Inferior Good: Diminishing Marginal Stupidity in Action

Monday, July 10, 2006

Price is the ultimate tool of conservation

Knowledge Problem’s Lynne Kiesling nicely frames the central grid management issues confronting public power.

Paraphrasing Lynne, the current goals are regulated retail prices, no new transmission lines, no new generation, and no blackouts. Assuming continued growth in electricity demand though, the best publicly run electric system can only achieve 3 of the 4 goals in the long run.

As demand increases, you need to A) allow dynamic pricing mechanisms to properly allocate scare energy resources, or B) build more power plants in the region, or C) build transmission to bring power from another region, or D) suffer blackouts.

California is a great example. Grid management options A through C were basically off the table, which eventually led to the selection of option D by default. Indeed, NIMBY politics makes it very difficult to exercise options B and C.

Of course, by far the most efficient solution is option A with occasional use of options B and C.

[Ed: What about conservation?] Yes, conservation efforts do play a role. But generally conservation efforts are not sufficient to mitigate demand increases. This is because regulated price schemes destroy the best conservation incentive; market-based price signals.

For example, prolonged heat waves can put a lot of pressure on the northeastern power grid. Why? Because millions of homes, offices, school’s etc. crank of their electricity hogging’ air conditioners.

But if most consumers faced variable, market based prices for energy, you can bet they’d take energy conservation more seriously. For during that heat wave, electric prices would increase (reflecting increases in energy demand). As a result of these higher prices, some consumers would take mitigating action. Perhaps they’d set the thermostat to 78 degrees instead of 72 degrees, or maybe they’d invest in better roof insulation. These actions would serve to lessen the increase in demand, thereby protecting the integrity of the grid.

In this way, price is the ultimate tool of conservation.

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