VJC H1 ECONS ans

Suggested Answers for H1 CSQ 1 (a) Compare the trends in domestic and industrial electricity consumption in the UK from 2010 to 2014. [2] Both domestic and industrial electricity consumption in the UK decreased overall from 2010 to 2014. [1] However, domestic electricity consumption saw an increase from 2011 to 2012, but industrial electricity consumption decreased throughout the period. [1] (b) (i) Using Tables 1 and 2, what can you infer about UK households’ price elasticity of demand for electricity? [4] Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. [1] From Tables 1 and 2, it can be seen that households’ expenditure on electricity increased although the quantity consumed decreased. [1] This implies that the price of electricity had risen across the period. Since households’ expenditure on electricity increased with higher prices and reduced consumption quantity, it suggests that households’ demand fo r electricity is price inelastic. [1] The increase in expenditure from higher prices outweighs the fall in expenditure from less electricity consumed. [1] (ii) Comment on the likely price elasticity of supply for electricity. [2] Any justified stand on the likely Es value is accepted, such as: The supply of electricity is likely to be price inelastic [1], as it is difficult to obtain more inputs for electricity production such as due to a limit on how much coal can be mined. [1] OR The supply of electricity is likely to be price elastic [1], as power plants are likely to have spare output capacity and inputs such as coal are readily available as they can be stockpiled. [1] (c) Using demand and supply analysis, explain one supply-side reason that accounts for the rise in the use of renewable energy sources for electricity production in the UK. [3] Any ONE of the following reasons: Increase in supply [1]

Lower marginal cost of production due to renewable energy subsidies from the UK government [1] Evidence: “The Government has encouraged the shift to green energy through subsidies for renewable generation” (Ext. 1) [1] OR Increase in supply [1] Lower marginal cost of production due to cheaper imported solar panels from China for renewable energy generation [1] Evidence: “One decision had a significant part to play in the drop in solar costs: a few years ago, China’s government opted to subsidise its manufacturing sector to produce cheap solar panels” (Ext. 3) [1] (d) Extract 4 highlights protectionist measures that the European Commission adopted in the solar panel industry. Comment on the arguments for and against such protectionism. [6] For Protectionism [3m] Protectionism can help to protect jobs in the solar panel in dustry in the EU. Given that China has been accused of ‘dumping’ solar panels into the EU by subsidising their manufacturing sector (Ext. 3), EU producers of solar panels would not be able to compete against Chinese imports, resulting in firms “going out o f business and significant job cuts” (Ext. 3). Implementing protectionist measures can help EU -produced solar panels become relatively more competitive against Chinese imports, resulting in a shift in expenditure from imports to domestic production which will increase aggregate demand, leading to higher domestic output and generation of jobs. Against Protectionism [3m] However, implementing protectionism would harm Chinese exports and China may in turn retaliate with trade barriers against the EU (Ext. 4: “could spark tit - for-tat retaliation”). This would result in EU losing export revenue, causing a fall in aggregate demand which results in lower national income and job losses. In addition, the EU benefitted from having Chinese solar panels at a lower cost (Ext. 3), and so protectionist measures imposed on imported Chinese solar panels would also cause the cost of such r enewable energy infrastructure to rise. This could slow down the EU’s shift towards renewable energy. (e) According to Extract 5, power generation creates “external costs that are not reflected in market prices”. (i) Explain how these ‘external costs’ may lead to market failure. [5] Power generation produces negative externalities which are external cost to third parties not involved in production or consumption of the good. [1]

The pollution generated from power generation (e.g. burning of coal) may give rise to harmful health effects to residents living near the power plant. (Ext. 5: “environmental and health impacts”) [1] The existence of these external costs causes a divergence between the Marginal Private Cost (MPC) and Marginal Social Cost (MSC), where MSC > MPC. [1] If left to the free market, producers would produce at Q where Marginal Private Benefit = Marginal Private Cost, since they only consider the revenue and input costs for power generation. However, since society considers all costs and benefits, the socially optimal level of power generation is at Q* where Marginal Social Benefit = Marginal Social Cost. This results in an overproduction of Q - Q*. [1] A deadweight welfare loss results as for Q to Q*, the total social costs (area D+E) is greater than the total social benefits (area E). [1] (ii) Discuss the relative effectiveness in addressing this market failure problem by using renewable energy subsidies as opposed to taxation. [8] To resolve the market failure problem caused by negative externalities from electricity generation, the government should implement policies to reduce electricity generation using ‘dirty’ methods such as coal-fired power plants. Policy 1: Renewable energy subsidies The government can provide subsidies for electricity generation using renewable energy sources. By subsidising renewable energy, it decreases the marginal cost of production for renewable energy which increase s the supply and reduces the price of renewable energy. With renewable energy and coal MPC = SS E MEC (Marginal External Costs) P* P Costs, Benefits ($/q) MSC (Marginal Social Costs) = MPC + MEC Q/t MPC Marginal Private Costs = SS MPB = MSB = DD Q* Q D

being substitutes as sources of electricity generation, electricity producers would now switch from using coal to the relatively cheaper alternative of renewable energy. This decreases the demand for electricity produced from coal plants, resulting in a lower output from coal -fired power plants and hence removing the welfare loss due to negative externalities. However, the use of renewable energy subsidies would incur a burden on the government budget and its usefulness depends on how well renewable energy can be introduced into the existing electricity supply grid. As Extract 2 mentions, in the case of the UK it remains prohibitively expensive to connect renewable energy projects to the existing aged electricity grid. Furthermore, the UK government may find it difficult to finance spending to upgrade the electricity grid or subsidise renewable energy projects given the budget deficit that it is already facing. Policy 2: Tax on electricity produced using coal The government can impose a tax on production of electricity using coal. By imposing a tax, it raises the marginal cost of production for coal-fired power plants. The producer will now reduce its output to the socially optimal level, removing the welfare loss arising from negative externalities. OR The government can impose a tax on pollution generated from coal power plants. By imposing a tax based on per unit of pollution generated, it increases the marginal cost of production for the electricity firm. The firm is then incentivised to use cleaner methods of electricity production so as to reduce the amount of taxes it needs to pay. This would address the root