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Skip to 0 minutes and 13 secondsWhen talking about economics, we often talk about money. Discussions on energy economics tend to be directed at the prices of energy, the profits of energy firms, or the monetary value of energy resources. Although money is a key parameter in economics, this does not mean that economics is equal to discussing monetary issues. To state this even stronger, money is not an essential component of economics. Remember, economics is about making choices between alternative utilizations of scarce resources. If the value of the alternative utilisation can be expressed in monetary values, it is easier to make decisions, as all alternatives are expressed in the same unit.

Skip to 0 minutes and 58 secondsOne of the fundamental roles of money is therefore to facilitate economic agents in making the optimal decision how to use their scarce resources. The key condition for money to fulfil this role is that all alternatives are properly priced. By "properly priced goods," we mean that the price reflects the cost to produce one additional unit, given the current total demand for that good. These costs are called the marginal costs. If prices reflect the marginal cost of producing goods, economic agents can truly make the comparison between the benefits of using a good for a particular purpose and the opportunity cost of using that good for other purposes.

Skip to 1 minute and 44 secondsAfter all, the value of using a good for other purposes is reflected by how much other economic agents are prepared to pay for using that good. The willingness to pay of all agents together determines the demand for goods. In reality, however, many goods are not priced properly. This holds for many types of goods, but in particular, for energy. Energy markets are set to suffer from several kinds of market failures, which means that the prices in these markets do not perfectly reflect the marginal cost of supplying that good. One example of these market failures is the environmental externality of using fossil fuels. The carbon emissions resulting from burning fossil fuels contribute to climate change.

Skip to 2 minutes and 34 secondsThis effect of using these fuels is a cost which is not included in the market price. Hence, economic agents use too much of these fuels, as they cannot properly include these opportunity costs in their decisions regarding energy use. In economic terms, the consumption decisions are not efficient because the price of fossil fuel does not fully reflect the opportunity costs. We must not blame consumers for their inefficient decisions, but elaborate on the question, how to improve the design of markets or to take other measures so that consumers can improve the efficiency of their decisions of energy use. This type of environmental policy measure may be a part of energy transition.

The role of money in energy economics

In this video Machiel elaborates on the role of money in economics. Using an example you will learn about the marginal costs of producing goods and its importance in determining prices in energy markets. This leads us to discuss the fundamental economic concept of market failures, taking the environmental externality of using fossil fuels as a prominent example. Please take your time to go through all of the economic concepts that were explained in this activity again if necessary, as you will be needing them during the rest of this week.

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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