Download Chapter Objectives

Chapter 21
The Economics of Energy,
The Environment, and
Global Climate Change
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
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Basics of energy supply and demand
Energy sustainability
Economics of conservation
Economics of the environment
Controlling pollution
Global climate change
21-2
Basics of Energy Supply and
Demand
• Since 1850, oil usage per person in the
US has more than tripled.
• Since 1973, due to the energy shocks of
1973 and 1979, energy usage per person
in the US has remained relatively
constant.
• The US uses more energy per person than
most other countries.
21-3
US Energy Consumption per Person
21-4
Global Energy Consumption per
Person, 2005
21-5
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.
21-6
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.
21-7
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.
21-8
Share of World’s Energy Supply
Energy source
Coal
Crude oil
Natural gas
Nuclear
Hydro
Combustible renewable
Solar, geothermal, wind,
and other
1973
24.4%
46.2%
16.0%
0.9%
1.8%
10.6%
0.1%
2005
25.1%
35.1%
20.7%
6.3%
2.2%
10.1%
0.5%
21-9
The Real Price of Gasoline
21-10
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.
21-11
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 argument.
• This implies a slowdown in oil production
and is equivalent to an upward shift of the
supply curve for oil.
21-12
World Crude Oil Reserves
21-13
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 quantity demanded and
supplied goes down.
21-14
Energy Conservation in Response to a
Supply Shift
21-15
Energy Conservation in Response to a
Supply Shift
New supply curve
for gasoline
Price of
gasoline
Supply curve for
gasoline
P1
B
P
A
Demand curve for
gasoline
Q1
Q
Quantity of gasoline supplied/bought
21-16
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 and quantity demanded and supplied
to fall.
21-17
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
21-18
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.
21-19
Energy Conservation with a Gas Tax
21-20
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.
21-21
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.
21-22
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.
21-23
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.
21-24
The Impact of Noise Externalities on
Airline Passengers
21-25
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.
21-26
Controlling Pollution
– The second approach is the market-based
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 tradeable pollution permits.
A pollution permit gives a business the right to emit
a particular amount of pollution. This is often
called a cap-and-trade system.
21-27
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.
21-28
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.
21-29
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.
21-30