Applied Analysis of the Carbon Price Mechanism in Australia - Essay Example

The new Carbon Price Mechanism to be announced by Australian government will impact the social well-being of the consumers and will also affect the household budgets. However, the compensations proposed to be made by the government will reduce the adverse effects that these higher prices would have, otherwise, on the energy consumption patterns of the consumers. These effects may be well described with the help of Consumer choice theory. A basic assumption of Consumer choice theory is that the consumer wishes to maximize the utility.

In other words, their decision making is rational. However, it is also assumed that the income available to a consumer to be spent is also limited. Subject to such available budget, the consumer seeks to maximize the total utility gained from consumption of goods and services. 1. EFFECT OF RISING PRICES ON ECONOMIC WELL-BEING OF CONSUMERS: As explained earlier, consumers have limited incomes. With these incomes, they wish to maximize their satisfaction. This satisfaction is gained through consuming goods and services.

However, with limited incomes, there is a limitation on the consumption of goods. Where the consumer has equal preference for two goods, he is said to be indifferent between these two goods. The income of an individual consumer is shown in the diagram below. It is assumed that this income is divided by the consumer for the consumption of two products, one of which is the energy source shown along the X-axis. The economic well-being of the consumer is in that he uses both the goods to his entire satisfaction with his limited income.

To explain the effect of rising prices on economic well-being of households, assume that the consumer has a limited income which is represented by Budget line BC1. This budget line in the graph shows that the consumer can divide his income between the energy source and other goods by such income. The indifference curve IC1 shows different consumption options available to the consumer for consumption generate equal utility to the consumer. But all the points situated on IC1 are located above the budget line except Point A.

so, the consumer will get maximum satisfaction by utilizing X1 units of energy source and Y1 units of good Y. With corresponding increase in the price of energy source, the units which may be consumed by the consumer become less. So, the budget line is rotated inwards. New budget line obtained is BC2. The new indifference curve obtained after rising the price of energy source is IC2 and the new equilibrium point which generates maximum satisfaction for the consumers is B. at this point, the consumer will get maximum satisfaction by consuming X2 units of energy source and Y2 units of product Y.

It is to be noted that due to rise of price of energy source, the consumption of both the products has been reduced. Thus, this will adversely affect the well-being of the consumer as the consumer will have to sacrifice the units of both the goods in order to attain equilibrium for the consumption of both the units. EFFECT OF RISING PRICES ON ENERGY CONSUMPTION PATTERNS OF HOUSEHOLDS: The rising prices will also affect the energy consumption patterns of the households. It will specially affect the consumption patterns if the consumers have an alternative source of energy.

In case of rising prices, the consumer consumption pattern will be tilted towards that alternative source of energy. The budget line is BC1 before the price change and the IC will show the