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innovation and management in energy industry
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Innovation & Management in the Energy Industry
Lecture 1 – Introduction
• Course overview• Basics of Microeconomics
Course Overview
Who am I?
• Christian JaagPhD (University of St. Gallen)
• Managing Partner, Swiss EconomicsEconomic consulting in network economics with a focus on regulation and competition economicsLecturer (University of St. Gallen, University of Zürich, EPFL)
• Former AssignmentsHead of Regulatory Economics, Swiss PostVisiting scholar, Rutgers UniversityCFO (interim), joiz social tv
• [email protected]; [email protected]
3
Goal of the Course
At the end of the course the student is expected to be able to explain the main economic and political forces behind energy demand and supply as well as the rationales for economic policy in the energy sectors. The student must be able to use economic tools and principles to analyze energy issues and to formulate energy policy instruments.
Page 4
General Motivation and Context of the Course
Page 5
TechnologySociety
Innovation and Mgmtin Energy
Politics
EconomyRegulation
Course Outline
6
Date Topic Presenters1 Feb 17 Course overview
Basics of microeconomicsChristian Jaag
2 Feb 24 Market failureRegulation: Institutions and current issues
Christian JaagProf. Matthias Finger
3 March 3 Innovation Christian Jaag
4 March 10 Sustainability and regulation Christian Jaag
5 March 17 Student presentationsInvestment decisions
StudentsDr. Urs Meister
6 March 24 Student presentations Students
7 March 31 Exam
Recommended reading:Carol A. Dahl (2004). International Energy Markets: Understanding Pricing, Policies and Profits. PenWell
Student Presentation
7
• 9 groups• 20 minutes presentation per group• 10 minutes discussion per group• Deadline for presentation slides:
Noon of the day before the presentation• Late submissions will result in a lower grade
Student Presentations
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March 17• Carbon emission markets: the problem they attempt to solve and how• The cost of nuclear energy: how to price risk• Current and future drivers of energy demand
March 24• The future of electric energy storage between base- and peak load; effect of
decentralized energy production• Electric energy price forecast in light of supply-, demand- and regulatory
scenarios• Smart grids and smart meters: costs and benefits• Unbundling vs. vertical integration• The future of fossil fuels• Swiss Energy Strategy 2050
Basics of Microeconomics
What is Microeconomics?
Study of the behavior of individuals in making decisions on the allocation of limited resources.
• Individuals may be persons or firms.• Persons strive for happiness o utility maximization• Firms strive for profit o profit maximization
Why is this relevant for innovation and management in the energy industry?
Page 10
Basics of Microeconomics
Principle of Comparative Advantage
Demand
Supply
Characterizing Demand and Supply
Equilibrium and Welfare
Basics of MicroeconomicsPrinciple of Comparative Advantage
Opportunity cost: value of the best alternative forgone
Examples?
Page 12
Basics of MicroeconomicsPrinciple of Comparative Advantage
13
Good 1
Good 2
Good 1
Good 225 100
100Production possibilityfrontier in country A
Production possibilityfrontier in country B
Opportunity cost per unit of good 1 in country A: 1/4 unit of good 2
Opportunity cost per unit of good 1 in country B: One unit of good 2
o Country A as a comparative advantage in producing good 1o Country B as a comparative advantage in producing good 2
100
Basics of MicroeconomicsPrinciple of Comparative Advantage
Example: Both countries wish to consume the same amount of both goods
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Good 1
Good 2
Good 1
Good 225 100
100100
2050
Basics of MicroeconomicsPrinciple of Comparative Advantage
Example: Both countries wish to consume the same amount of both goods
Country AAutarchyGood 1 20 Good 2 20
TradeGood 1 100Good 2 0
Trade allows for specialization and the exploitation of comparative advantages
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Country B
50 50
0100
Total
7070
100100
Basics of MicroeconomicsPrinciple of Comparative Advantage
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Good 1
Good 2100
Joint productionpossibility frontier
100
125
200
Basics of MicroeconomicsPrinciple of Comparative Advantage
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Basics of MicroeconomicsPrinciple of Comparative Advantage
David Ricardo (1772-1823)
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Basics of Microeconomics
Comparative Advantage
Demand
Supply
Characterizing Demand and Supply
Equilibrium and Welfare
Basics of MicroeconomicsWillingness-to-Pay
• Let Alice be a consumer and 𝑍 be some good.
• Alice’s willingness-to-pay (𝑊𝑇𝑃) for a given quantity 𝑞 of 𝑍 is the monetary value she attaches to this quantity 𝑞 of 𝑍.
• The benefit that Alice derives from buying an extra unit of 𝑍 is called Alice’s
marginal willingness-to-pay 𝑀𝑊𝑇𝑃 .
• Law of Demand: 𝑀𝑊𝑇𝑃 decreases in quantity.
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Basics of MicroeconomicsDemand – Illustration
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1 2 3 4 5 6
Example
𝑞 = 3
𝑊𝑇𝑃 = area under columns up to 3
𝑀𝑊𝑇𝑃 = area under column 4 (the extra benefit of an additional unit)
𝑞
𝑝
Basics of MicroeconomicsDemand (I)
• Let 𝑝 be the price charged for a unit of 𝑍.
• If 𝑀𝑊𝑇𝑃 < 𝑝, then Alice will not buy the respective additional unit of 𝑍.
• If 𝑀𝑊𝑇𝑃 ≥ 𝑝, then Alice will buy the respective additional unit of 𝑍 and enjoy a marginal consumer-surplus of (𝑀𝑊𝑇𝑃 – 𝑝).
• Whether Alice demands an additional quantity of 𝑍 is determined by her 𝑀𝑊𝑇𝑃.
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Basics of MicroeconomicsDemand (II)
• Alice’s demand function consists of all her 𝑀𝑊𝑇𝑃𝑠.
• Since Alice would maximally pay a price equal to her 𝑀𝑊𝑇𝑃 for the respective units consumed, her demand generates a relation between price and quantity.
• Assuming the goods to be infinitely divisible, the demand function can be represented by a curve.
• Background «ceteris paribus» assumption: Other factors affecting demand are kept constant (prices of other goods, Alice’s income etc.).
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Basics of MicroeconomicsDemand – Illustration
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𝑞
𝑝
𝑑
Alice’s MWTP = Alice’s demand function d
Basics of MicroeconomicsChanges in Consumer Surplus
• Recall that consumer surplus is defined as (𝑀𝑊𝑇𝑃 –𝑝).
• Suppose the price of good 𝑍 increases.
• With a higher price, Alice’s demand decreases.
• This implies a change in the consumer surplus.
25
Basics of MicroeconomicsIllustration of Consumer Surplus
𝑝
𝑞 𝑞
𝑝
10
consumer surplus
Basics of MicroeconomicsChange in Consumer Surplus due to Price Increase
loss in consumer surplus due to reduced consumption
loss in consumer surplus due to paying a higher price for the units still consumed𝑝
𝑞 𝑞
𝑝
𝑞′
𝑝′
10
total loss in consumer surplus
final consumer surplus
Basics of Microeconomics
Comparative Advantage
Demand
Supply
Characterizing Demand and Supply
Equilibrium and Welfare
Basics of MicroeconomicsAssumption of Perfect Competition
• A firm cannot influence the price, as it is too small relative to the frictionless market, on which completely identical goods are traded.
• If the firm were to increase the price, then it will not sell anything, since all demand will go to its competitors.
• If the firm were to decrease the price, then all demand will turn to the firm, which will exceed its capacity.
• Thus, the only decision variable of the firm is the quantity q it supplies to the market.
• Firms are therefore called «price takers» in perfectly competitive markets.29
Basics of MicroeconomicsSupply Function
• Given its cost structure, a price-taking firm maximizes its profits:
max𝑞
𝑝𝑞 − 𝑐 𝑞
� 𝑝 − 𝑐′ 𝑞 = 0� 𝑝 = 𝑐′ 𝑞
• Thus, at profit maximum, price equals marginal cost!
• For any given price 𝑝, the firm will supply the quantity 𝑞, such that 𝑝 = 𝑐′ 𝑞 .
• The marginal cost function 𝑐′ 𝑞 is the firm’s supply function.
• Marginal cost is assumed to be constant or increasing in quantity. 30
31
Basics of MicroeconomicsDerivation of the Supply Curve
𝑞
𝑞
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑐(𝑞)
𝑡𝑜𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 𝑟(𝑞)
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡 =𝑐(𝑞)𝑞
𝑚𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 =𝜕𝑐(𝑞)𝜕𝑞
= 𝑐′
𝑝𝑟𝑖𝑐𝑒 𝑝
32
Basics of MicroeconomicsIllustration of the Supply Function
𝑞
𝑝𝑝 = 𝑐′(𝑞)
𝑆𝑢𝑝𝑝𝑙𝑦 𝐹𝑢𝑛𝑐𝑡𝑖𝑜𝑛
Basics of MicroeconomicsProducer Surplus
• In analogy to consumer surplus, the area between the market price and the supply function is called producer surplus.
• For every quantity 𝑞, the supply function denotes the minimum price at which the firm is willing to supply 𝑞.
• If this minimum price is smaller than the market price, then there is a surplus for the producer.
33
34
Basics of MicroeconomicsIllustration of Producer Surplus
𝑞
𝑝
𝑝
𝑞
𝑐′(𝑞)
producer surplus
35
Basics of MicroeconomicsChange in Producer Surplus due to Price Increase
𝑞𝑒 𝑞
𝑝
𝑝𝑒
𝑝′
𝑞′
original producer surplus
gain in producer surplus, due to the price increase of the already sold units
gain in producer surplus, due to the additionally sold units.
𝑐′(𝑞)
total gain in producer surplus
Basics of Microeconomics
Comparative Advantage
Demand
Supply
Characterizing Demand and Supply
Equilibrium and Welfare
Basics of MicroeconomicsElasiticities
Elasticities measure relative percentage changes between two variables:
Examples: Price elasticity of supply, income elasticity of demand,…
Why elasticities?• Independence of units used• Comparability between different goods
37
𝜺 =
𝝏𝒒𝒒𝝏𝒑𝒑
=𝝏𝒒𝝏𝒑
𝒑𝒒
Basics of MicroeconomicsCharacterization of Goods by Means of Elasticities
𝒒: quantity demanded, 𝒃: income, 𝒑: price
• Law of demand holds
• Normal good energy
• Inferior good (“dirty” energy)
• Substitutes coal, gas
• Complements car, gas
38
𝝏𝒒𝒊𝝏𝒃
𝒃𝒒𝒊
< 𝟎
𝝏𝒒𝒊𝝏𝒃
𝒃𝒒𝒊
> 𝟎
𝝏𝒒𝒊𝝏𝒑𝒋
𝒑𝒋𝒒𝒊
> 𝟎
𝝏𝒒𝒊𝝏𝒑𝒋
𝒑𝒋𝒒𝒊
< 𝟎
𝝏𝒒𝒊𝝏𝒑𝒊
𝒑𝒊𝒒𝒊
< 𝟎
Basics of MicroeconomicsCharacterization of Goods by Means of Elasticities
𝒒: quantity demanded, 𝒃: income, 𝒑: price
• Elastic demand
• Inelastic demand
• Do we normally observe goods exhibiting inelastic demand?
39
𝝏𝒒𝒊𝝏𝒃
𝒃𝒒𝒊
> −𝟏
𝝏𝒒𝒊𝝏𝒑𝒊
𝒑𝒊𝒒𝒊
< −𝟏
Basics of Microeconomics
Comparative Advantage
Demand
Supply
Characterizing Demand and Supply
Equilibrium and Welfare
Basics of MicroeconomicsMarket Equilibrium
The equilibrium price 𝑝𝑒 is determined by • Graphically: the intersection of market demand and market supply
• Economically: 𝑀𝑊𝑇𝑃 = 𝑐′(𝑞)
41
Supply
producer surplus
𝑞
𝑝
𝑝𝑒
𝑞𝑒
consumer surplus
Demand
Basics of MicroeconomicsWelfare Considerations (I)
• In markets with perfect competition, welfare (total surplus) is maximized in equilibrium.
• 1. Suppose any 𝑞 > 𝑞𝑒:
42
𝑝𝑒
𝑞𝑒
𝑝′
𝑞′
A B CD
Price decreases to 𝑝′
A: transformed from producer surplus to consumer surplus
B+C: gain in consumer surplus
B+C+D: “loss” in producer surplus
net effect: decrease of total welfare by D compared to equilibrium
𝑞
𝑝
Demand
Supply
Basics of MicroeconomicsWelfare Considerations (II)
• 2. Suppose any 𝑞 < 𝑞𝑒:
43
𝑝𝑒
𝑞𝑒
𝑝′
𝑞′
Price increases to 𝑝′
A: transformed from consumer surplus to producer surplus
B: loss in consumer surplus
C: loss in producer surplus
Net effect: decrease of total welfare by B + C compared to equilibrium
A BC
𝑞
𝑝Supply
Demand
Lecture 1Summary
• Microeconomics studies the behavior of individuals in making decisions on the allocation of limited resources.
• Trade allows for specialization and the exploitation of comparative advantages.
• Demand represents the buyer’s the marginal willingness to pay.• Supply results from profit maximization and equals the seller’s marginal
cost (under perfect competition).• Consumer surplus is the difference between the buyer’s marginal
willingness to pay and the price.• Producer surplus is the difference between the price and the seller’s
marginal cost.• Welfare is the sum of consumer surplus and producer surplus.
44