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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 14 seconds Although we have a clear definition of energy transition policies, the more difficult question to answer is how to define the optimal contents of such a policy. Any policy measure affecting the decisions which energy consumers and producers make may result in an energy transition. But not every energy transition contributes to welfare. In the previous sessions, we have learned that government policies intervening in the decisions of economic agents may only have a welfare-improving effect if the market fails to give the correct signals. This implies that the first and fundamental issue to be analysed before implementing any energy transition policy is the existence of market failures.

Skip to 1 minute and 3 seconds Without significant evidence of the occurrence of market failures, policy measures face the risk of creating more damage for welfare than benefits. If a market failure exists, the next step is to think of effective and efficient measures. By “effective,” we mean that a measure must have an impact on the decisions of consumers and producers. Defining “effective” measures is much more complex than may be expected. Earlier in this course, we have seen that the price elasticity of demand determines how effective any price measure can be. If consumers are not sensitive to the price of energy, that means the price elasticity is low. Policy measures raising the price of energy do not have an effect on actual behaviour.

Skip to 1 minute and 57 seconds The effectiveness of policy measures also depends on indirect effects, such as the rebound effect and the waterbed effect, which will be discussed later on. Policy measures not only need to be effective. They should also be efficient. By “efficiency,” we mean that the cost of implementing a measure should be lower than the benefits realised by this measure. The costs of a measure include both the transaction costs for governments and economic agents and the costs of change in the decisions made by these agents. Take, for instance, a subsidy for consumers to implement energy-saving measures. The transaction costs of these measures refer to all the costs of designing the subsidy, informing the public, and administrative costs for consumers.

Skip to 2 minutes and 50 seconds On top of these costs, the subsidy creates additional costs since it induces consumers to take energy-saving measures which will be too costly to them without the subsidy. These costs should be weighed against the benefit of having a lower energy consumption by consumers. If the policy objective of this measure is to reduce the environmental burden of energy consumption, this benefit can be expressed in monetary values by using so-called shadow prices for the environmental effects, such as a reduction in the emissions of NOx or CO2.

Economic criteria to develop optimal policies

How can we define the optimal contents of energy transition policies? Again you need the concept of market failures to determine whether policy measures are welfare improving. In this video also the economic concepts of effectiveness and efficiency are discussed, which will assist you in defining the optimal energy transition policy.

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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