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This content is taken from the University of Groningen's online course, Solving the Energy Puzzle: A Multidisciplinary Approach to Energy Transition. Join the course to learn more.

Skip to 0 minutes and 13 seconds My name is Machiel Mulder. I am professor of energy markets and director of the Centre for Energy Economics Research at the Faculty of Economics and Business of the University of Groningen. In this session, we will look at energy transition from an economic point of view. We will see that economics is not just about talking about prices and financial issues but about how firms and consumers make decisions regarding the use of scarce resources. We will define energy transition as policy measures which are meant to change the decisions of energy consumers and energy producers. One of the fundamental concepts in economics is scarcity. What do we mean by scarcity? The meaning of this concept in economics differs from the common-sense meaning.

Skip to 1 minute and 5 seconds In daily life, we call something scarce when there is hardly any supply. For instance, when many people want to have a good that’s only limitedly available. This notion of scarcity may be reflected by the price of a good. See, for instance, the movement of the price of oil since the early 1970s. We see in this graph that the price of oil increased strongly in the 1970s until its peak in 1985. In that year, the price of oil decreased strongly to levels of about $20 per barrel, which was more or less maintained until the early years of the new century. In 2004, the price of oil surged again to levels above $100 per barrel.

Skip to 1 minute and 52 seconds But more recently, the price declined by about $50 per barrel. This movement in the price of oil is partly related to the tightness of the international oil market. If the demand for oil approaches the capacity level of supply, price goes up. And the other way around. When there is abundant production capacity, the price of oil may go down. In daily life, we say that oil is a more scarce commodity when the price is high, and that oil is less scarce when the price is low. A high oil price, for instance, may indicate, that the technical availability of oil decreases. That means that new marginal fields are less easy to produce oil from.

Skip to 2 minutes and 38 seconds The view that the costs of drilling new oil fields will become higher and higher is called the peak oil explanation. Looking from a more theoretical economics perspective, however, the scarcity of a commodity does not depend on the magnitude of the supply in relation to demand. The latter is called the tightness of a market. Independent of the tightness of a market and the price of a good, a good is viewed as scarce if it can be used in alternative ways. By using a good in one specific way, the other ways of using it are not available anymore.

Skip to 3 minutes and 16 seconds Even if the price of oil is low, using a barrel of oil as feedstock in the industry implies that that barrel of oil cannot be used anymore for, for instance, generating electricity. Hence a good is scarce if using that good implies that alternative uses are made impossible. These costs are called opportunity costs because the costs of using a good are determined by the missed benefits of alternative ways of utilisation. Why is scarcity such an important concept in economics? Because it shows that economics is about making choices between alternatives. And electricity producer, for example, who sells electricity to a domestic retailer cannot use it anymore for export.

Skip to 4 minutes and 5 seconds Hence, the opportunity cost for an electricity producer of selling electricity to a retailer consists of the revenues which could be received by, in this example, exporting it. Also, energy consumers face opportunity costs when they consume energy in a specific way. If they use gasoline to drive with their car to a soccer stadium, they cannot use this gasoline anymore to drive to another destination. By having defined scarcity and opportunity costs, we immediately arrive at another fundamental notion in economics, efficiency. Firms and consumers are viewed to make efficient decisions if the benefits to them of using a good in a specific way exceeds the opportunity costs.

Skip to 4 minutes and 57 seconds In the example of the electricity producer, if the price of electricity paid by the retailer would be below the price which could be earned by exporting the electricity, the decision to sell electricity to the retailer is called inefficient.

Skip to 5 minutes and 15 seconds In the next sessions, you will need the concepts or scarcity, opportunity costs, and efficiency to be able to assess energy transition from an economic point of view.

What do economists mean by the notion of ‘scarcity’?

With this first video you start to take a look at energy transition from an economic point of view. Machiel Mulder, professor of Regulation of Energy Markets at the University of Groningen, introduces you to the economic concepts of scarcity, opportunity costs and efficiency. Also he explains the differences between the concepts of scarcity and tightness. Have you recently read news articles on the scarcity of energy? Please share them with your fellow students in the comments section below.

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This video is from the free online course:

Solving the Energy Puzzle: A Multidisciplinary Approach to Energy Transition

University of Groningen