In recent years the cost of producing solar energy has fallen dramatically. Discuss the economic effects of cheaper solar power on the energy industry and wider economic welfare.
Solar power is an alternative energy source to coal and natural gas.
Solar power also has a significant environmental advantage over traditional fossil fuels.
- It is renewable. there is no danger of running out.
- It does not cause pollution. There are no CO2 and other emissions created from solar power.
- Solar power has significant positive externalities. Switching to solar energy would help reduce the environmental costs (pollution, global warming) associated with fossil fuels.
Coal / Gas industries
The fall in the price of solar energy means that demand for coal and gas (a substitute to solar energy) is likely to fall, either in the short term or long term. Currently, solar energy is still a little more expensive. This graphs suggests that solar power is $1, whereas gas / coal is in the band $0.30 to $0.90. However, the sharp downward trend appears for solar power to become cheaper as technology improves.
As industry and consumers switch to solar alternatives, the coal / gas industry will face a fall in demand. This could lead to lower prices of coal due to excess supply.
This fall in demand for coal and gas could see firms leaving those industries (and a subsequent fall in supply). Alternatively, some coal firms may respond by cutting prices to try and undercut the price of solar power. This increased competition could lead to even lower energy prices for consumers. However, ultimately, you would expect the coal and gas industry to decline as people switch to solar.
However, it could take considerable time for this switch to occur. Many countries may be reluctant to invest in solar power plants, when it is still more expensive. Also, they may be unwilling to invest money in developing new power stations, and out of habit they may continue to use fossil fuels.
The existing coal and gas industries may have an influential lobby and seek to protect their interests. They could lobby for protection to make sure national energy providers continue to use fossil fuels.
Also, the impact may depend on the country. For example, a country like the US with wide deserts would be ideal for building solar power stations; it may be more difficult in countries in northern Europe with less sun.
It depends how governments respond
The falling price of solar power suggests there may soon be a market incentive to use solar energy rather than fossil fuels. But, that has not quite happened yet. Given the positive externalities of solar power, there is a case for the government to subsidise solar energy to encourage its take up rate. This would be particularly beneficial for a developing economy like China which has very bad pollution levels. Adopting solar power would help reduce air pollution. Decarbonising energy would also help reduce CO2 emissions which have contributed to global warming.
This diagram shows that the social marginal benefit of consuming solar energy is greater than private marginal benefit. The free market equilibrium is at Q1 (where S=D). However, due to positive externalities, the socially efficient point is at Q2 (where SMC=SMB). Therefore, in this case there is an argument that the government should subsidise solar power, shifting supply to S2 and increasing consumption.
This would improve social efficiency because it would speed up the adoption of solar energy and reduce the costs from burning fossil fuels.
Other issues of falling price of solar energy
The impact on other industries. The growth of solar power could have a big impact on other industries. There may be greater incentive to develop electric powered cars or electric trains, which can be topped up on solar energy. In the long term, this would reduce the demand for oil and petrol as well as natural gas.
Reduce economic influence of oil and gas producing countries. At the moment, countries in the middle east produce a high percentage of the world’s energy needs. The growth of solar energy could make energy more democratic and less dependent on fossil fuel reserves. For example, the EU has imported a lot of natural gas from Russia. If solar power comes to replace natural gas, it would adversely affect the Russian energy industries (and Russian economy), and make the EU less dependent on energy imports. Given recent political developments in Russia and Ukraine, this shows there could be important geopolitical influences from the growth of solar power. It could reduce the US dependency on oil imports from the Middle-East.
Environment and economy. An important feature of better solar technology is that it makes it much easier to meet CO2 emission targets without sacrificing economic growth. We can have the best of both worlds – clean energy, plus economic growth and higher living standards.
Solar power in Europe
The improved technology surrounding solar power is very significant. It has brought clean energy within practical use. Given the significant environmental benefits, there is a very strong case for government intervention to accelerate the switch to solar power. The reluctance to switch to solar power is delaying a global improvement in living standards.