Economics 331b

1

• Economics 331b
• Energy Regulation

2
Reasons for Regulation of Oil-Using Capital

• Externalities
• Local pollution
• Climate change
• Congestion
• Road accidents
• Macroeconomic/trade
• Impact of oil price on business cycle
• Optimal tariff
• Political/military
• Imperfect decisionmaking
• Discounting
• Split incentives
• Poor information

3
First-best policy options
4
Inefficiencies with using second-best
energy-regulatory policies

• Ineffective because so far from target (example
  of CAFE standards and congestion).
• Ineffective because of rebound effect which
  arises when target wrong input (capital instead
  of fuel).
• Ineffective because covers such a small fraction
  of market (automobiles in global carbon market).
• Not cost-beneficial if already have energy taxes.

5
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.
• Here is the basic economics

6
Economics of rebound effect

• Basic results from many demand studies
• Short-run gasoline price-elasticity on vmt
  -0.1 (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

7
Discounting Issues

• A common concern is that private-sector decision
  makers use discount rates that are higher than
  social discount rate.
• Each of these issues has a different policy
  implication
• Taxation capital taxes lead to wedge between
  social and private.
• Social underinvestment leads to overall rate of
  return lower than social marginal utility
• Behavior stuff People cant count
• Capital market imperfections Liquidity
  constraints mean that the cost of capital to
  individuals is above-market because of borrowing
  constraints, bankruptcy,
• Risk/CCAPM Investment has high correlation with
  total output (or more properly the MU of
  consumption)

8
Optimal tariff argument on oil taxes

• 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.

9
Supply of oil imports into the US
For numerical assumptions, see next slide.
10
Numerical example for US
11
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

12
Price
Short-run production capacity
Production