Lecture 14
Lecture 14 Final Examination Review Final examination – Wednesday, 9 June 2010, 1-3pm, HG F1 Handout for Energy Economics and Policy May 27, 2009 Thomas F. Rutherford, Center for Energy Policy and Economics, ETH Zürich 14.1
Term Paper Assessments on the Final Examination You will be asked to indicate which five papers by your fellow students are the best among those submitted this term. You may not vote for your own paper. You should decide in advance of the final examination which five papers you like best and be prepared to write one or two sentences about why you think these are particularly good.
http://www.cepe.ethz.ch/education/EnergyPolicy/papers.html
1
14.2
An Overview of the Course
Generalities Our course objectives include: 1. Provide an introduction to the principles of energy economics and related policy applications. 2. Provide an introduction to environmental implications of energy use. 3. Provide and overview of the role of economic analysis in designing policies which address issues of energy security, climate change and related environmental externalities. 4. Examine the environmental implications of energy use and the role of economic analysis in the designing policies which address issues of energy security, climate change and other environmental externalities.
14.3
Ancillary Objectives Additional learning objectives of this course: 1. Provide an introduction to the use of models in energy policy analysis. 2. Introduce sources of energy market data, and the analysis of these data in Excel. 3. Provide an introduction to writing in economics. 14.4
Course Contents Lectures are organized as follows: 1. 2. 3. 4. 5.
Principles of energy analysis and economics Crude oil markets Electricity markets Natural gas markets Environmental challenges to energy use 14.5
Economic Concepts • • • • • • • •
Demand and supply elasticities Market equilibrium Tax incidence Natural monopoly Deregulation and privatization Market power under oligopoly Transaction-cost Externalities 1
• • • •
Public goods Monopsony Bilateral monopoly Game theory 14.6
2
An Overview of the Lectures
Economic Analysis of Competitive Markets I Microeconomics review: Marshallian market equilibrium (a) Market demand and market supply (b) Marginal willingess to pay/accept (c) Excise, sales, specific and ad-valorem taxes (d) Elasticities of supply and demand (e) Consumer and producer surplus (f) Tax revenue and deadweight loss II Some graphical examples of applied price theory (a) Price controls: maximum prices (b) Price controls: minimum prices (c) Minimum wage (d) The market for kidneys III Putting applied microeconomics to work (a) Calibration in applied microeconomics (b) A brief introduction to coal (c) Building an economic equilibrium model (d) Using an economic model 14.7
Carbon Footprint and Embodied Energy 1. Input-output analysis • Basic balance of production and consumption • Constant proportions: The basis for modeling • Calculating labor requirements and emissions 2. Embodied energy 3. Emissions embodied in trade 4. Implications for climate policy 14.8
The Coal Market Exercise 1. Find data on base year production, consumption and prices of coal in a collection of countries which collectively represent global coal supply and demand. 2. Calibrate a model to these data. 3. Perform counterfactural analysis by applying excise taxes in a subset of regions, corresponding to the Annex-B member states. 4. Evaluate the global leakage rate: `=
% increase in coal use in non-Annex B states % decrease in coal use in Annex B states
5. Does the leakage rate exceed 100% as is claimed by some critical of climate policy? 6. Investigate the proposition that The most interesting answer to any question in economics is: It depends. 14.9
2
Calibrated Linear Supply Functions In calibrated equilibrium models we can use a reference price, reference quantity and an elasticity of supply to define a linear supply function. That is, we can write: Ps Qs = Q¯ s 1 + ηS ¯ − 1 Ps where: Q¯ s is the reference supply quantity P¯s is the reference supply price Note that when Ps = P¯s , Qs = Q¯ s .
14.10
Calibrated Demand The own-price elasticity of demand (ηD < 0) is defined as: ηD =
% change quantity = % change price
∆Q QD ∆PD PD
and a demand function can be calibrated to match a reference price-quantity pair: PD QD (pD ) = Q¯ D 1 + ηD ¯ − 1 PD where: Q¯ D is the reference demand quantity P¯D is the reference demand price
14.11
Energy Economics Topics 1. 2. 3. 4. 5. 6. 7.
Energy and economic history Coal markets today Gas markets today CO2 impact on electricity dispatch Activity analysis The International Energy Agency A multiregional input-output model 14.12
Activity Analysis: An Example When there are a discrete set of production technologies, each characterized by a marginal cost and a capacity, the supply curve becomes a step function corresponding to the sorted sequence of plant capacities. Consider a market in which the commodity is supply by the following four technologies: a b c d
cj 2 5 7 10
kj 2 2 4 ∞ 14.13
Activity Analysis Supply Curve
3
P cd = 10
kd = +∞
cc = 7
kc = 4 cb = 5
kb = 1
ca = 2
ka = 2 2
7
4
Q 14.14
Market Equilibrium with Activity Analysis Consider a market equilibrium when there are multiple discrete supply technologies. As in the conventional continuous Marshallian model, the equilibrium price and quantity is defined by the intersection of the supply and demand schedules:
P cd = 10
cc = 7
cb = 5
ca = 2
2
4
7
Q 14.15
Market Equilibrium and Social Surplus A convenient property of the competitive market allocation is that it maximizes social surplus, as illustrated in this figure: P cd = 10
cc = 7
cb = 5
ca = 2
2
7
4
Q 14.16
4
Constrained Optimization Approach Let Qt ≥ 0 denote output from technology t, P denote the equilibrium price, PS and CS denote producer and consumer surplus. The market equilibrium then solves: max PS +CS subject to: • Market supply equals technology output: S = ∑ Qt t
• Market equilibrum price is on the demand curve: 5 P = 10 − S 6 • Producer surplus is the area below the market price and above the cost of production: PS = ∑(P − ct )Qt t
• Consumer surplus is the area under the demand curve: CS =
(10 − P) S 2
14.17
Geometric Interpretation of the Equilibrium P 10
7 CS∗ = 7.5
P∗ = 5
PS∗ = 6
2
2
S∗ = 3
7
4
Q 14.18
Generation Dispatch without Climate Policy
Vic Niemeyer, Electric Power Reseach Institute
14.19
5
Generation Dispatch with Climate Policy
Vic Niemeyer, Electric Power Reseach Institute
14.20
The End of Oil 1. 2. 3. 4. 5. 6. 7. 8. 9.
Peak Oil Proven Reserves and undiscovered Resources Top Five Oil-Producing Countries Oil Refining Bias in Oil Resource Estimates Role of Technology in Oil Production Unconventional Oil Hubbert Curves Hotelling’s Rule 14.21
Monopoly and Oligopoly 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Causes of monopolies – pure monopoly. Marginal revenue, marginal cost and profit maximization. Monopolistic pricing and monopoly markup. Efficiency cost of monopoly (deadweight loss) Regulation of natural monopoly. What is an oligopoly? Cournot competition and Nash equilibrium. Reaction curve and best response. Iso-profit lines. Collusion. 14.22
Energy-Economy Modeling 1. A calibrated model of world oil markets. 2. Use of Excel for solving economic equilibrium models. 3. Hogan and Manne: The Fable of the Elephant and the Rabbit. 14.23
Natural Gas Markets 1. Natural gas production, distribution and marketing 2. Historical development of natural gas markets in North America and Europe. 3. Equilibrium model illustrating distinction between competitive and oligopolistic markets. 14.24
6
Electricity Market Management – Nordic and California Experiences 1. 2. 3. 4. 5.
Lessons from successful and unsuccessful energy market reforms. Special characteristics of electricity. Market design issues in power markets. Competition issues: potential sources of market power and role of retail competition. Infrastructure regulation. 14.25
Energy, Poverty and Development 1. 2. 3. 4. 5. 6.
Non-commercial energy in India. Direct and indirect energy use. Energy access issues in third-world countries Energy poverty and public health. Energy poverty and development. Energy demand in China: past, present and future. 14.26
3
Two Sample Analytical Questions
Carbon Leakage Carbon Leakage. Consider a two region model of the market for coal. Coal supply is competitive and is characterized by a linear supply schedule. Output in regions A and B are initially equal, and the elasticity of supply equal to η in both regions. Demand for coal is likewise described by an identical linear schedule in each region. The price elasticity of coal demand is equal to σ . Region A introduces an environmental tax equal to τ. Region B has no tax. Compute the leakage rate as a function of τ, η and σ .
14.27
Activity Analysis Consider a market equilibrium in which there are several discrete supply technologies. The reference equilibrium is depicted as follows with a benchmark supply equal to 3. P cd = 10
cc = 7 cb = 5
ca = 2
2
4
7
Q
1. Indicate the value of consumer and producer surplus in this diagram. 2. How would the equilibrium price, quantity and social suplus would change if technology b were removed from the market. 3. What happens to the market equilibrium if a unit subsidy of 3 were applied on demand? 14.28
4
Some Sample Essay Questions
Sample Essay Question: The California Electricity Crisis What are special features of the market for electricity which call for state intervention? Describe the process of electricity market deregulation and how this went wrong in California. Compare and contrast the experience in deregulation of California and Nordic electricity markets.
14.29
Sample Essay Question: Embodied Carbon Discuss the challenges to global regulation of carbon dioxide emissions presented by international trade in energy intensive goods. Include an explicit desciption of an analytic framework through which the carbon content of a country’s imports and exports can be quantified. Discuss the importance of carbon embodied in international trade for Switzerland.
14.30
Sample Essay Question: The End of Oil Describe what the world should expect with the “End of Oil”. Which countries play important roles in this process? In what ways do the Hubert and Hotelling models agree/disagree about the timing of peak oil? What is meant by “unconventional oil” and what role does this play in the market for liquid fuels?
14.31
7
Sample Essay Question: Natural Gas Describe the potential role of natural gas in European climate policy. What does market concetration (both in terms of producers and consumers) imply for the role of natural gas as a bridge to a low carbon future?
14.32
Sample Essay Question: Chinese growth and energy demand Describe some of the recent developments in Chinese energy markets. What factors have affected growth in energy demand over the past 20 years? What are some common misperceptions about Chinese energy markets?
14.33
Sample Essay Question: Market Power and Windfall Profits in Emissions Permit Markets Discuss the economic logic supporting the use of emission permit markets. What is the EU ETS? When was it created? How does it work? What markets does it cover? How is it to be introduced? What are alternative explainations for the erratic trends in permit prices during the first phase of this program?
14.34
8
Term Paper Assessments on the Final Examination You will be asked to indicate which five papers by your fellow students are the best among those submitted this term. You may not vote for your own paper. You should decide in advance of the final examination which five papers you like best and be prepared to write one or two sentences about why you think these are particularly good.
http://www.cepe.ethz.ch/education/EnergyPolicy/papers.html
1
14.2
An Overview of the Course
Generalities Our course objectives include: 1. Provide an introduction to the principles of energy economics and related policy applications. 2. Provide an introduction to environmental implications of energy use. 3. Provide and overview of the role of economic analysis in designing policies which address issues of energy security, climate change and related environmental externalities. 4. Examine the environmental implications of energy use and the role of economic analysis in the designing policies which address issues of energy security, climate change and other environmental externalities.
14.3
Ancillary Objectives Additional learning objectives of this course: 1. Provide an introduction to the use of models in energy policy analysis. 2. Introduce sources of energy market data, and the analysis of these data in Excel. 3. Provide an introduction to writing in economics. 14.4
Course Contents Lectures are organized as follows: 1. 2. 3. 4. 5.
Principles of energy analysis and economics Crude oil markets Electricity markets Natural gas markets Environmental challenges to energy use 14.5
Economic Concepts • • • • • • • •
Demand and supply elasticities Market equilibrium Tax incidence Natural monopoly Deregulation and privatization Market power under oligopoly Transaction-cost Externalities 1
• • • •
Public goods Monopsony Bilateral monopoly Game theory 14.6
2
An Overview of the Lectures
Economic Analysis of Competitive Markets I Microeconomics review: Marshallian market equilibrium (a) Market demand and market supply (b) Marginal willingess to pay/accept (c) Excise, sales, specific and ad-valorem taxes (d) Elasticities of supply and demand (e) Consumer and producer surplus (f) Tax revenue and deadweight loss II Some graphical examples of applied price theory (a) Price controls: maximum prices (b) Price controls: minimum prices (c) Minimum wage (d) The market for kidneys III Putting applied microeconomics to work (a) Calibration in applied microeconomics (b) A brief introduction to coal (c) Building an economic equilibrium model (d) Using an economic model 14.7
Carbon Footprint and Embodied Energy 1. Input-output analysis • Basic balance of production and consumption • Constant proportions: The basis for modeling • Calculating labor requirements and emissions 2. Embodied energy 3. Emissions embodied in trade 4. Implications for climate policy 14.8
The Coal Market Exercise 1. Find data on base year production, consumption and prices of coal in a collection of countries which collectively represent global coal supply and demand. 2. Calibrate a model to these data. 3. Perform counterfactural analysis by applying excise taxes in a subset of regions, corresponding to the Annex-B member states. 4. Evaluate the global leakage rate: `=
% increase in coal use in non-Annex B states % decrease in coal use in Annex B states
5. Does the leakage rate exceed 100% as is claimed by some critical of climate policy? 6. Investigate the proposition that The most interesting answer to any question in economics is: It depends. 14.9
2
Calibrated Linear Supply Functions In calibrated equilibrium models we can use a reference price, reference quantity and an elasticity of supply to define a linear supply function. That is, we can write: Ps Qs = Q¯ s 1 + ηS ¯ − 1 Ps where: Q¯ s is the reference supply quantity P¯s is the reference supply price Note that when Ps = P¯s , Qs = Q¯ s .
14.10
Calibrated Demand The own-price elasticity of demand (ηD < 0) is defined as: ηD =
% change quantity = % change price
∆Q QD ∆PD PD
and a demand function can be calibrated to match a reference price-quantity pair: PD QD (pD ) = Q¯ D 1 + ηD ¯ − 1 PD where: Q¯ D is the reference demand quantity P¯D is the reference demand price
14.11
Energy Economics Topics 1. 2. 3. 4. 5. 6. 7.
Energy and economic history Coal markets today Gas markets today CO2 impact on electricity dispatch Activity analysis The International Energy Agency A multiregional input-output model 14.12
Activity Analysis: An Example When there are a discrete set of production technologies, each characterized by a marginal cost and a capacity, the supply curve becomes a step function corresponding to the sorted sequence of plant capacities. Consider a market in which the commodity is supply by the following four technologies: a b c d
cj 2 5 7 10
kj 2 2 4 ∞ 14.13
Activity Analysis Supply Curve
3
P cd = 10
kd = +∞
cc = 7
kc = 4 cb = 5
kb = 1
ca = 2
ka = 2 2
7
4
Q 14.14
Market Equilibrium with Activity Analysis Consider a market equilibrium when there are multiple discrete supply technologies. As in the conventional continuous Marshallian model, the equilibrium price and quantity is defined by the intersection of the supply and demand schedules:
P cd = 10
cc = 7
cb = 5
ca = 2
2
4
7
Q 14.15
Market Equilibrium and Social Surplus A convenient property of the competitive market allocation is that it maximizes social surplus, as illustrated in this figure: P cd = 10
cc = 7
cb = 5
ca = 2
2
7
4
Q 14.16
4
Constrained Optimization Approach Let Qt ≥ 0 denote output from technology t, P denote the equilibrium price, PS and CS denote producer and consumer surplus. The market equilibrium then solves: max PS +CS subject to: • Market supply equals technology output: S = ∑ Qt t
• Market equilibrum price is on the demand curve: 5 P = 10 − S 6 • Producer surplus is the area below the market price and above the cost of production: PS = ∑(P − ct )Qt t
• Consumer surplus is the area under the demand curve: CS =
(10 − P) S 2
14.17
Geometric Interpretation of the Equilibrium P 10
7 CS∗ = 7.5
P∗ = 5
PS∗ = 6
2
2
S∗ = 3
7
4
Q 14.18
Generation Dispatch without Climate Policy
Vic Niemeyer, Electric Power Reseach Institute
14.19
5
Generation Dispatch with Climate Policy
Vic Niemeyer, Electric Power Reseach Institute
14.20
The End of Oil 1. 2. 3. 4. 5. 6. 7. 8. 9.
Peak Oil Proven Reserves and undiscovered Resources Top Five Oil-Producing Countries Oil Refining Bias in Oil Resource Estimates Role of Technology in Oil Production Unconventional Oil Hubbert Curves Hotelling’s Rule 14.21
Monopoly and Oligopoly 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Causes of monopolies – pure monopoly. Marginal revenue, marginal cost and profit maximization. Monopolistic pricing and monopoly markup. Efficiency cost of monopoly (deadweight loss) Regulation of natural monopoly. What is an oligopoly? Cournot competition and Nash equilibrium. Reaction curve and best response. Iso-profit lines. Collusion. 14.22
Energy-Economy Modeling 1. A calibrated model of world oil markets. 2. Use of Excel for solving economic equilibrium models. 3. Hogan and Manne: The Fable of the Elephant and the Rabbit. 14.23
Natural Gas Markets 1. Natural gas production, distribution and marketing 2. Historical development of natural gas markets in North America and Europe. 3. Equilibrium model illustrating distinction between competitive and oligopolistic markets. 14.24
6
Electricity Market Management – Nordic and California Experiences 1. 2. 3. 4. 5.
Lessons from successful and unsuccessful energy market reforms. Special characteristics of electricity. Market design issues in power markets. Competition issues: potential sources of market power and role of retail competition. Infrastructure regulation. 14.25
Energy, Poverty and Development 1. 2. 3. 4. 5. 6.
Non-commercial energy in India. Direct and indirect energy use. Energy access issues in third-world countries Energy poverty and public health. Energy poverty and development. Energy demand in China: past, present and future. 14.26
3
Two Sample Analytical Questions
Carbon Leakage Carbon Leakage. Consider a two region model of the market for coal. Coal supply is competitive and is characterized by a linear supply schedule. Output in regions A and B are initially equal, and the elasticity of supply equal to η in both regions. Demand for coal is likewise described by an identical linear schedule in each region. The price elasticity of coal demand is equal to σ . Region A introduces an environmental tax equal to τ. Region B has no tax. Compute the leakage rate as a function of τ, η and σ .
14.27
Activity Analysis Consider a market equilibrium in which there are several discrete supply technologies. The reference equilibrium is depicted as follows with a benchmark supply equal to 3. P cd = 10
cc = 7 cb = 5
ca = 2
2
4
7
Q
1. Indicate the value of consumer and producer surplus in this diagram. 2. How would the equilibrium price, quantity and social suplus would change if technology b were removed from the market. 3. What happens to the market equilibrium if a unit subsidy of 3 were applied on demand? 14.28
4
Some Sample Essay Questions
Sample Essay Question: The California Electricity Crisis What are special features of the market for electricity which call for state intervention? Describe the process of electricity market deregulation and how this went wrong in California. Compare and contrast the experience in deregulation of California and Nordic electricity markets.
14.29
Sample Essay Question: Embodied Carbon Discuss the challenges to global regulation of carbon dioxide emissions presented by international trade in energy intensive goods. Include an explicit desciption of an analytic framework through which the carbon content of a country’s imports and exports can be quantified. Discuss the importance of carbon embodied in international trade for Switzerland.
14.30
Sample Essay Question: The End of Oil Describe what the world should expect with the “End of Oil”. Which countries play important roles in this process? In what ways do the Hubert and Hotelling models agree/disagree about the timing of peak oil? What is meant by “unconventional oil” and what role does this play in the market for liquid fuels?
14.31
7
Sample Essay Question: Natural Gas Describe the potential role of natural gas in European climate policy. What does market concetration (both in terms of producers and consumers) imply for the role of natural gas as a bridge to a low carbon future?
14.32
Sample Essay Question: Chinese growth and energy demand Describe some of the recent developments in Chinese energy markets. What factors have affected growth in energy demand over the past 20 years? What are some common misperceptions about Chinese energy markets?
14.33
Sample Essay Question: Market Power and Windfall Profits in Emissions Permit Markets Discuss the economic logic supporting the use of emission permit markets. What is the EU ETS? When was it created? How does it work? What markets does it cover? How is it to be introduced? What are alternative explainations for the erratic trends in permit prices during the first phase of this program?
14.34
8
