This presentation includes Externalities and its types with examples in energy applications

1. TOPIC:
VALUATION OF EXTERNAL EFFECTS OF ENERGY USE
BY:
ENGR. TARIQUE AHMED MEMON
Lecturer, Department of Mechanical Engineering,
Quaid-e-Awam University of Engineering Sciences
and Technology (QUEST) Campus Larkano
Pakistan.

2. CONTENTS
• Externality & its Types
• The Externalities of Energy
• Energy production and conversion
• Energy Use
• Assessing the Externalities of Power
Generation
• Internalization of externality
• References
TARIQUE AHMED MEMON

3. Externality
• A consequence of an economic activity that is
experienced by unrelated third parties.
• Types
• Positive Externality (External Benefit)
• Negative Externality (External Cost)
TARIQUE AHMED MEMON

4. Positive Externality (External Benefit)
• Consumption or production of a good causes a
benefit to a third party.
• Examples
• The construction and operation of an airport
• This will benefit local businesses
• A foreign firm that establishes up-to-date
technologies to local firms and improves their
productivity
TARIQUE AHMED MEMON

5. Positive Externality (External Benefit)
TARIQUE AHMED MEMON
Vehicles charged by electricity from
a renewable source
reduces GHG emissions and
improves local air quality leading to
better public health.
An individual receiving a vaccination for
disease decreases the;
• likelihood of the individual's own infection,
• also likelihood of others becoming infected
Examples

6. • Positive Externalities
– Vaccinations
– Gardens
– restored historic buildings,
– Research & Development
– Education

7. EducationEducation
• Education can be considered a positive externality
• Educated children are more likely to become good
citizens (voters, productive workers, less crime).
• Benefits spill over to general public beyond the
benefit to individual students.
TARIQUE AHMED MEMON

8. • A farmer who grows apple trees provides
a benefit to a beekeeper. The beekeeper
gets a good source of nectar to help
make more honey.
• If you walk to work, it will reduce
congestion and pollution, benefiting
everyone else in the city.
TARIQUE AHMED MEMON

9. • Social benefit is the total benefit to society from producing or
consuming a good / service.
• Social benefit includes all the private benefits plus any external
benefits of production / consumption.
• Examples
• Cycling to work. If we cycle to work, the private benefits include
• Lower cost of cycling rather than driving
• Health benefits of cycling
• Ability to avoid congestion, and quicker journey to worker.
• The social benefit of cycling may also include external benefits,
such as:
• Lower congestion for other road users
• Lower pollution levels from a decision to cycle rather than drive
• Better health may lead to lower health care costs.
• Therefore, in this case, the social benefit of cycling may be greater
than private benefit.
TARIQUE AHMED MEMON

10. POSITIVE EXTERNALITIES
• Private Benefits and Social Benefits
–Marginal private benefit
•The benefit to the consumer of an additional unit of a good
or service.
–Marginal external benefit
•The benefit of an additional unit of a good or service that
people other than the consumer of the good or service
enjoy.
TARIQUE AHMED MEMON

11. POSITIVE EXTERNALITIES
• Private Benefits and Social Benefits
–Marginal social benefit
•The marginal benefit enjoyed by the entire society—by the
consumers of a good or service and by everyone else who
benefits from it.
•Marginal social benefit is the sum of marginal private
benefit and marginal external benefit:
•MSB = MPB + Marginal external benefit
TARIQUE AHMED MEMON

12. Externalities 12
POSITIVE EXTERNALITIES
When 15 million students
attend college . . .
• marginal external benefit is
$15,000 per student.
• marginal private benefit is
$10,000 per student.
• marginal social benefit is $25,000
per student.
Private Benefit and Social
Benefit with an Externality
An external benefit creates a wedge
between social benefit and private
benefit.

13. Externalities 13
POSITIVE EXTERNALITIES
Inefficiency with an External Benefit
With an external benefit,
equilibrium tuition is $15,000 and
the equilibrium quantity is 7.5
million students.
The market equilibrium is
inefficient because marginal social
benefit exceeds marginal cost. In
other words, people other than the
students benefit from the students’
education and would be willing to
pay something for it.

14. Externalities 14
POSITIVE EXTERNALITIES
The gray triangle shows the
deadweight loss created by the
uninternalized external benefits of
college education.
The efficient quantity is 15 million
students, where marginal social
benefit equals marginal cost.
Inefficiency with an External Benefit

15. Negative Externality (External Cost)
• Consumption or production of a good causes a
harmful effect to a third party.
TARIQUE AHMED MEMON
Examples
Pollution emitted by a factory that
spoils the surrounding environment
and affects the health of nearby
residents

16. Negative Externality (External Cost)
• Anthropogenic climate change as a
consequence of greenhouse gas emissions
from burning oil, gas, and coal.
• Water pollution by industries that adds
effluent, which harms plants, animals, and
humans.
• Noise pollution during the production process,
which may be mentally and psychologically
disturbing.
TARIQUE AHMED MEMON

17. TARIQUE AHMED MEMON

18. Social Cost
• Social cost – Social cost is the total cost to society. It includes both private
costs plus any external costs.
• Private Costs + External Costs = Social Costs
• Private costs for a producer of a good, service, or activity include the costs
the firm pays to purchase capital equipment, hire labor, and buy materials
or other inputs.
• Private costs of airport
• Cost of constructing airport.
• Cost of paying workers to run airport
• External costs are not reflected on firms’ income statements or in
consumers’ decisions. However, external costs remain costs to society,
regardless of who pays for them.
• External Cost of airport
• Noise and air pollution to those living nearby.
• Risk of accident to those living nearby.
TARIQUE AHMED MEMON

19. NEGATIVE EXTERNALITIES
• Private Costs and Social Costs
–Marginal private cost
•The cost of producing an additional unit of a good or service
that is borne by the producer of that good or service.
–Marginal external cost
•The cost of producing an additional unit of a good or service
that falls on people other than the producer.
TARIQUE AHMED MEMON

20. NEGATIVE EXTERNALITIES
• Private Costs and Social Costs
–Marginal social cost
•The marginal cost incurred by the entire society—by the
producer and by everyone else on whom the cost falls.
•Marginal social cost is the sum of marginal private cost and
marginal external cost:
•MSC = MC + Marginal external cost
TARIQUE AHMED MEMON

21. • If goods or services have negative externalities,
then we will get market failure.
• This is because individuals fail to take into
account the costs to other people.
• To achieve a more socially efficient outcome, the
government could try tax the good with negative
externalities.
• This means that consumers pay the full social
cost.
• With a negative externality the Social Cost >
Private Cost
TARIQUE AHMED MEMON

22. Externalities 22
NEGATIVE EXTERNALITIES
Private Cost and Social Cost
with an Externality
When output is 4,000 tons of
chemicals per month . . .
• marginal private cost is $100 a
ton.
• marginal external cost is $125 a
ton.
• marginal social cost is $225 a
ton.
An external cost creates a wedge
between social cost and private
cost.

23. Externalities 23
NEGATIVE EXTERNALITIES
With an external cost, equilibrium
price is $100 a ton and equilibrium
quantity is 4,000 tons a month.
Inefficiency with an External
Cost
The market equilibrium is
inefficient because marginal social
cost exceeds marginal benefit.

24. Externalities 24
NEGATIVE EXTERNALITIES
The gray triangle shows the dead-
weight loss created by the
uninternalized pollution externality.
Inefficiency with an External Cost
The efficient quantity is 2,000 tons
a month, where marginal social cost
equals marginal benefit.

25. Externalities
Positive (+benefit) Negative (+cost)
Production
(honey)
Consumption
(education)
Consumption
(cigarettes)
Production
(pollution)
In review:
TARIQUE AHMED MEMON

26. The Externalities of Energy
• The “externalities” of energy refer to the social
effects arising from the process of producing
the energy, but that are not reflected in the
market price of the energy.
• A typical example is pollution.
• combustion gases from fossil-fuel power
stations
• sulfur oxides (SOx)
• nitrogen oxides (NOx)
TARIQUE AHMED MEMON

27. The Externalities of Energy
• This in turn affected the natural environment,
the health of local residents and the private
property of third parties not directly related
with the energy production activities.
TARIQUE AHMED MEMON

28. • The construction and operation of energy
supply facilities result in negative effects on
human health and the environment through
intermediate effects on air, water and
terrestrial systems.
• These environmental externalities can be
valued and added to the direct internal costs
of supply, to produce the full social benefit of
energy conservation.
TARIQUE AHMED MEMON

29. Energy production and conversion
• The production and application of energy conversion
technologies may cause considerable damage to
human health, ecosystems or materials.
• Monetary valuation may help to inform the decision-
making process at three main levels:
1. Selecting the national “energy mix”
• composition of the national energy mix depends on the
advantages and disadvantages of each type of energy
with regard to government objectives
• (e.g., energy independency, production costs,
greenhouse gases (GHG) emissions)
TARIQUE AHMED MEMON

30. 2. ƒChoice of the tools to achieve energy policy
objectives:
• Once energy policy objectives set, governments have a
wide range of tools at their disposal to reach those
objectives: subsidies, tax credits, emission taxes, etc.
3. ƒChoice of infrastructure location:
• to determine the location of energy production sites.
• For example, building and running power plants may
induce a stream of external cost and benefits which
should be taken into account to assure the
acceptability of the project
TARIQUE AHMED MEMON

31. Energy Use
• Final energy consumption or “energy use” can
be divided between five major groups:
• Industry
• Transport (road, air, rail, navigation)
• Agriculture, forestry and fishing
• Services
• Residential
TARIQUE AHMED MEMON

32. Assessing the Externalities of Power
Generation
• Pollution damage from emissions other than CO2
• costs arising from emissions that cause damage to the environment
or to people.
• These include a wide variety of effects, including damage from acid
rain and health damage from oxides of sulphur and nitrogen from
fossil fuel power plants.
• Other costs in this category include factors such as power industry
accidents (whether they occur in coal mines, on offshore oil or gas
rigs, in nuclear plants, on wind farms, or at hydro plants), visual
pollution and noise.
• Major external impacts attributed to electricity generation are
those caused by atmospheric emissions of pollutants, such as
particulates, sulphur dioxide (SO2) and nitrogen oxide (NOx), and
their impacts on public health, materials, crops, forests, fisheries
and unmanaged ecosystems.
TARIQUE AHMED MEMON

33. • The external damage costs of emissions of
carbon dioxide
• External costs arising from greenhouse gas
emissions from electricity-generating facilities
lead to climate change with all its associated
effects.
• Costs associated with climate change, such as
damage from flooding, changes in agriculture
patterns and other effects, all need to be
taken into account.
TARIQUE AHMED MEMON

34. GHG Emissions Intensity of Electricity Generation Methods
TARIQUE AHMED MEMON

35. External damage costs for electricity
production
TARIQUE AHMED MEMONExternality Cost of Various Electricity Generating Methods, European Union

36. Internalization of externality
• Making markets and societies work better.
• Internalizing an externality involves altering
incentives so that people take account of the
external effects of their actions.
• The government can internalize an externality by
imposing a tax/subsidy to reduce/increase the
equilibrium quantity to the socially desirable
level.
TARIQUE AHMED MEMON

37. Internalization of externality
• Internalization can be accomplished either via
governmental action or via the market
• Using policies such as taxes or fees to add
external costs to market prices.
– Levying a tax on goods with negative externalities
– Imposing a subsidy on goods with positive
externalities
TARIQUE AHMED MEMON

38. Negative Externalities: Pollution
• Government Actions in the Face of External
Costs
– There are three main methods that the
government uses to cope with external costs:
 Taxes
 Emission charges
 Marketable permits
TARIQUE AHMED MEMON

39. Negative Externalities: Pollution
– Taxes
– The government can set a tax equal marginal
external cost.
– The effect of such a tax is to make marginal
private cost plus the tax equal to marginal social
cost,
MC + tax = MSC.
TARIQUE AHMED MEMON

40. Negative Externalities: Pollution
– Emissions Charges
– The government sets a price per unit of pollution,
so that the more a firm pollutes, the higher are its
emissions charges.
– For the emissions charge to induce the firm to
generate the efficient level of pollution, the
government would need a lot of information that
is usually unavailable.
TARIQUE AHMED MEMON

41. Negative Externalities: Pollution
– Marketable Permits
– Each firm is assigned a permitted amount of
pollution per period and firms trade permits.
– The market price of a permit challenges polluters
with the social marginal cost of their actions and
leads to an efficient outcome.
TARIQUE AHMED MEMON

42. References
1. http://www.investopedia.com/terms/e/externality.asp
2. https://en.wikipedia.org/wiki/Externality
3. Externalities of Energy and Nuclear Power (Atomic Energy Society of Japan,
Social and Environmental Division , August 2010)
4. The Economics of Renewable Energy by David Timmons, Jonathan M. Harris, and
Brian Roach
5. THE VALUA 0 OF ENVIRONMENTAL EXTERNALITIES IN ENERGY CONSERVATION
PLANNING by PaulL, Chernick,EmilyJ.Caverhill PLC, Incorporated
6. Renewable energy: Externality costs as market barriers by Anthony D. Owen
(School of Economics, The University of New South Wales, Sydney, NSW 2052,
Australia)
7. http://www.economicshelp.org/micro-economic-essays/marketfailure/
8. http://www.economicsonline.co.uk/Market_failures/Externalities.html
TARIQUE AHMED MEMON

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