Applied Analysis of the Carbon Price Mechanism in Australia - Case Study Example

Running Head: Applied Analysis of the Carbon Price Mechanism in Australia Your name Course name Professors’ name Date Introduction In an effort to reduce carbon emission, the Government of Australia proposed operation of carbon price mechanism. To understand its likely effects, this paper will first study the consequence of rising energy prices on the economic wellbeing of households. Secondly, the paper will analyze possible effect of the increased cost of traditional energy sources. This will be compared with the change in consumption patterns of Australian households. The last part of the essay will focus on how government cash payments influence household budgetary allocations, energy consumption patterns, and wellbeing of consumers. Effects of rising energy prices Economic wellbeing of a household is often determined by ability of a household to maintain minimum living standards by using its economic resources1. These economic resources i.e. income and wealth, ultimately provide a means by which each household meet their consumption of goods and services. Since most households depend on income to satisfy their consumption, low-income earnings imply that the families would not be able to achieve certain standards of economic wellbeing. From this scenario of economic wellbeing, it is apparent that changes in energy prices have direct impact in disposable income, which is an economic resource. Consumption expenditure of a household is likely to be affected by changes in energy prices in four different ways. In the first context, higher energy prices reduce discretionary income since consumers would now have fewer funds to spend after settling their energy bills. Where demand for energy is less elastic, income effect will be larger. Even in a situation of perfectly inelastic demand for energy, any changes in price would have an impact on energy share in consumption. While consumers may choose to borrow money as a response measure to rising energy prices, this is only short lived. In the end, purchasing power of the consumer declines. The second effect of an increasing price is creation of uncertainty about future thus prompting consumers to postponed purchasing consumer durables.2 Thirdly is an increase in precautionary savings due to rising energy prices. People tend to save more money as a precaution measure for an increasing energy prices. The final effect of a rising energy price on household wellbeing is a declining demand for products that are complementary in use with energy. This means that rising prices of energy motivates households to forgo purchase of products used together with energy. To illustrate changes in consumption patterns due to changes in prices and available income, indifference curves, number lines and resultant consumption line is drawn as shown below3. The theory of price and resource allocation clearly states that any change in relative prices causes resources to be reallocated. This means that consumers will opt for cheaper commodity while reducing expensive ones. If the price of energy increases, consumer budget line tilts inwards about point X as shown by the arrow. The original level of satisfaction is no longer attainable thus forcing the consumer to operate under the new budget line marked red. This high price of energy creates a new equilibrium of E2 with less demand for energy and more demand for other goods. If purchasing power of consumer’s declines due to reduced discretionary income, the budget line shifts inside. This is shown by the green budget line. A falling purchasing power drives a consumer to buy less of energy and other goods. This phenomenon is otherwise termed in consumer choice as income effect4. Effects of Increases in the cost of traditional sources of energy The traditional sources are the well-established sources of energy that shapes civilization. Coal, natural gas, nuclear energy, and oil are among the traditional sources of energy. For a long time, Australians have become used to low and stable prices of energy. This is rapidly being substituted by rising capital cost and price of natural gas in addition to black coal. The cost effect added to rising carbon prices ultimately imparts negatively on the consumer. Rising cost of traditional sources of energy motivates Australian households to resort to other related products like electricity. As an example, a $100 per ton increase in price of black coal could add about $53 per MWh to coal fired electricity. This shows a possibility of substitution across all fuels. It can therefore be argued that as traditional sources of energy decrease in quantity and become expensive to extract, other sources of energy also gains higher prices. The high cost of traditional sources of energy makes Australian consumer shy away from them and reconsider other alternatives. This feature can be illustrated in the graph below. From the diagram above, rising cost of traditional sources of energy plays a role of increasing price of this energy5. Where price of this commodity increases, the budget line tilts inside as shown indicating that less of traditional sources has been demanded while more renewable sources is needed. Australia expects a growth of wind and solar supply technologies that acts as substitutes for non-renewable traditional sources of energy. According to DCCEE, renewable target scheme was implemented in 2009 in a government strategy to ensure minimum destruction of environment6. Effect of increased government cash payments Increased government cash payments i.e. increased pension scheme has a wide range of effects on household budgets, energy consumption patterns and economic wellbeing. Transfer payment effectively addresses equity since household with meagre or no income can now meet their needs as a result providing social safety net. Government payment has the effect of protecting the most vulnerable household from changes in structures. Even though economic shocks tend to reduce real income, transfer payment for the vulnerable category of persons also increases. It can therefore be concluded that transfer payment in form of pension increases discretionary income. At the end, purchasing power of houses and demand improves Pensioners are classified as vulnerable group since they cannot supplement their incomes by working. According to Australia Bureau of Statistics, several families will be affected by carbon pricing7. Australian government plans to distribute extra payment in advance with a view of preparing Australians for carbon prices. To reduce destruction of environment, the government of Australia plans to impose carbon price requiring polluters to pay for their pollution emitted into the environment. On the other hand, families will be protected from adverse conditions by being offered pension payments that exceed average expected carbon tax impact. There is no doubt therefore that transfer payment is an incentive for people to participate in clean methods of generating energy while also improving their wellbeing through earnings form government payments. At the end, the raised income derived from transfer payment expands disposable income and avails more economic resources. This is a tendency to develop economic wellbeing of the people. The diagram below would assist to exemplify the impact of carbon pricing on welfare. The main role of this carbon tax is to internalize the externality in a way to include external cost in the final price of a good. A consumer would therefore pay the social cost. Even though the government has raised tax by p2-p1, revenue generated is spent on the same consumers in form of government pension payment. Taxes imposed on carbon therefore encourage consumers to resort to other alternative sources of energy, i.e. renewable energy sources. SMC is the social marginal cost to society PMC is private marginal cost to individual PMB is private marginal benefit to individual Conclusion It is apparent from the discussion that rising energy prices contributes to dislocated household wellbeing. This was particularly confirmed by a disrupted distribution of economic resources following changes in discretionary income and wealth. Moreover, raising the price of energy motivates a consumer to increase their precautionary savings. The essay further gave a vivid analysis of the effect of increased cost of traditional sources of energy. Finally, influence of government payments on household budgets, energy consumption patterns, and economic wellbeing was given necessary attention. To comprehend the government intention, a study on carbon prices was indispensable. Works Cited ABS (Australian Bureau of Statistics) 2011, Catalogue number 6467.0 - Pensioner and Beneficiary Living Cost Index, Dec 2010, released 14 February 2011, http://www.abs.gov.au/ausstats/abs@.nsf/mf/6467.0. Accessed 6 September 2011. Amadae, S.M. (2003). Rationalizing Capitalist Democracy: The Cold War Origins of Rational Choice Liberalism, Chicago: University of Chicago Press. Bernanke, B.S. (1983). “Irreversibility, Uncertainty, and Cyclical Investment,” Quarterly Journal of Economics, 98(1): 85-106. DCCEE (Australian Government Department of Climate Change and Energy Efficiency) 2010, ‘Renewable Energy Target’, Department of Climate Change and Energy Efficiency, online, http://www.climatechange.gov.au/government/initiatives/renewable- target.aspx. Accessed 6th September 2011. Lipsey, R. G. (1975). An introduction to positive economics. 4th ed. London: Weidenfeld & Nicolson. Volker, B., & Haller, H. (1987). "Demand theory," The New Palgrave: A Dictionary of Economics, v. 1, pp. 785–92. Read More