EME 810
Solar Resource Assessment and Economics

5.2 Supply and Demand of Energy


Reading Assignment

When we deal with goods and services tied to energy systems, things get pretty interesting!

When you think about energy and natural resources, the tendency in energy economics is to think mainly of "non-renewable resources" or exhaustible resources like coal/oil/natural gas, etc. I want you to think about how much of our social economic perspective on energy is based on exhaustible resources.

We want to better understand why our clients and stakeholders (or even we) make decisions to adopt technologies that deliver goods and services from the Sun. The form of energy is radiant, from a Solar resource system, and we transform radiant energy into other useful forms to do work.

Energy Supply and Demand

The readily accessible energy that can be used to "do work" in society is still considered a limited natural resource, or good. In economic terms, we would say that many of our useful energy goods are scarce.

As we read in EBF 200, "What is Economics?" Prof. Gregory Mankiw lists seven microeconomic principles. Recall that microeconomics refers to individual economic actors considered as people and firms and their corresponding interactions in markets.

  1. People face tradeoffs.
  2. The cost of something is what you give up to get it.
  3. Rational people think at the margin.
    (Watch the following YouTube video of Thinking at the Margin by Prof. Mario Villarreal-Diaz.)
    Thinking at the Margin
    Click Here for Transcript for Thinking at the Margin Video.

    MARIO VILLARREAL-DIAZ: Individuals make choices and tradeoffs based on comparisons. When they are trying to decide what is the best choice, depends on those comparisons. One alternative versus the other. Let's think about ordering some fast food.

    If you go to a restaurant and they have the combo number one, and the combo number one includes a hamburger and some French fries, and the price is 10 dollars, then you can take a look at the combo number two. And the combo number two includes the hamburger and the fries and a milkshake. And it's 13 dollars.

    So, immediately when you think about it, you say, well, what am I going to get from those extra 3 dollars? A milkshake. So, that extra unit of food is going to cost me 3 dollars. So, the question you are trying to answer is, is that milkshake worth 3 dollars for me or not?

    And then, you make your choice. You make your decision of combo number one versus combo number two. That's thinking at the margin. At the margin means to think about the next increment, the next unit. That relatively small change, the net addition or subtraction when I make a choice.

    Marginal thinking helps us understanding puzzles such as why diamonds are so much more expensive than water, given that water is indispensable and essential for life. And the answer is that the marginal utility of water compared to the marginal utility of diamonds decreases way faster.

    Think about the first glass of water if you're thirsty-- very satisfying. Think about the second one. Think about the 20th or 50th glasses of water. Maybe you will be not that happy with getting that 50th glass of water. And now think about diamonds. What is the marginal utility of that extra unit of diamonds?

    Probably will not decrease at all. Probably will even increase. What I'm trying to say here is that if you compare the value of the extra unit of water versus the value of the extra unit of diamonds, it is obvious why diamonds are much more expensive than water.

    Individuals make choices at the margin all the time. This is part of the way we think, even though we don't notice. But not only individual decisions such as buying combo number one or combo number two are made thinking at the margin. Businesses also make decisions with this way of thinking.

    For example, if a business wants to hire an extra employee, they think exactly about the same way. How much is it going to cost me, that extra employee? Well, it's going to cost me his or her salary. Well, now we need to compare it versus what? How much he's going to produce.

    What is going to be the value added for having an extra employee? What is his or her marginal production? And then, of course, if his or her marginal production is larger than how much I'm going to pay his or her marginal cost, then it's a good business decision to hire that extra person.

    These basic tools, such as incentives, matter, opportunity cost, and thinking at the margin are not substitute. They complement each other. They are intertwined in the way economists see the world. Thus, when somebody is deciding about the combo one versus the combo two and thinking, should I get the milkshake? That is worth for me three more dollars?

    She's not only thinking about that extra pleasure that the milkshake is going to give her but about the opportunity cost of using those $3 to buy that milkshake. And what is the alternative use of those three dollars? Maybe some popcorn at the movies. Maybe candy at the movies or what have you.

    So, at the same time that is thinking at the margin is thinking at the opportunity cost of that money, how to allocate those resources. So, we do that all the time. For a public official, it might be the case that marginal analysis doesn't come that naturally because there is not that attachment.

    However, it should. Because still there is an alternative use of those public funds. So, public officials should think, if I allocate these resources in this project, how much I'm going to get out of it? And maybe I'm not going to get enough, and I should invest that money in somewhere else.

    Credit: Learn Liberty
  4. People respond to incentives.
  5. Trade can make everyone better off.
  6. Markets are usually a good way to organize economic activity.
  7. Governments can sometimes improve market outcomes.

In solar systems design, we work to Maximize Solar Utility for the client or stakeholders in a given locale. We will describe the methodologies to do so in the next lesson. But our clients are individuals who are in demand of a solar good. The firms developing or deploying SECSs are supplying access to the solar goods.

  • Consumers (clients) can be thought of as "Utility Maximizers;" they want to achieve the highest preference for given goods or service.
  • Suppliers (designers/engineers/builders) can be thought of as "Profit Maximizers."

Forms of Energy in Demand

Across the planet, there are non-uniform, ever-increasing demands for energy as thermal heat and electrical power. Light, as electromagnetic radiation, is another form of energy, used as well for visual comfort and indoor activities. The photon can be harvested via a solar energy conversion device. To be clear, photons are ephemeral (flows); they are not collected like fuel in a tank (not stocks).

Energy can be described in terms of sources (as in energy re-sources) and in terms of forms (as in energy trans-form-ations). Think of it this way, an energy source is a resource system, from which we appropriate useful resource units in a given form. Energy is neither created nor destroyed, so if the energy is in a less useful form, we must use an Energy Conversion Device (ECD, not a very technical term, but useful here) to transform one form into a more useful form.

  • Thermal (heat)
  • Radiant (electromagnetic, light)
  • Motion (kinetic)
  • Electrical (also called power in the industry)
  • Chemical
  • Nuclear
  • Gravitational

Energy scarcity is partially related to the loss of energy quality with successive transformations. Light happens to be an incredibly high quality of energy, which is then transformed into chemical energy by plants (photosynthesis), or into thermal energy by opaque materials, or kinetic energy via wind, or electrical energy via photovoltaics. (Nuclear and gravitational energy are not linked so directly to radiant energy here.)

Our society is used to beginning with "concentrated sunshine" (geofuels from stored photosynthesis in coal, oil, and gas), and then transforming the chemical form to the thermal form (hot steam), which is then transformed into the motion form (to spin a turbine-generator) and finally transformed into electrical energy.

Sidenote on Heat and Power

The terms Heat and Power have been adopted by several industries to have a specialized trade meaning.

  • Power is electrical energy (as opposed to a rate of energy use), and
  • Heat is thermal energy (as opposed to the transfer of energy).

Thus, in the energy industry, we hear about Combined Heat and Power (CHP) for energy conversion systems that provide two useful forms in one system.

Self-check questions:

1. What is the form of solar energy?

Click for answer.

ANSWER: Radiant form, as high-quality energy, shortwave light.

2. What is the energy transformation that is accomplished by a photovoltaic Energy Conversion Device?

Click for answer.

ANSWER: Radiant to Electric form.

3. On the demand side of economics, a consumer can be called a...

Click for answer.

ANSWER: utility maximizer, and as such is looking for the highest preference among a selection of goods or services.

4. What does it mean to "think at the margin"?

Click for answer.

ANSWER: The margin in economics is the incremental change in cost for the extra unit of goods, and thinking at the margin is focusing on the incremental changes and responses to those changes.

Optional Reading on Energy Economics

Optional: G. Mankiw Principles of Economics. This might be a nice resource for your future study but is not required for this course.