ABSTRACT
Economics focuses on making the best use of scarce resources, the concept of economic efficiency. The theory applies to energy resources as it does to any other scarce resource. Market failure results when markets produce an economically inefficient outcome. This chapter focuses on three sources of market failure in energy markets: monopoly, externalities, and public goods characteristics. Economists prefer competition to monopoly because the loss to consumers from higher prices exceeds the profit gain to the monopolist, so that on balance society is worse off. Pareto improvements restrict us to those outcomes that make at least one person better off, without making anyone else worse off. Maximum social welfare in cost-benefit analysis (CBA) sums up consumer surplus (CS), the difference between willingness to pay and the price, and producer surplus (PS), the difference between price and marginal or opportunity cost. Economics can help evaluate how best to achieve society's goals with regard to the use of our scarce energy resources.
