Economics 331b

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• Economics 331b
• Finale on economics
• of energy regulation

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• We are heading into a major period of
  energy/climate-change regulations. Here are some
  of the major economic issues
• Rebound effect
• Energy efficiency standards affect the
  energy-intensity of new capital goods
• Because they lower the MC, they may increase
  utilization, leading to the rebound effect.
• Oil premium
• Increase oil use leads to higher oil world price
• This leads to higher total imports costs and
  macro disturbance
• Public finance issues
• Regulation and energy taxes lead to higher prices
• These lead to dead-weight loss when P gt MC
• This leads to double dividend hypothesis and to
  concern about using standards (with no revenues)
  instead of taxes (with revenues that can lower
  other taxes)
• Cost of capital/discounting (later on this one)

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Economics of rebound effect
Price of vmt
Effect of efficiency improvement
Rebound effect
Before mpg improvement
After mpg improvement
G
Gasoline consumption
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Economics of rebound effect

• Assume that regulation increases energy
  efficiency of a capital good from mpg0 to mpg1
  . The question is whether the lower cost of a vmt
  (vehicle-mile traveled) would offset the lower
  cost.

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Empirical estimates of rebound effect

• Basic results from many demand studies
• Short-run gasoline price-elasticity on vmt
  -0.10 (0.06)
• Long-run gasoline price-elasticity on vmt
  -0.29 (0.29)
• Therefore, the rebound would be 10 to 29 percent
  of mpg improvement.
• This can be applied to other areas as well.
• Reference Phil Goodwin, Joyce Dargay And Mark
  Hanly, Elasticities of Road Traffic and Fuel
  Consumption with Respect to Price and Income A
  Review, Transport Reviews, Vol. 24, No. 3,
  275292, May 2004, available at
  http//www2.cege.ucl.ac.uk/cts/tsu/papers/transpre
  v243.pdf

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Source UK Energy Research Centre, The Rebound
Effect
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Oil premium

• The oil premium refers to the excess of the
  social marginal cost of oil consumption over the
  private marginal cost.
• Analytically, this is

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Monopsony premium

• Basic argument. The point is that the US has
  market power in the world oil market. By levying
  tariffs, we can change the terms of trade (oil
  prices) in our favor.
• Regulation and taxes are a substitute for the
  optimum tariff.
• Example
• world supply curve to US Q Bp? , ?gt0
• US cost of imported oil V pQ B-1Q(11/ ?) ,
  k an irrelevant constant
• marginal cost of imported oil V(Q) (11/?)
  B-1Q1/ ? p (11/ ?)
• So optimal tariff is ad valorem
• t 1/ ? inverse elasticity of supply of
  imports
• Reference D. R. Bohi and W. D. Montgomery,
  Social Cost of Imported Oil and UU Import
  Policy, Annual Review of Energy, 1982, 7, 37-60.

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Basics of deriving oil (monopsony) premium

• Here is a more rigorous proof of the oil-import
  premium

Notes (1) This does not have to be a tariff. It
is really a shadow price on oil imports. (2)
Example of Ramsey tax theory.
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The monopsony premium
P, MC of oil
MSC
S
Import premium at free-market imports
Optimal Tariff at Optimized oil imports
D
Imported oil
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Q(free market)
Q(optimal)
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Macroeconomic externality

• Somewhat more tenuous is the macroeconomic
  externality.
• Idea is that there are impacts of changes in oil
  prices on macro economy because of inflexible
  wages and prices.
• So have another linkage
• The second term was discussed in optimal tariff.
  The first term comes from macroeconomics (see
  next slide).
• This, however, is very controversial and the
  estimates are not robust.

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Macroeconomic externality

• A standard macro/oil-price equation with good
  results.

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Macroeconomic externality

• Simplified derivation
• We can also derive that monopsony/macro
  eGDP/pQ

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Updated estimates
Cited in Hillard G. Huntington, The Oil Security
Problem, EMF OP 62, February 2008.
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Numerical example for US
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Optimal tariff argument on oil taxes

• t 1/ ? inverse supply elasticity.
• Complications Formula actually is
• Some notes
• Supply elasticity depends critically on whether
  oil market is at full capacity (2007 v. 2009).
  Very inelastic in full capacity short run quite
  elastic when OPEC adjusts supply. (See next
  slide.)
• The optimal tariff in terms depends upon the
  initial price because it is an ad valorem tariff.
• The externality is a global externality for
  consuming countries because it is a globalized
  market.
• Note this is a pecuniary, not a technological
  externality. So it is a zero-sum (or slightly
  negative-sum) game for the world. This has
  serious strategic implications and suggest that
  the diplomacy of the oil-price externality is
  completely different from true global public
  goods like global warming.
• le

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Price
Short-run production capacity
Production
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The double dividend hypothesis

• Some have argued that using ecological or
  environmental taxes has a double dividend
• Get environmental benefit when P lt MSB.
• Can use revenues from ecological taxes to reduce
  other burdensome taxes
• In economics, the burden is measured as
  deadweight loss (DWL)
• Related issue in current context is whether the
  additional debt incurred by the stimulus package
  has such high DWL that the net economic effect is
  negative (Kevin Murphy).

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The dead weight loss of taxes/regulation
P, MC of oil
If add new taxes (regulation) Additional
revenues D B Additional DWL C
B MDWL/Mtaxes (CB)/D-B)
(B)/D-B) When are you on the wrong side of the
peak of the Laffer curve?
S T1 T2
P2
D
C
S T1
P1
E
B
S
A
P0
Imported oil
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Thoughts on double dividend hypothesis

• Do not have DWL if raising price to the Pigovian
  level actually lowing the DWL from a subsidy
• Actually a little more complicated because need
  to look at existing taxes (e.g., gasoline) and
  complementarity/substitution patterns with other
  goods and services.
• 2. A regulation is a tax with the revenues
  rebated to the polluter. If use regulations
  rather than taxes, you therefore lose the second
  half of the double dividend.
• This is key argument in cap and trade v. carbon
  taxes (or more generally regulation v. taxes)
• 3. If standards are beyond Pigovian levels, then
  can incur serious DWL if do not attend to the
  revenue side of the issue.
• 4. Empirical estimates of MDWL of taxes all over
  the place from 0.2 to 2 per dollar of revenue.