The Dirty Cost of Cleaner Energy

In a perfectly competitive market, the price is typically set equal to marginal cost. This is the cost to the producer of producing one more unit of the good. When price equals marginal cost, economic efficiency is maximised. Consumer surplus is the difference between what consumers are willing to pay and what they actually pay. Producer surplus is the difference between what producers receive for a good and their cost of producing it. At a price equal to marginal cost, the sum of consumer and producer surplus is maximised, and the total gains from trade (economic surplus) are at their peak.

Any price above marginal cost reduces the consumer’s benefit from the transaction by more than it increases the producer’s benefit. This is because of how surplus is distributed between consumers and producers in a market. When the price is set above marginal cost, the producer is charging more than what it costs to produce the additional unit, which means consumer surplus decreases (consumers pay a higher price and fewer units are sold, reducing total surplus). When this happens, consumers derive less benefit from the transaction because they are paying a price higher than what would have been necessary to cover the production cost of the good. This extra price they pay above the marginal cost reduces their surplus. When the price of a toaster is set above marginal cost, such as £15 instead of £10, consumers experience a reduction in consumer surplus by paying more per unit, and the market experiences a deadweight loss because fewer toasters are sold than would be at the efficient price, resulting in a net loss of total surplus, and a misallocation of resources that could have otherwise increased economic utility.

Producers benefit from the higher price, as they receive more revenue per unit than the marginal cost. However, the gain for producers is typically smaller than the loss faced by consumers, because the producer's surplus increases by the price difference (£15 - £10 in our example) for each unit sold, but the number of units sold will likely decrease because consumers will buy less at the higher price. The producer’s surplus increases only on the remaining units sold (but the quantity sold likely decreases). This reduction in quantity sold reduces the potential for additional producer surplus that could have been earned if the price was lower (that is, closer to marginal cost). The portion of the total surplus (consumer plus producer) that disappears due to the higher price is called a deadweight loss.

The higher price discourages consumption, as fewer consumers are willing to pay the inflated price. Those consumers who would have bought the good at a price closer to the marginal cost do not get to purchase it, resulting in a loss of both consumer and producer surplus. The producer does not gain enough from the higher price to compensate for this loss, since fewer units are sold overall. Consumers lose more than producers gain because the reduction in consumer surplus (from paying the higher price and from fewer units being purchased) is greater than the increase in producer surplus from the higher price. Deadweight loss results from transactions that no longer occur due to the higher price, representing inefficiency, and amounting to a net loss to society.

What we’ve seen so far is that the economy as a whole would be better off if the price is equal to marginal cost, ensuring maximum benefit from trade for both consumers and producers. It should be clear at this point that when governments implement climate policies that artificially increase energy costs (e.g., through carbon taxes, cap-and-trade systems, or regulations that mandate the use of more expensive, cleaner energy sources), these policies create many economic inefficiencies similar to the ones caused by pricing above marginal cost. We can see why by applying the same economic reasoning as above. By introducing measures that increase the price of energy above its market-determined marginal cost, consumers end up paying more for energy than they would have in a free market. This leads to a reduction in consumer surplus because consumers have to pay a higher price for the same quantity of energy, reducing the benefit they derive from each unit of energy they consume. When energy costs rise, lower-income households and businesses with tight budgets may reduce their energy consumption or cut back on other spending to compensate, and some smaller businesses (and ultimately consumers) may be priced out of the market altogether.

Just as before with toasters, suppose the marginal cost of energy from fossil fuels is £50 per megawatt-hour, but due to carbon taxes or regulations requiring renewable energy usage, the price consumers pay rises to £70. This £20 price increase represents a loss of consumer surplus, as they are forced to pay more than the true cost of production. While most consumers and small businesses lose, producers of renewable energy benefit in what has become a rigged crony capitalist system, where more expensive cleaner technologies gain because the higher price of energy artificially incentivises their production methods, even though their marginal costs are typically higher than fossil fuels, and less efficient for the UK economy. 

These producers receive producer surplus because they are able to charge higher prices that reflect the environmental cost embedded in climate policies – but, alas, the net benefit for these producers is almost always not larger than the consumer losses, because the increase in energy prices causes a deadweight loss, similar to what happens when prices are set above marginal cost. Consumers purchase less energy due to the higher price, leading to a reduction in energy consumption that exceeds the socially optimal level if we ignore environmental externalities. As well as inflated prices harming business and consumers, some energy needs will remain unmet, or consumers may resort to less efficient alternatives (such as cutting down on important activities that rely on energy, like heating or transportation), reducing overall welfare. This deadweight loss represents a loss in total economic efficiency: the difference between the energy that would have been consumed at a price closer to marginal cost and what is actually consumed at the artificially higher price due to policy interventions.

They get away with this assault on our economy by peddling the lie that these artificially higher prices are necessary to internalise externalities by reflecting the cost of fossil fuel-based energy production, including its environmental harm. But this is one of the greatest sleight of hand tricks ever played by politicians on the electorate. This disgraceful crony capitalist arrangement results in a redistribution of wealth from consumers to producers (particularly clean energy producers) and the government (through taxes), while at the same time putting the UK industry at a disadvantage from other more competitive nations. 

It is disgraceful that politicians have the power to artificially increase energy costs energy and make production more expensive for businesses, leading to reduced output, job losses, and higher prices for goods and services, which get passed on disproportionately to the poorest people in society. Climate policies are pushed hardest by socialists, when they are actually (as is so often the case with socialism) worst of all for the poor. The reality is - as is surely plain for all to see in these awful economic times - energy prices have increased above marginal cost far too quickly, aimlessly and recklessly, and far too precipitously for alternative energy technologies to become competitive in price and efficiency, causing energy prices to rise significantly above the true marginal cost of clean energy production, and creating larger inefficiencies and more severe deadweight loss than necessary.