Energy Efficiency Efficiency or Monopsony Tim Brennan Professor
Energy Efficiency: Efficiency or Monopsony Tim Brennan Professor, Public Policy and Economics, UMBC Senior Fellow, Resources for the Future brennan@umbc. edu 7 th International Industrial Organization Conference Boston, MA Apr. 5, 2009 Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA
Energy efficiency definition, backdrop • More energy service per unit of energy consumed o CFL, high “efficiency” AC, etc. • Long-time interest increasing o Excessive energy use due to lack of effective real-time pricing o Greenhouse gas emissions o NIMBY concerns regarding generator, transmission expansion • But reasons to question what’s going on • Maryland electricity policy principles o People use too much electricity o But the price is too high, implying too little consumption o Requires consumer “cognitive limitations” Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 2
Slogans that sound good, but … • “The cheapest power plant is the one you don’t build” • Would we say this about … o o … schools? … vaccines? … art? … academic conferences? • Or anything else, without checking on WTP? • Possible justifications for WTP < cost o Time-averaged rates rather than peak MC o Environmental costs not internalized o And, for some, that consumers can’t figure out how to reduce demand Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 3
But another possibility - monopsony • Not efficient, but maximizing consumer welfare • Object less electricity to keep the price down • How to get around the rationing problem? o Inefficient rationing of excess demand at monopsony price can reduce consumer welfare, let alone total • Subsidize electricity “efficiency” investments to hold down price and ration demand • Key result: Subsidize efficiency o Like “theory of second best” but where market price is too high by consumer welfare standard Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 4
General issue: Total vs. Consumer Welfare • Motivated by continuing antitrust debate • Should benefits to firms mitigate losses to consumers o Williamson “rectangles beat triangles” • Fisher and Lande, Pittman argue otherwise o Congressional intent o Distributional assumptions o Institutional biases against enforcement; multiple hurdles • Heyer, Carlton o Traditional efficiency grounds o Eventual pass through • Note: Broad policy analysis gives profit some weight Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 5
Results here • Overview of monopsony (to be skipped) o Except to note that consumer welfare increased by holding down price if marginal cost not perfectly elastic • The rationing problem: more restrictive condition for monopsony to increase consumer welfare • Turn to efficiency, first social optimum • If supply less than perfectly elastic, consumer welfare increased by subsidy of energy efficiency, even if consumers (one way or another) cover all costs of energy efficiency • Conclude with caveats; antitrust “welfare” debate Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 6
The monopsony rationing problem • Assume equal probability of purchase at any WTP price P deman d consumer surplus gain from lower prices comp P monopsony Q Brennan: Efficiency or Monopsony? efficient Q consumer surplus loss from rationing P= MC marginal cost MC quantity Q 7 th IIOC: Boston, MA 7
Conditions for rationing to trump monopsony • When does the lost surplus from proportional rationing outweigh the gains from lower prices, at the margin? • Demand relatively elastic o Increased demand at lower price increases rationing fraction • Supply relatively elastic o Greater reduction in supply increases rationing fraction • Formal condition for rationing to trump monopsony • es + |ed| > • Sum of absolute value of elasticities exceeds ratio of revenue to consumer surplus at competitive price Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 8
Introducing energy efficiency • Energy efficiency investments shift electricity demand • Pivot, not decline – otherwise, efficiency reduces consumer surplus p p Q(p, x) Q(p, x + dx) Q(p, x) Q • “Rebound effect” inevitable at sufficiently high prices • Assume that efficiency, use are substitutes Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 9
Efficient energy efficiency • Let: o q be energy use produced at cost c(q); o x be energy efficiency produced at cost h(x); o w(q, x) be willingness to pay for qth unit of energy with x units of efficiency in place • Welfare given by • First-order conditions are w(q, x) = c'(q) • Both are marginal WTP = marginal cost Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 10
Regulator cares only about consumer welfare • Maximize consumer welfare subject to o “Efficiency” costs covered o Price of electricity equals marginal cost • First-order condition for energy efficiency becomes • Can show that λ < q from the first-order condition for energy use, if supply not perfectly elastic • Because wx <0, efficiency price less than marginal cost • Max only consumer welfare => subsidize efficiency! Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 11
Caveats • Would a consumer-oriented regulator monopsonize? o Price discriminate instead? o If set p and q together, choose q to maximize total surplus and then choose p = AC to transfer all surplus to consumers • Could a consumer-oriented regulatory monopsonize? o Not all states have market power in relevant wholesale markets o But some (CA, NY, TX) likely do o Also, may be intrastate “load pockets” when peak demand constrains transmission capacity Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 12
Is electricity susceptible to monopsony? • General picture: “hockey stick” pricing • Misleading portrait of “marginal cost” o But high demand happens less frequently o Less time to recover capital costs o Hence, competitive prices typically exceed MC at quantities below that supplied • But would monopsony then be legal? o Profits arise from foregoing opportunity to recover capital cost o Violates FPC v. Hope Natural Gas (1944) legal standard o Essentially, precludes “taking” of regulated firm capital Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 13
Back to total vs. consumer welfare • Recap results, first o A consumer-oriented regulator, to monopsonize, may have to solve rationing problem o Would subsidize efficiency to do so o Hence, efficiency subsidy programs could be monopsony o Caveats on incentive, ability, and legality important • Consumer, not total welfare isn’t just antitrust (ex. Can. ) • But it is unusual, compared to all policies o Even equity-related policies typically require recognition of spectrum of effects, at least for political feasibility • Lesson: The consumer vs. total welfare debate may actually matter more for regulation Brennan: Efficiency or Monopsony? 7 th IIOC: Boston, MA 14
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