Chapter 19Chapter 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 ObjectivesLearning 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.

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Basics of Energy Supply Basics of Energy Supply and Demandand 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.

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Energy ConsumptionEnergy 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.

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U.S. Energy Consumption per U.S. Energy Consumption per PersonPerson

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Global Energy Consumption Global Energy Consumption per Person, 2008per Person, 2008

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Energy SupplyEnergy 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.

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Energy SupplyEnergy 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.

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Energy SupplyEnergy 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.

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Where the World’s Energy Where the World’s Energy Comes FromComes From

Energy source 1973 2008Coal 24.4% 27.0%Crude oil 46.2% 33.1%Gas 16.0% 21.1%Nuclear 0.9% 5.8%Hydro 1.8% 2.2%Combustible renewables

10.6% 10.0%

Solar, geothermal, wind, and other

0.1% 0.7%

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The Real Price of GasolineThe Real Price of Gasoline

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Energy SustainabilityEnergy 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.

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World Oil ReservesWorld 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.

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New Supply of Natural GasNew 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.

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Economics of ConservationEconomics 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.

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Energy Conservation in Energy Conservation in Response to a Supply ShiftResponse to a Supply Shift

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Economics of ConservationEconomics 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.

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The Effect of a Speed Limit on The Effect of a Speed Limit on the Gasoline Marketthe Gasoline Market

Demand curve for gasoline

Q

P

Demand curve for gasoline with 55 mph speed limitPrice of

gasoline

Q1

Quantity of gasoline supplied/bought

Supply curve for gasoline

P1B

A

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Economics of ConservationEconomics 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.

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Energy Conservation with a Energy Conservation with a Gas TaxGas Tax

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Alternatives to Fossil FuelsAlternatives 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.

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Economics and the Economics and the EnvironmentEnvironment

• 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.

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Impact of Pollution ExternalitiesImpact 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.

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Measuring the Damage Done Measuring the Damage Done by Pollution Externalitiesby 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.

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Equilibrium in a Market with Equilibrium in a Market with ExternalitiesExternalities

• 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.

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The Impact of Noise Externalities The Impact of Noise Externalities on Airline Passengerson Airline Passengers

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Controlling PollutionControlling 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.

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Controlling PollutionControlling 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 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.

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Global Climate ChangeGlobal 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.

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Global Climate ChangeGlobal 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.

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Global Climate ChangeGlobal 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.

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