Energy, Externalities & ClimateEmissions &

Energy, Externalities & Climate
Emissions & ExternalitiesMuch of energy produced and used in
U.S. and around the world is from fossil fuelsBurning fossil
fuels yield air-borne emissionsSO2NOxCH4VOCPM2.5Mercury
(from coal)CO2
Emissions & ExternalitiesMuch of energy produced and used in
U.S. and around the world is from fossil fuelsBurning fossil
fuels yield air-borne emissionsSO2NOxCH4VOCPM2.5Mercury
(from coal)CO2So??Damage to natural environment,
cropsDamage to buildings, infrastructureMost important of all –
ill health and even deathCO2 – greenhouse gas that can affect
climate
EmissionsOK, sure there is some bad stuff coming from fossil
fuels, but they yield a tremendous amount of valuable, low -cost
energyThe economic problem is negative externalities. If the

people who produce and/or consume fossil fuels actually
(somehow) bear the costs and adverse consequences of
emissions, then you could say the benefits of this energy
outweigh the costs.But if NOT then this
production/consumption imposes negative externalities on
others. As a result, too many fossil fuels are produced and
consumed.
Energy and the EnvironmentBefore Climate Change (BCC)
EraMajor environmental challengesAcid rain – SO2 and NOx
emissions from burning coalUrban smog and air pollution –
mainly from NOx , PM, and VOC from cars/trucksPolicies in
BCC EraClean Air Act Amendments of 1990Established EPA
Acid Rain Program – Innovative Cap & Trade
ProgramRestricted auto emissions via technology standards
(e.g., catalytic converters), tighter CAFÉ standards, and blended
fuel requirements
Energy and Climate Change
Energy and Climate ChangeProduction and consumption of
fossil fuels results in greenhouse gas (GhG) emissions – mainly
CO2 and CH4 (methane)The greenhouse effect from GhG
emissions results in climate change – a multi-faceted
impactHow has CO2 in atmosphere been changing?

Energy and Climate ChangeProduction and consumption of
fossil fuels results in greenhouse gas (GhG) emissions – mainly
CO2 and CH4 (methane)The greenhouse effect from GhG
emissions results in climate change – a multi-faceted
impactHow has CO2 in atmosphere been changing?And what are
the impacts of this?
Economic Analysis of Environmental ImpactsBefore we go too
far into climate issues, let’s look at how we can analyze
environmental policy related to energy issues.And look at
lessons from prior environmental policy efforts
Model of emissions regulationTwo sides of emissionsDamages –
Changes in emissions result in marginal cost of emissionsFor
CO2, we refer to MC of emissions as Social Cost of Carbon
(SCC)“Benefits” – Emissions are a side-effect of productive

economic activity (like burning natural gas to generate
electricity)Marginal benefit (MB) of emissions is extra benefi t
as emissions increase.Mirror image of MB is marginal
abatement cost of reducing emissions.
Managing Emissions Externalities
$
E
MB
MC
$
E
MB
MC
abatement
marginal abatement cost
Social Optimum
$
E
MB
MC

abatement
social optimum
emissions
Policy OptionsDo NothingSo called business as usualEmissions
TaxWhere do tax revenues go?Emissions CapTechnology
Standard(s)Cap and Trade ProgramIssue emissions permits
equal to capped emissions levelAuction off permits or give
away (grandfather)
$
E
MB
MC
abatement
$
E
MB
MC
abatement

$
E
MB
abatement
CAP
Cap & Trade
$
E
MB
abatement
CAP
Measuring Economic Damages from EmissionsA wide variety of
damagesContaminated air and water, damage to crops,
illness/deathTwo main approaches for measuring
damagesContingent ValuationAsk people about WTP for better
environmental quality, reduced health/mortality risksBased on
survey or questionnaire responsesMarket-based
ValuationIndirect method to reveal WTP for enviro quality,
reduced health/mortality risksBased on market price or wage
changes as enviro quality, health/mortality risks vary

Illustration – Mortality RiskSuppose you knew for sure that
reducing air emissions by some amount would save one life; you
don’t know which person’s life, just that one life is saved. How
much is this worth in dollars? How much should society and
policy-makers value this life?
policy-makers value this life?Gov. Andrew Cuomo: “My
mother’s not expendable. You cannot put a value on human life.
You do the right thing. That’s what Pop taught us.”But let’s
suppose you needed to come up with a $ value for saving a life
– how would you do it? What would you come up with?
policy-makers value this life?Gov. Andrew Cuomo: “My
mother’s not expendable. You cannot put a value on human life.
You do the right thing. That’s what Pop taught us.”But let’s
suppose you needed to come up with a $ value for saving a life
– how would you do it? What would you come up with?
Putting an economic value on lifeContingent Valuation
ApproachGather survey responses about (hypothetical) WTP to

avoid various mortality risks [reduced auto crash risk,
workplace death risk, etc.]
From EPA website …
In the scientific literature, these estimates of willingness to pay
for small reductions in mortality risks are often referred to as
the "value of a statistical life.” This is because these values are
typically reported in units that match the aggregate dollar
amount that a large group of people would be willing to pay for
a reduction in their individual risks of dying in a year, such that
we would expect one fewer death among the group during that
year on average.
From EPA website …
This is best explained by way of an example. Suppose each
person in a sample of 100,000 people were asked how much he
or she would be willing to pay for a reduction in their
individual risk of dying of 1 in 100,000, or 0.001%, over the
next year. Since this reduction in risk would mean that we
would expect one fewer death among the sample of 100,000
people over the next year on average, this is sometimes
described as "one statistical life saved.”
Now suppose that the average response to this hypothetical
question was $100. Then the total dollar amount that the group
would be willing to pay to save one statistical life in a year
would be $100 per person × 100,000 people, or $10 million.
This is what is meant by the "value of a statistical life.”
Importantly, this is not an estimate of how much money any
single individual or group would be willing to pay to prevent
the certain death of any particular person.

Putting an economic value on lifeMarket-based Valuation
ApproachCompensating wage differences – how do wages differ
across occupations as mortality risk varies?You can find this via
regression analysis of market wage dataCan derive VSL – value
of a statistical life – based on the mortality risk coefficient in a
wage regression.
Earnings Regression Approach
Run a regression of annual income (I) on explanatory variables
including occupation (OCCP) and mortality rate for jobs in
occupation (MORT), where MORT indicates number of deaths
per 100,000 workers per year.
I = a + b*EDUC + c*OCCP + d*MORT + … + error
How do you interpret d coefficient?
Earnings Regression Approach
Run a regression of annual income (I) on explanatory variables
including occupation (OCCP) and mortality rate for jobs in
occupation (MORT), where MORT indicates number of deaths
per 100,000 workers per year.
I = a + b*EDUC + c*OCCP + d*MORT + … + error
d = △I/ △MORT = Change in annual income for having one
more death/100,000 per year.
VSL = d*100,000

Unique Environmental Challenges Posed by Climate
ChangeHealthy climate is global public goodMultiple large
uncertaintiesInequality and welfare analysisLong-term
persistent impactsRole of discount rate for NPV analysis
Climate, the Economy, and Climate PolicyMany areas of the
natural and social sciences involve complex systems that link
multiple areas and disciplines. This is particularly true for the
science, economics, and policy of climate change, which
involve a wide variety of fields from atmospheric chemistry to
game theory.Integrated assessment analyses and models play a
key role in putting the pieces together. Integrated assessment
models (IAMs) integrate knowledge from two or more domains
into a single framework. These are sometimes theoretical but
are increasingly computerized, empirical, dynamic, non-linear
models of varying levels of complexity.
Climate, the Economy, and Climate PolicyMany areas of the
natural and social sciences involve complex systems that link
multiple areas and disciplines. This is particularly true for the
science, economics, and policy of climate change, which
involve a wide variety of fields from atmospheric chemistry to

game theory.Integrated assessment analyses and models play a
key role in putting the pieces together. Integrated assessment
models (IAMs) integrate knowledge from two or more domains
into a single framework. These are sometimes theoretical but
are increasingly computerized, empirical, dynamic, non-linear
models of varying levels of complexity.
STERN REVIEW: The Economics of Climate Change
iv
Figure 1 Greenhouse-gas emissions in 2000, by source
Power
(24%)
Transport
(14%)
Buildings
(8%)
Industry (14%)
Other energy
related (5%)
Waste (3%)
Agriculture
(14%)

Land use
(18%)
NON-ENERGY
EMISSIONS
ENERGY
EMISSIONS
Energy emissions are mostly CO2 (some non-CO2 in industry
and other energy related).
Non-energy emissions are CO2 (land use) and non-CO2
(agriculture and waste).
Total emissions in 2000: 42 GtCO2e.
Source: Prepared by Stern Review, from data drawn from
World Resources Institute Climate
Analysis Indicators Tool (CAIT) on-line database version 3.0.
Under a BAU scenario, the stock of greenhouse gases could
more than treble by the
end of the century, giving at least a 50% risk of exceeding 5°C
global average
temperature change during the following decades. This would
take humans into
unknown territory. An illustration of the scale of such an
increase is that we are now
only around 5°C warmer than in the last ice age.
Such changes would transform the physical geography of the
world. A radical
change in the physical geography of the world must have

powerful implications for
the human geography - where people live, and how they live
their lives.
Figure 2 summarises the scientific evidence of the links
between concentrations of
greenhouse gases in the atmosphere, the probability of different
levels of global
average temperature change, and the physical impacts expected
for each level. The
risks of serious, irreversible impacts of climate change increase
strongly as
concentrations of greenhouse gases in the atmosphere rise.
iv
Figure 1 Greenhouse-gas emissions in 2000, by source
Power
(24%)
Transport
(14%)
Buildings
(8%)
Industry (14%)
Other energy
related (5%)
Waste (3%)
Agriculture
(14%)
Land use
(18%)
NON-ENERGY
EMISSIONS

ENERGY
EMISSIONS
Energy emissions are mostly CO
2
(some non-CO
2
in industry and other energy related).
Non-energy emissions are CO
2
(land use) and non-CO
2
(agriculture and waste).
Total emissions in 2000: 42 GtCO2e.
Source: Prepared by Stern Review, from data drawn from
World Resources Institute Climate
Analysis Indicators Tool (CAIT) on-line database version 3.0.
Under a BAU scenario, the stock of greenhouse gases could
more than treble by the
end of the century, giving at least a 50% risk of exceeding 5°C
global average
temperature change during the following decades. This would
take humans into
unknown territory. An illustration of the scale of such an
increase is that we are now
only around 5°C warmer than in the last ice age.
Such changes would transform the physical geography of the
world. A radical
change in the physical geography of the world must have
powerful implications for
the human geography - where people live, and how they live
their lives.

Figure 2 summarises the scientific evidence of the links
between concentrations of
greenhouse gases in the atmosphere, the probability of different
levels of global
average temperature change, and the physical impacts expected
for each level. The
risks of serious, irreversible impacts of climate change increase
strongly as
concentrations of greenhouse gases in the atmosphere rise.
v
Figure 2 Stabilisation levels and probability ranges for
temperature increases
The figure below illustrates the types of impacts that could be
experienced as the world comes into
equilibrium with more greenhouse gases. The top panel shows
the range of temperatures projected at
stabilisation levels between 400ppm and 750ppm CO2e at
equilibrium. The solid horizontal lines indicate
the 5 - 95% range based on climate sensitivity estimates from
the IPCC 20012 and a recent Hadley
Centre ensemble study3. The vertical line indicates the mean of
the 50th percentile point. The dashed
lines show the 5 - 95% range based on eleven recent studies4.
The bottom panel illustrates the range of
impacts expected at different levels of warming. The
relationship between global average temperature

changes and regional climate changes is very uncertain,
especially with regard to changes in
precipitation (see Box 4.2). This figure shows potential changes
based on current scientific literature.
1°C 2°C 5°C4°C3°C
Risk of weakening of natural carbon absorption and possible
increasing
natural methane releases and weakening of the Atlantic THC
400 ppm CO2e
450 ppm CO2e
550 ppm CO2e
650ppm CO2e
750ppm CO2e
5% 95%
Sea level rise threatens
major world cities, including
London, Shanghai, New
York, Tokyo and Hong Kong
Falling crop yields in many developing regions FoodFood
WaterWater
EcosystemsEcosystems
Risk of rapid Risk of rapid

climate climate
change and change and
major major
irreversible irreversible
impactsimpacts
Eventual Temperature change (relative to pre-industrial)
0°C
Rising crop yields in high-latitude developed
countries if strong carbon fertilisation
Yields in many developed regions
decline even if strong carbon fertilisation
Large fraction of ecosystems unable to maintain current form
Increasing risk of abrupt, large-scale shifts in the
climate system (e.g. collapse of the Atlantic THC
and the West Antarctic Ice Sheet)
Significant changes in water availability (one
study projects more than a billion people suffer
water shortages in the 2080s, many in Africa,
while a similar number gain waterSmall mountain glaciers
disappear worldwide –
potential threat to water
supplies in several areas Greater than 30% decrease
in runoff in Mediterranean
and Southern Africa
Coral reef ecosystems
extensively and

eventually irreversibly
damaged
Possible onset of collapse
of part or all of Amazonian
rainforest
Onset of irreversible melting
of the Greenland ice sheet
Extreme Extreme
Weather Weather
EventsEvents
Rising intensity of storms, forest fires, droughts, flooding and
heat waves
Small increases in hurricane
intensity lead to a doubling of
damage costs in the US
Many species face extinction
(20 – 50% in one study)
Severe impacts
in marginal
Sahel region
Rising number of people at risk from hunger (25
– 60% increase in the 2080s in one study with
weak carbon fertilisation), with half of the
increase in Africa and West Asia.
Entire regions experience
major declines in crop yields

(e.g. up to one third in Africa)
2 Wigley, T.M.L. and S.C.B. Raper (2001): 'Interpretation of
high projections for global-mean warming', Science 293:
451-454 based on Intergovernmental Panel on Climate Change
(2001): 'Climate change 2001: the scientific basis.
Contribution of Working Group I to the Third Assessment
Report of the Intergovernmental Panel on Climate Change'
[Houghton JT, Ding Y, Griggs DJ, et al. (eds.)], Cambridge:
Cambridge University Press.
3 Murphy, J.M., D.M.H. Sexton D.N. Barnett et al. (2004):
'Quantification of modelling uncertainties in a large
ensemble of climate change simulations', Nature 430: 768 - 772
4 Meinshausen, M. (2006): 'What does a 2°C target mean for
greenhouse gas concentrations? A brief analysis based
on multi-gas emission pathways and several climate sensitivity
uncertainty estimates', Avoiding dangerous climate
change, in H.J. Schellnhuber et al. (eds.), Cambridge:
Cambridge University Press, pp.265 - 280.
v
Figure 2 Stabilisation levels and probability ranges for
temperature increases
The figure below illustrates the types of impacts that could be
experienced as the world comes into
equilibrium with more greenhouse gases. The top panel shows
the range of temperatures projected at
stabilisation levels between 400ppm and 750ppm CO
2
e at equilibrium. The solid horizontal lines indicate
the 5 - 95% range based on climate sensitivity estimates from
the IPCC 2001

2
and a recent Hadley
Centre ensemble study
3
. The vertical line indicates the mean of the 50
th
percentile point. The dashed
lines show the 5 - 95% range based on eleven recent studies
4
. The bottom panel illustrates the range of
impacts expected at different levels of warming. The
relationship between global average temperature
changes and regional climate changes is very uncertain,
especially with regard to changes in
precipitation (see Box 4.2). This figure shows potential changes
based on current scientific literature.
1°C2°C 5°C4°C3°C
Risk of weakening of natural carbon absorption and possible
increasing
natural methane releases and weakening of the Atlantic THC
400 ppm CO
2
e
450 ppm CO
2
e
550 ppm CO
2
e
650ppm CO
2
e
750ppm CO
2
e

5% 95%
Sea level rise threatens
major world cities, including
London, Shanghai, New
York, Tokyo and Hong Kong
Falling crop yields in many developing regions
Food
Food
Water
Water
Ecosystems
Ecosystems
Risk of rapid
Risk of rapid
climate
climate
change and
change and
major
major
irreversible
irreversible
impacts
impacts
Eventual Temperature change (relative to pre-industrial)
0°C
Rising crop yields in high-latitude developed
countries if strong carbon fertilisation
Yields in many developed regions
decline even if strong carbon fertilisation
Large fraction of ecosystems unable to maintain current form
Increasing risk of abrupt, large-scale shifts in the
climate system (e.g. collapse of the Atlantic THC
and the West Antarctic Ice Sheet)
Significant changes in water availability (one
study projects more than a billion people suffer

water shortages in the 2080s, many in Africa,
while a similar number gain water
Small mountain glaciers
disappear worldwide –
potential threat to water
supplies in several areas
Greater than 30% decrease
in runoff in Mediterranean
and Southern Africa
Coral reef ecosystems
extensively and
eventually irreversibly
damaged
Possible onset of collapse
of part or all of Amazonian
rainforest
Onset of irreversible melting
of the Greenland ice sheet
Extreme
Extreme
Weather
Weather
Events
Events
Rising intensity of storms, forest fires, droughts, flooding
andheat waves
Small increases in hurricane
intensity lead to a doubling of
damage costs in the US
Many species face extinction
(20 –50% in one study)
Severe impacts
in marginal
Sahel region
Rising number of people at risk from hunger (25
–60% increase in the 2080s in one study with

weak carbon fertilisation), with half of the
increase in Africa and West Asia.
Entire regions experience
major declines in crop yields
(e.g. up to one third in Africa)
2
Wigley, T.M.L. and S.C.B. Raper (2001): 'Interpretation of
high projections for global-mean warming', Science 293:
451-454 based on Intergovernmental Panel on Climate Change
(2001): 'Climate change 2001: the scientific basis.
Contribution of Working Group I to the Third Assessment
Report of the Intergovernmental Panel on Climate Change'
[Houghton JT, Ding Y, Griggs DJ, et al. (eds.)], Cambridge:
Cambridge University Press.
3
Murphy, J.M., D.M.H. Sexton D.N. Barnett et al. (2004):
'Quantification of modelling uncertainties in a large
ensemble of climate change simulations', Nature 430: 768 - 772
4
Meinshausen, M. (2006): 'What does a 2°C target mean for
greenhouse gas concentrations? A brief analysis based
on multi-gas emission pathways and several climate sensitivity
uncertainty estimates', Avoiding dangerous climate
change, in H.J. Schellnhuber et al. (eds.), Cambridge:
Cambridge University Press, pp.265 - 280.
CI Report for CP Drain Cleaning
Introductory Information
Analyst name (student)
Client name
Competitor name
Date of report
Executive Summary

One paragraph, straight to the point on the biggest issue and
how to solve it
Main Report
· Describe the client’s services (what do they offer)
· Describe the competitor’s services
· Describe the strengths of the competitor’s website - what do
they do well? (Hint: use both a visual review of the site as well
as the Hubspot Marketing Grader)
· Describe the weaknesses of the competitor’s website - what do
they do well? (Hint: use both a visual review of the site as well
as the Hubspot Marketing Grader)
· Describe what you think are strengths and weaknesses of the
competitor’s overall business.
Conclusions and Recommendations
· Describe how CP Drain Cleaning can improve their website
and business to better compete with the analyzed competitor.
Electricity Restructuring
and Competition
Electricity MarketsTraditional Organization of Electricity
Provision in U.S.Govt regulated, vertically integrated public
utilitiesLast 25 YearsWave of restructuring and introduction of
electricity trading and competition across U.S. and other
nationsNow large-scale wholesale electricity markets operate

across many parts of U.S.
Factors leading to restructuring & deregulation
Prior track record of deregulating energy markets and other
industries once considered natural monopolies
telecomm, airlines, railroads,
High electricity prices in spite of regulation
In U.S. states such as NY, California, New England
In other countries, such as U.K.
As the U.S. electricity transmission grid was built out in the
2nd half of 20th century, electric utilities started buying and
selling energy from each other
This illustrated feasibility of trading energy across the grid in
markets
Political Push
2nd Bush President
Electricity Restructuring – A How-To GuideUnbundle
generation from transmission and distributionIt’s important to
allow multiple business firms to own and operate generation
plants (independent power producers (IPPs) or merchant
generators)This may require forcing some vertically integrated
IOUs to divest some of their generation assets

Electricity Restructuring – A How-To GuideEstablish an
organized market for wholesale electricity tradingSellers are
firms like merchant generators that inject energy into the
gridBuyers are retail distributors and industrial users that
withdraw energy from the gridMarket rules might include an
advance-trading (e.g., day-ahead) market as well as a real-time
balancing market
Electricity Restructuring – A How-To GuideSet up an
organization to manage and coordinate energy flows over the
gridThis could be an independent system operator (ISO) or a
regional transmission organization (RTO)Key
responsibilitiesBalance energy supply and demand in real
timeMaintain system reliabilityCoordinate new transmission
investments
Wholesale Market Competition
Electricity Restructuring – A How-To GuideRetail
distributionOwnership and operation of local distribution
networks would typically continue as regulated public utilities
(natural monopoly rationale)But it is feasible to introduce retail
competition via brokers and energy re-sellers who purchase
wholesale energy, re-sell it to retail customers, and pay fees to
local distribution companies for use of the local network.

Wholesale Electricity MarketsLet’s examine a perfect
competition model of a short-run (hourly) wholesale electricity
marketDemand SideDemand varies hour by hour, as weather
conditions and desired electricity usage changeVery price
inelastic – most retail customers pay fixed retail pricesSupply
SideMost supply comes from fossil fuel generatorsFF supply is
driven by cost of generation and capacities of generation
units.Generation from renewables is intermittent
Fossil Fuel Generation and SupplySupply curve from FF
generation is comprised of a series of steps –Width of step is
generation capacity of a unitHeight of step is marginal cost
(MC) of the unitFF MC of generationMC = heat rate x fuel cost
+ emissions rate x emissions tax rate
Generation Example
Type Marginal Operating Cost Capacity
Nuclear $12/MWh 1000 MW
Coal $25/MWh 2500 MW
Gas $55/MWh 1500 MW
Turbine (peaker) $90/MWh 500 MW
Example with Supply and DemandDraw the competitive supply
curve for the production of electric energy on this system
Assume that demand is 3000 MW and is completely price
inelastic in the very short run. What would be the spot price in a
perfectly competitive wholesale electricity market? Assume that
demand is 4500 MW and is completely price inelastic in the

very short run. What would be the competitive spot price be?
What if there is a downward sloping demand function:D(P) =
5050 – 10PWhat is the spot price in a perfectly competitive
market?Assume that demand is 6000 MW for prices up to
$110/MWh, but that 600 MW of this demand would be willing
to be curtailed for prices above $110/MWh or more. What is the
perfectly competitive market price in this case?
Competitive Supply Curve
Example - continuedLet’s use the example to tease out
wholesale purchase costs for buyers (distributors).Assume that
demand is 3000 MW for 8 hours/dayAssume that demand is
4500 MW for 12 hours/dayAssume that demand is 6000 MW for
prices up to $110/MWh, but that 600 MW of this demand would
be willing to be curtailed for prices above $110/MWh or more
for 4 hours/day
Example - continuedLet’s use the example to tease out
wholesale purchase costs for buyers (distributors).Assume that
demand is 3000 MW for 8 hours/dayAssume that demand is
4500 MW for 12 hours/dayAssume that demand is 6000 MW for
prices up to $110/MWh, but that 600 MW of this demand would
be willing to be curtailed for prices above $110/MWh or more

for 4 hours/dayThen prices are:P = $25 for 8 hours/dayP = $55
for 12 hours/dayP = $110 for 4 hours dayAverage purchase cost
for buyers = (8*$25+12*$55+4*$110)/24 = $50.4/MWh
Renewable Energy in Wholesale MarketsWhat happens when
renewable energy (wind turbines, solar panels) generation
capacity is added?Let’s look at how the example changes when
1000 MW of solar photovoltaic generation capacity is added to
the grid.Impact on wholesale prices and price volatility?
Competitive Supply Curve with 1000 MW renewable capacity
added
Electricity Markets over the GridWholesale Electricity
CompetitionThe scope and size of the market can be expanded
by using the transmission network to connect buyers and sellers.
A bigger market can enable more suppliers to compete for
sales.If there are no transmission bottlenecks, then a grid-
connected area can operate as a single market with a single
price.But sometimes transmission links will be capacity-
constrained, and prices in different parts of the network will
differ.Locational Marginal PricesCompetitive prices at each
node of the network that take into account transmission
constraints.See next 2 slides for LMP contour mapsGoogle
MISO-PJM LMP contour map to see current map

MISO-PJM pricing contour map – evening March 11, 2019
MISO-PJM pricing contour map – afternoon March 12, 2019
Trouble w/ Electricity Markets?California restructured its
electricity industry and opened wholesale market to competition
in 1998California Energy Crisis of 2000Why?High summer
demandLarge drop in hydro-electricity importsSpike in natural
gas pricesMarket power of IPPs – especially at peak demand
timesImpactBIG increase in wholesale prices (~400-
500%)Distco’s squeezedRolling blackouts
End of California CrisisDistribution utilities nearly bankrupt by
early 2001California ended its restructuring experiment in
2001State govt negotiates new supply contracts for utilities
(very costly contracts!)Arnold gets elected
governorRestructuring grinds to a halt in most of Western U.S.
Why did restructuring flop in CA?Problems with CA
restructuring planLimits on long-term forward contracts
between generation suppliers and distribution utilitiesLack of

retail buyer price response (no real time pricing)NIMBY
obstacles to generation investments (not enough slack in
system)
18 THE STANDARD PRESCRIPTION
FIGURE 2.1 Physical functions of electricity.
FINAL CUSTOMERS ( RETAIL SALES )
OFFICE HOUSEFACTORY
LOCAL DISTRIBUTION
SYSTEM
GENERATION
( POWER PLANTS )
TRANSMISSION
NETWORKS ( GRID )
FLOW OF POWERMETER
SYSTEM
OPERATIONS
Reforming the Industr y 45
This is all we will say about Model 2 structural issues. Models 3
and 4
are where the action is. It is, however, worth remembering that
the new

trading arrangements can be developed and put into operation
before Mod-
els 3 and 4 are actually introduced. Transmission and system
operations can
be separated from generation and new trading arrangements
instituted be-
fore any deregulation takes place or any competitors enter the
market. In
the United States, this would be somewhat similar to the
operation of the
old tight pools, where (for many years, and well before the
introduction of
competition) the final price to customers was regulated but the
dispatch and
transmission were coordinated over a wide area, and the pricing
rules for
wholesale sales between companies were approved by FERC.
This should
not be taken as a proposal that the rules of the old tight pools
should be
adopted in the United States. However, the rules we do propose
for trading
arrangements later in the text could be adopted in modified
form even be-
fore wholesale competition is introduced.
M o d e l 3 : W h o l e s a l e C o m p e t i t i o n
Model 3 as we define it here has a fully competitive generating
sector. There
is no cost-of-service regulated generation. Distribution
companies (now
FIGURE 3.3 Model 3—wholesale competition.
DISTCO

CUSTOMER
DISTCOLARGECUSTOMER
LARGE
CUSTOMER
CUSTOMER
ENERGY SALES
IPPIPP IPP IPP IPP
TRANSMISSION WIRES
WHOLESALE
MARKETPLACE
1
Economics 473 Spring 2018
Problem Set Four
Answers are due, Wednesday, April 25, at our class meeting.
1. (10 points) Draw a graph with two curves: (1) the marginal
cost of GhG emissions abatement
curve, and (2) the marginal benefit of GhG emission abatement.

The marginal benefit of GhG
abatement is also referred to as the social cost of carbon.
a) Explain in words why the socially optimal level of GhG
emissions is not zero.
b) Suppose that the government sets a tax on GhG emissions
(e.g., a carbon tax). Show the optimal
level for the tax on emissions on your graph. Explain in words
how the tax is determined.
c) Suppose instead that the government establishes a cap and
trade program for GhG emissions.
Show the optimal level for the emissions cap on your graph.
Compare the outcome this cap and
trade program with the outcome for the emissions tax from part
(b).
d) Now suppose that the government sets a cap that is too
lenient; that is, the cap allows more
emissions than the optimal cap you identified in part (c). Show
the equilibrium trading price for
emissions permits with this ‘too lenient’ cap, and compare this
equilibrium trading price with the
optimal emissions tax from part (b).
e) Suppose that a higher social discount rate is used to calculate
future emission abatement costs
and benefits. Explain whether or not this change in the social
discount rate would affect the position
of the MC of abatement curve or the marginal benefit of
abatement curve, and the optimal current
level of abatement.
2. (5 points) Explain in words the meaning of the term,
‘levelized cost of energy’. LCOE is often
used to compare the costs of different technologies for
generating electricity. Explain pros and cons
of using LCOE for such comparisons.

Extra Credit (10 points) A variety of government policies
promote greater energy efficiency.
Examples include programs for more energy efficient lighting
and the federal CAFÉ program for
autos and light trucks. Consider the following claim –
“Government policies promoting energy efficiency are bound to
fail because of the rebound effect.
These policies have the unintended consequence of lowering the
effective price of energy services
and thereby encouraging greater energy use.”
Discuss this claim and explain whether or not you agree with it.

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