro
Combustible
renewables
Solar, geothermal,
wind, and other
1973
24.4%
46.2%
16.0%
0.9%
1.8%
10.6%
2008
27.0%
33.1%
21.1%
5.8%
2.2%
10.0%
0.1%
0.7%
19-10
The Real Price of Gasoline
19-11
Energy Sustainability
• World energy is likely to continue to
grow at a fast pace, driven by growth
in China, India, and other developing
countries.
• The question is whether future
supplies of energy will increase
enough to meet this demand.
• If not, sharply higher prices of energy
are likely to occur, which will slow
economic growth.
19-12
World Oil Reserves
• These is an ongoing debate among
economists and geologists about the
world’s crude oil reserves.
• The position that global production of
oil may be nearing its highest point is
called the peak oil theory.
• This implies a slowdown in oil
production and is equivalent to an
upward shift of the supply curve for oil.
19-13
New Supply of Natural Gas
• There is a new supply of natural gas
being developed from shale deposits.
• It is extracted by a new drilling technique
know as “hydraulic fracturing”.
• An example is the Marcellus Shale
found in Ohio, West Virginia,
Pennsylvania and New York.
• There are potential environmental side
effects.
19-14
Economics of Conservation
• Energy conservation is a shift in
economic activities to reduce the use
of energy.
• There are three types of energy
conservation.
– First, there is the normal market reaction
to higher oil prices.
• If the supply curve for oil shifts to the left, the
price of gasoline goes up, and the quantity
demanded and supplied goes down.
19-15
Energy Conservation in
Response to a Supply Shift
19-16
Economics of Conservation
– The second type of energy conservation
is the result of government intervention.
• Examples include the fuel efficiency
standards for cars (CAFÉ standards) and
speed limits.
• These actions shift the demand curve to the
left, causing price, the quantity demanded,
and the quantity supplied to fall.
19-17
The Effect of a Speed Limit on
the Gasoline Market
Price of
gasoline
Demand curve
for gasoline with
55 mph speed
limit
Demand curve
for gasoline
Supply curve for
gasoline
A
P
B
P1
Q1
Q
Quantity of gasoline supplied/bought
19-18
Economics of Conservation
– The third type of conservation is also the
result of government intervention, but
using a market-based approach.
• A market-based approach changes the price
signals that consumers and producers face in
order to move their behavior in the desired
direction.
• One example of a market-based approach
would be raising the tax on gasoline.
19-19
Energy Conservation with a
Gas Tax
19-20
Alternatives to Fossil Fuels
• Over the long run, the solution to rising
energy prices is likely to include
technological breakthroughs.
• This will make alternative energy sources
more attractive.
• These alternatives include: solar, nuclear,
biofuels, hydro, wind, and fuel cells.
• Each of these has economic advantages
and disadvantages.
19-21
Economics and the
Environment
• The key concept in environmental
economics is externalities.
• A negative externality is the
negative side effect from an exchange
that affects someone other than the
buyer and seller.
• A plant burning coal to generate
electricity produces externalities in the
form of various air pollutants, such as
sulfur dioxide and nitrogen dioxide.
19-22
Impact of Pollution Externalities
• There are several negative impacts from
pollution.
– First, health impacts caused by
externalities include loss of life and
reduction of health.
– The second negative impact from pollution
is material and crop damage.
– The third negative impact is the harm to
environmental amenities.
– Finally, pollution can do ecological
damage.
19-23
Measuring the Damage Done
by Pollution Externalities
• To measure the damage done by
pollution, economists use the
techniques of revealed preference
and stated preference.
• Revealed preference means that you
look at the choices that people make in
their daily lives to change their risk of
death by a little bit.
• Stated preference means that you ask
individuals how much they would pay to
reduce their risk of death by a little bit.
19-24
Equilibrium in a Market with
Externalities
• The competitive equilibrium occurs
where price equals marginal cost.
• The problem is that the competitive
equilibrium ignores the impact of the
externality.
• Taking the externality into account
shifts the marginal cost curve to the
left, resulting in higher prices and a
lower equilibrium quantity.
19-25
The Impact of Noise Externalities
on Airline Passengers
19-26
Controlling Pollution
• There are a number of ways to regulate
or control pollution:
– First is the command-and-control
approach.
• Government determines what products can’t be
produced through various regulations.
– For example, the Environmental Protection Agency
banned the pesticide DDT and issued strict regulation
on the amount of carbon monoxide produced by
autos.
• The command-and-control approach reduces
pollution, but is inflexible and forces all emitters
to meet the same standard. This raises costs.
19-27
Controlling Pollution
– The second approach is the marketbased approach, which uses prices to
create incentives to reduce pollution.
• One example of using a market approach to
reduce the amount of pollution is to tax the
product or process causing the externality.
The tax raises the price of the product.
• Another market-based approach for reducing
pollution is through tradable pollution
permits. A pollution permit gives a business
the right to emit a specific amount of pollution.
This is often called a cap-and-trade system.
19-28
Global Climate Change
• The current scientific consensus is that
the build-up of greenhouse gases such
as carbon dioxide will lead to a
significant warming of the Earth over
the next 100 years.
• The economic effects of global
warming could be very significant,
especially for the agricultural sector of
the economy.
• The potential solution to global climate
change falls into two categories:
adaptation and mitigation.
19-29
Global Climate Change
• Adaptation is the alteration of
consumer and business behavior to
reduce the damage from global climate
change.
– This approach uses price increases and
the resulting incentives to minimize the
harm from global warming.
– The impact on some groups in the society
could be high.
19-30
Global Climate Change
• Mitigation includes policies to significantly
reduce emissions of greenhouse gases.
– This approach also prefers to use price
signals to slow down the emission of
greenhouse gases.
– One proposed means for reducing the
incentive to burn fossil fuels is a carbon tax.
– The tax rate would vary for different fuels
according to their carbon content.
– The other proposed alternative is to use the
cap-and-trade system.
19-31