Question

Small Scale Solar Power Energy The average price of a 4KW solar panel system is approximately $4500 in Victoria. The Victorian Government has introduced the “Solar Homes Program” which provides eligible households with a government rebate of approximately $2300 to install a home solar system. This rebate is paid to the installer of the solar system. Households with solar panels can, in addition, receive a feed-in rebate (or cash return) of approximately 12 cents per kilowatt-hour for any unused solar energy which is returned to the state electricity grid or supply. Sources: Department of the Environment and Energy, Australian Energy Statistics, Table O, March 2019 and The Clean Energy Council of Australia Use the above information to: Discuss the market failure evident in this industry. Your answer should include a discussion of the most significant economic concepts relating to this market failure. Concepts that should be included but not limited to are: allocation of resources, type of externalities, corrective measures by the government, how market failure arises. Draw a graph for the market for solar systems and energy which demonstrates and illustrates the market failure discussed in part (i) and the intended effect of the government policy outlined in the above question. Discuss and graphically illustrate how the above government policies are likely to affect the market for non-renewable sources of electricity, such as coal-fired power (fossil fuels). In your answer, you should identify two relevant conditions (determinants) of demand and two relevant conditions (determinants) of supply in the market for non-renewables.

Answer 1

The incidence of market failure can be explained well through this exercise. The supporter of market economics think that free market price ensure efficient allocation of goods and services which in turn helps to achieve pareto optimality conditions; ie optimal allocation of resources. Market failure is a situation where free market price does not ensure optimal allocation of resources. This situation leads to loss of net social welfare.

In conventional energy like coal, fossil fuel, market price do not reflect the actual marginal cost of the supply of goods. The cost of environment pollution (negative externalities) for generation of thermal power is not included in its market price. As the cost of negative externalities are not included in the market price, its price becomes less and demand increases. Exactly opposite situation prevails in case of renewable energy- solar power. Here the cost of generation of unit power is higher but it contains positive externalities (zero environment pollution). The technology cost is higher but it ensure zero negative externalities and environment safety which make per unit cost dearer compared to conventional energy. Higher price automatically lead to lower demand.

In case of renewable energy, presence of external economics (zero environment pollution) Social Marginal Benefits (SMB) exceed Private Marginal Benefit (PMB) and Private Marginal Cost (PMC) exceed Social Marginal Cost (SMC). Whereas the vice-a-versa situation seemed to be prevail in case of non renewable energy.

In case of non-renewable energy demand is high because of its less price and established market. Its supply side also attract numerous producers due to availability of standard tested technology and established market reducing the risk for the entrepreneurs.   

Degree of Market failure can be reduced by government intervention. It may streamline either through imposing taxes (in case of presence of negative externalities, like conventional energy) or through allowing subsidies (in case of presence of positive externalities or zero negative externalities, like solar energy). Government can also discourage uses of energy generated out of non-renewable sources by imposition rationing system and encourage uses of energy by providing cash or benefits in kind to the users group, here, the household which are supposed to receive $12 cent per unused solar hour.

Here, the Government’s decision to provide rebate of $2300 per installation to the installer induce producer to manufacture more such panel which in turn help to enjoy economies of scale and to reduce marginal cost of supply of goods. On the other hand the Government also allowing cash back to the household with the aim to increase the size of the market and to increase demand for solar energy. These two intervention would be effective to reduce market failure. Hence in presence of market failure, Government’s intervention is necessary to correct it.