How Does The Cost Of Energy Affect Long-Term Growth

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• Energy o How does the cost of energy (c) affect long-term growth? o How does the energy intensity (e) affect long-term growth? o Can expensive energy lead to economic decline? Must it?
• Backstops: renewability, efficiency
• Depletable goods
• Substitutability of capital & resources
• Low substitutability between energy & GDP, but high substitutability between various kinds of energy
• Outcomes & efficiency o Reasons for inefficiency:
• Monopoly
• Producer externalities: pollution, tragedy of the commons
• Consumer externalities: pollution, congestion
• Declining marginal costs of production (natural monopolies)
• Non-rival consumption (scientific ideas, digital music)
• Non-excludable consumption (national defense, clean streets) o Efficient outcome: a situation in which it is not possible to raise one individual’s wellbeing without reducing the wellbeing of others; aka pareto efficiency. There is no waste which can be eliminated to somebody’s benefit. o Equitable outcome: fair or just outcome according to moral code or measure of social wellbeing or theory of justice. Not what is decided by markets or efficiency. o Sustainable outcome: use of resources that preserves valued resources for future generations. Requires inter-temporal judgments, in a world where the future cannot look after itself. o Efficiency, equity and sustainability are tradeoffs and countries behave differently on what is the optimal tradeoff for them. o Example: open access to lake; monopoly; depleting fish; regulation; efficiency. o Market equilibrium: the outcome of individual decisions by separate businesses and consumers interacting in the marketplace. It is characterized by the decentralization of decision-making. But the market fails in the case of an open-access commons. o Inefficiency
• Market fails:
• Externalities
• When MC < AC
• When goods are non-rival (your enjoyment does not diminish other people’s use of it; every consumer benefits from an extra unit of Q) or non-excludable (everyone has unrestricted access to it)
• Static (now) vs dynamic inefficiency (future): in the case of depletable goods, if you harvest now more than you need/could/should, it is gonna affect the dynamic efficiency because you reduce the future value to zero as the good depletes
• Dynamic inefficiency:
 Too much exploitation of a resource today compared with the future, which reduces the present value of income.
• Static inefficiency:
 Too many units of physical capital to harvest the amount of resources harvested today
• Problems with open-access resources:
 Congestion
 Lack of protection of future capacity of the resource
 Impatience with slow rate of natural replacement o There is no guarantee that a free market is going to put the level of extraction at a sustainable level and at the maximum level of extraction Instruments for a mixed economy o The present gets more of a depletable good due to its rising price (like energy). Notice that the cheaper fossil fuel gets used up first and then the more expensive backstop technology comes on line. The “backstop” price falls, because of a technological innovation, so it is worth investing in R&D.
• PV = FV/(1+r)t ; FV = PV (1+r)t
• Rate of return: r = (ΔCt+1/ΔCt) – 1
• Price of future goods: P1 = 1 / (r+1)
• Mixed economy o 1) Property rights: can slow the depletion of natural resources compared with the “Commons” o 2) Regulation o 3) Permits (tradable or not) o 4) Taxes (and corrective taxation) o Differences between them: ease of administration, who collects the revenues, uncertainty o Negotiation is also a strategy to deal with externalities o Redistribution
• Social insurance (unemployment, disability)
• Merit goods (health, education)
• Income transfers
• Retirement security o Public goods and market failure
• Regulation (e.g. environment, finance)
• Infrastructure
• Science and technology
• Public institutions (central banking)
•
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