Energy Economics and Negative Externality
Externalities having Negative Costs to Society
Externalities of Energy
Market-based Environmental Policy
Externalities are Market Failure or Failure of Markets
It can be considered that the economists believe markets are unambiguously resulting in efficient results. It is with the total surplus maximized when the markets operate without interference from the other institutions. If it were the case, then there would be no efficient role for the non-market institutions in society along with their justification having concerns about the distribution of surplus. It specifically concerns about the equity and fairness because these relate to the allocation of market of scarce resources (Menanteau, Finon and Lamy 2003, Sutherland 1991). However, such issues play specific role in the justification of non-market institutions that are being motivated by efficiency rather than equity concerns. These conditions are known as externalities and they emerge with the decisions of certain parties in the market having a direct impact on others in a way that is not captured by market prices (Brown 2001, Owen 2006, Mulder and Hagens 2008). This paper is considering the energy economics while reflecting the negative externalities.
Externalities having Negative Costs to Society
The negative externality causes the quantity of equilibrium to be larger than the socially optimum quantity. The social cost curve is identical to the cost of organization in the absence of the externality. However, the negative externality causes the social cost curve to include the private cost for the production of the products along with the additional cost paid by people. In order to correct the inefficiency due to externalities, the quantity produced would be changed to the optimal level of the additional cost of the externality (Allcott and Greenstone 2012, Longo, Markandya and Petrucci 2008). A new equilibrium having the social cost curve fulfilling the demand curve indicating the socially optimal level. It can be said that the socially optimal level of production is lower than the privately optimal level because the private market is not paying the full cost of the actions. Minimizing the quantity produced in the private market increasing the total social welfare (Duke and Kammen 1999, Scheraga 1994, Allcott and Greenstone 2012, Menanteau, Finon and Lamy 2003).
A negative externality exists when the production and consumption of products results in costs imposed on people not involved with the transaction or the use of the good. For instance, an individual smoking a cigarette in a restaurant has made a decision to smoke depending on the marginal benefits and marginal costs. It is found that the individuals living near industry emitting pollution apart from the fact that the people who do not produce or consume that specific produced good pay the cost of pollution (Pitt 1985, Jansen and Seebregts 2010, Dincer 2000, Jaffe, Newell and Stavins 2004). In order to understand the negative externalities, it can be said that the introduction of the concept of the social curve.
The main reason of the negative externality of being inefficient is due to the market equilibrium reflects the private costs of production. If the people involved in the transaction of the goods that could be forced to pay the social cost along with the private cost of producing the good that can solve the issue and the efficient market equilibrium can be reached. It is known that the producers and consumers are forced to internalize the externality when the producers and consumers of the goods (Allcott and Greenstone 2012, Jansen and Seebregts 2010, Longo, Markandya and Petrucci 2008, Mulder and Hagens 2008).
Externalities of Energy
The externalities of energy refer to the social impacts arising from the process of production of energy that are not being reflected in the market price of the energy. One of the major example is the pollution as it is observed in Japan that combustion of gases from the fossil fuel power stations are released into the atmosphere. It influences the natural environment but the health of local residents and the private property of third parties not associated with the energy production activities (Dincer 2000, Menanteau, Finon and Lamy 2003, Mulder and Hagens 2008, Sutherland 1991, Allcott and Greenstone 2012, Longo, Markandya and Petrucci 2008). It is an example of externalities of energy and the cases like this with negative impacts are referred to the external cost. The costs incurred for installing such removal equipments that were incorporated into the production price of energy. It implies that the negative affects of combustion gases that were reflected in the market price.
Moreover, the costs of production that are faced by each of the producers of energy require the imposition of costs of pollution in society (Allcott and Greenstone 2012, Duke and Kammen 1999, Brown 2001, Jansen and Seebregts 2010, Mulder and Hagens 2008, Owen 2006, Longo, Markandya and Petrucci 2008). The following figure provides the market demand and supply graph for the production of hero cards. There are production externalities due to which the market can produce xM at the price pM with all the consumers and producers doing best in equilibrium. The consumers can get the shaded blue area in surplus while producers get the shaded magenta area. It can be said that the production of hero cards produce pollution but every card produced is imposing a pollution cost on society. Neither a cost that is borne by the people consuming nor those produce that produce it (Pitt 1985, Menanteau, Finon and Lamy 2003, Brown 2001, Allcott and Greenstone 2012, Jaffe, Newell and Stavins 2004, Longo, Markandya and Petrucci 2008, Menanteau, Finon and Lamy 2003).
Figure 1: (DeCanio and Watkins 1998, Hassett and Metcalf 1993, Jaffe, Newell and Stavins 2004)
The part b of the above graph is reflecting the green curve labeled as SMC. This curve represents the social marginal cost of producing hero cards. It includes the marginal costs of producers that are captured in the market supply curve but it includes the additional cost of pollution that is imposed on others. It can be said that the social marginal cost curve is required to lie above the supply curve because it includes costs in addition to the ones incurred by producers (Allcott and Greenstone 2012, Duke and Kammen 1999, Jansen and Seebregts 2010, Longo, Markandya and Petrucci 2008, Pitt 1985, Menanteau, Finon and Lamy 2003). The reason behind it is that the SMC curve is parallel to the supply curve, which implies a constant marginal cost of pollution for the produced hero card.
Consequently, Barney would decide the continuation of producing the long-term benefits from the production as represented by the marginal willingness to pay of the overall cost of additional production for society. The Barney would certainly produce the hero card due to certain consumer to whom this card is worth more than the costs incurred by society as measured by SMC (Hassett and Metcalf 1993, Duke and Kammen 1999, Allcott and Greenstone 2012, Jaffe, Newell and Stavins 2004, Longo, Markandya and Petrucci 2008, Longo, Markandya and Petrucci 2008).
It can be said that the competitive markets can produce sufficiently in the presence of negative pollution externalities. Consequently, the potential for government policy for enhancing the efficiency exists while reducing the deadweight loss from the overproduction of market. It is known that the taxation of goods is one policy tool that can minimize the output of market. In the absence of externalities, it is not efficient because the market allocation of resources is required to be efficient. However, this minimization of inefficient output level to minimize rather than increase in the deadweight loss (Dincer 2000, Hassett and Metcalf 1993, Jansen and Seebregts 2010, Longo, Markandya and Petrucci 2008, Menanteau, Finon and Lamy 2003, Mulder and Hagens 2008, DeCanio and Watkins 1998).
For instance, it can be said that the market demand and supply curves along with the optimal production level xB that can be selected by Barney. It is depicted in the panel of the graph. It is apparent that the buyers in the market are most probably to face the higher price pB while sellers are to receive the lower price pS with the difference between the two prices that represent the payment t per unit in taxes (DeCanio and Watkins 1998, Hassett and Metcalf 1993, Longo, Markandya and Petrucci 2008, Menanteau, Finon and Lamy 2003, Owen 2006, Jansen and Seebregts 2010). In the panel b, the more directly the efficiency of tax is apparent. In the absence of the tax, the market produces the output xM and at the price p M (Jaffe, Newell and Stavins 2004).
Figure 2: (Jansen and Seebregts 2010, DeCanio and Watkins 1998, Duke and Kammen 1999, Menanteau, Finon and Lamy 2003)
In the presence of the externalities, the price signal is distorted as it does not coordinate production and consumption. The tax removes the distortion while causing the market to internalize the externality. For the government to be able to impose an efficient Pigouvian tax t, the optimal quantity is required to be known to reach the market. The difference between the market demand and supply at that optimal quantity is required to be known. In other words, the government is required to know the marginal social damage caused by pollution at the optimum quantity (Duke and Kammen 1999, Jaffe, Newell and Stavins 2004, Jansen and Seebregts 2010, Menanteau, Finon and Lamy 2003, Longo, Markandya and Petrucci 2008, Allcott and Greenstone 2012, Sutherland 1991).
Market-based Environmental Policy
The most common market-based environmental policy is required to work with the determination of the government on overall level of population, which is acceptable. It is then issued in pieces of paper that permit the owner to emit the specific quantity of different types of pollutants per week or year. These pieces of paper are known as tradable pollution permits, which represents the right to pollute by certain amount. These rights are issued by government through the auction or giving them to different organizations operating in different industries (Allcott and Greenstone 2012, Duke and Kammen 1999, Brown 2001, DeCanio and Watkins 1998, Jaffe, Newell and Stavins 2004, Jansen and Seebregts 2010, Longo, Markandya and Petrucci 2008). It turns out that it does not require the precise way of using with the distribution as government has permitted. It means that the specific feature of the analysis is the individuals owning such permits to sell them to others if they select. The policy caps the entire level of pollution while fixing it with the number of pollution permits and allowing the trade in permits for determining the use (Menanteau, Finon and Lamy 2003, Duke and Kammen 1999, Jaffe, Newell and Stavins 2004, Jansen and Seebregts 2010, Mulder and Hagens 2008, Pitt 1985).
Pollution vouchers have certain value to producers because they allow producers to emit pollution in the process of production. At the same time, the producer selects the use of such type of voucher while incurring the economic cost because the producer may select to sell the voucher to someone. In this way, every producer has to weigh the costs and benefits of the use of pollution permits while knowing that few vouchers can lead to gain benefits of the pollution abating technologies more easily. The organizations in certain industries can have a demand for such vouchers as compared to the organizations in other industries (Brown 2001, Jansen and Seebregts 2010, Duke and Kammen 1999, Longo, Markandya and Petrucci 2008, Dincer 2000, DeCanio and Watkins 1998, Mulder and Hagens 2008, Menanteau, Finon and Lamy 2003). Consequently, the introduction of pollution permits in an economy can enable the government to create a new market. The following graph is depicting a new market in which pollution permits is on horizontal axis and the price per pollution permit is on vertical axis (Allcott and Greenstone 2012, Hassett and Metcalf 1993, Longo, Markandya and Petrucci 2008).
The introduction of specific amount of quantity of permits can enable the government to set a perfectly inelastic supply at precisely that quantity resulting in the level of entire pollution across the industries. It can be said that the organizations emitting pollution in the production processes demand such type of vouchers with the demand based on the amount of pollution involved in producing different goods. It further involves the way of reducing the amount of pollution emitted in production. Organizations that find it difficult in reducing the pollution will be willing to pay more for the right to pollute as compared to those who can place a filter on their smokestacks. This can set the price for pollution vouchers at equilibrium (Allcott and Greenstone 2012, Longo, Markandya and Petrucci 2008, Jaffe, Newell and Stavins 2004, DeCanio and Watkins 1998, Menanteau, Finon and Lamy 2003, Mulder and Hagens 2008).
Figure 3: (DeCanio and Watkins 1998, Jaffe, Newell and Stavins 2004, Menanteau, Finon and Lamy 2003)
It can be assumed that the government can monitor the pollution of industries in most effective manner because it is a system of pollution vouchers to achieve different milestones. First of all, it imposes a cost on polluters while requiring the purchase of sufficient pollution rights for the pollution being emitted. It can cause an upward shift in organization MC curve because of the input of production process and it can shift the market supply curve in polluting industries. Such type of shift can result in less production of output in such polluting industries. Secondly, the system introduces incentives for organizations to seek organization as compared to the cost of pollution vouchers (Dincer 2000, Longo, Markandya and Petrucci 2008, Allcott and Greenstone 2012, Menanteau, Finon and Lamy 2003). Thirdly, the system can create an incentive for new organizations to emerge while investing independently in research and development of pollution abating technologies due to the increase in system with the demand for such technologies considering the fact that polluters would pay for vouchers for production (Allcott and Greenstone 2012, Dincer 2000, Longo, Markandya and Petrucci 2008, Menanteau, Finon and Lamy 2003).
Consequently, the system achieves entire reduction in pollution at the least social cost along with the absence of government adjusting policy to change the conditions. The government does not have to be in the business to pick the reduction of pollution in industry. All the government has to set an entire pollution target while printing a corresponding quantity of pollution permits. The newly created pollution permit market is found to be government intervention that harness of power of a newly created market for generating the required information for reducing pollution at the lowest possible cost without any interference of government (Brown 2001, Hassett and Metcalf 1993, Duke and Kammen 1999, Jansen and Seebregts 2010, Mulder and Hagens 2008, Jaffe, Newell and Stavins 2004).
It can be said that the idea of taxing the polluting industries has lost considerable favor among economists. It is so because the technology allows the establishment of market in tradable pollution permits that enables governments to tax pollution. It can be suspected that it is possible to detect pollution while favoring the taxing it rather than its output as well. The taxation on pollution directly has certain advantages over Pigouvian taxes that are equal to establishment of tradable pollution permits on increase in tax rate set at same level as the price per unit of pollution (Dincer 2000, Jaffe, Newell and Stavins 2004, Jansen and Seebregts 2010, Longo, Markandya and Petrucci 2008). The pollution taxes are similar to the cap and trade system due to which environmental policy makers nevertheless debate their relative merits. It is considered that the precise target levels can be set for pollution with the cap and trade systems permitting the determination of per unit pollution price require implementing the target. It is believed that per unit of pollution cost appropriately through a tax for permitting organizations to plan. If the per unit of pollution tax is set at the same rate as per unit of pollution price emerging under a specific cap in a cap and trade system. It is issue that is raised in policy debates regarding cap and trade vs. pollution taxes related to politics (Dincer 2000, Longo, Markandya and Petrucci 2008, Allcott and Greenstone 2012).
Externalities are Market Failure or Failure of Markets
It is observed that markets produce inefficient quantities of goods that exhibit positive and negative consumption along with the production externalities. The efforts of civil society can contribute in greater efficiency in the absence of government intervention. The government policies are designed to change market output directly or indirectly harness the advantages of market forces or institutions of civil society. It is explored that the issues in markets, governments, and civil society implement optimal outcomes for society. It can ascertain the appropriate balance of markets, government, and civil society depending on the specifics of the social issue to be solved (Duke and Kammen 1999, Longo, Markandya and Petrucci 2008, Menanteau, Finon and Lamy 2003, Hassett and Metcalf 1993). It is observed that the policy enhancing efficiency tool being possessed by the government to implement the optimal outcomes for society is effective. The basic reason that a market can overproduce in the case relative to the efficient quantity is the producers being not forced to face the complete costs imposed on societies during the decisions market. Specifically, the pollution that is generated is air pollution and the producer escapes paying for the input that is used in the production process unless some process is implemented (Duke and Kammen 1999, Allcott and Greenstone 2012, Jaffe, Newell and Stavins 2004, Mulder and Hagens 2008).
It can be concluded that the government can impose pressures on the producers and consumers of the goods for internalizing the externality through the taxes being designed. It deals with the impacts of the negative externalities, which is known as the corrective taxes. It is concluded that the markets cease to be efficient maximizing the social surplus in the presence of externalities. The existence of markets presumes underlying system of property rights that require the explicit involvement of the government. It is also found that the market failure arising from the externalities is caused by the failure of the market to exist (Jaffe, Newell and Stavins 2004, Longo, Markandya and Petrucci 2008).
Allcott, Hunt, and Michael Greenstone. “Is There an Energy Efficiency Gap?” Journal of Economic Perspectives, American Economic Association, 2012: 3-28.
Brown, Marilyn A. “Market failures and barriers as a basis for clean energy policies.” Energy Policy, 2001: 1197 — 1207.
DeCanio, S.J., and W.E. Watkins. “Investment in energy ef-ciency: Do the characteristics of ?rms matter?” Rev. Econ. Statist, 1998: 95 — 107.
Dincer, Ibrahim. “Renewable energy and sustainable development: a crucial review.” Renewable and Sustainable Energy Reviews, 2000: 157 — 175.
Duke, Richard, and Daniel M. Kammen. “The Economics of Energy Market Transformation Programs.” The Energy Journal, 1999: 15-64.
Hassett, K.A., and G.E. Metcalf. “Energy conservation investment: Do consumers discount the future correctly?” Energy Policy, 1993: 710 — 716.
Jaffe, Adam B., Richard G. Newell, and Robert N. Stavins. “Economics of Energy Ef-ciency.” Encyclopedia of Energy, 2004: 79-90.
Jansen, Jaap C., and Ad J. Seebregts. “Long-term energy services security: What is it and how can it be measured and valued?” Energy Policy, 2010: 1654 — 1664.
Longo, Alberto, Anil Markandya, and Marta Petrucci. “The internalization of externalities in the production of electricity: Willingness to pay for the attributes of a policy for renewable energy.” Ecological Economics, 2008: 140-152.
Menanteau, Philippe, Dominique Finon, and Marie-Laure Lamy. “Prices vs. quantities: choosing policies for promoting the development of renewable energy.” Energy Policy, 2003: 799 — 812.
Mulder, Kenneth, and Nathan John Hagens. “Energy Return on Investment: Toward a Consistent Framework.” AMBIO: A Journal of the Human Environment, 2008: 74-79.
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Pitt, Mark M. “Equity, externalities and energy subsidies The case of kerosine in Indonesia.” Journal of Development Economics, 1985: 201 — 217.
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