ECONOMIC APPROACHES TO ENERGY QUALITY
From an economic perspective, the value of a heat equivalent of fuel is determined by its price. Pricetaking consumers and producers set marginal utilities and products of the different energy vectors equal to their market prices. These prices and their marginal productivities and utilities are set simultaneously in general equilibrium. The value marginal product of a fuel in production is the marginal increase in the quantity of a good or service produced by the use of one additional heat unit of fuel multiplied by the price of that good or service. We can also think of the value of the marginal product of a fuel in household production.
The marginal product of a fuel is determined in part by a complex set of attributes unique to each fuel, such as physical scarcity, the capacity to do useful work, energy density, cleanliness, amenability to storage, safety, flexibility of use, and cost of conversion. However, the marginal product is not uniquely fixed by these attributes. Rather, the energy vector’s marginal product varies according to the activities in which it is used; how much and what form of capital, labor, and materials it is used in conjunction with; and how much energy is used in each application. As the price rises due to changes on the supply side, users can reduce their use of that form of energy in each activity, increase the amount and sophistication of capital or labor used in conjunction with the fuel, or stop using that form of energy for lower value activities. All these actions raise the marginal productivity of the fuel. When capital stocks have to be adjusted, this response may be somewhat sluggish and lead to lags between price changes and changes in the value marginal product.
The heat equivalent of a fuel is just one of the attributes of the fuel and ignores the context in which the fuel is used; thus, it cannot explain, for example, why a thermal equivalent of oil is more useful in many tasks than is a heat equivalent of coal. In addition to attributes of the fuel, marginal product also depends on the state of technology, the level of other inputs, and other factors. According to neoclassical theory, the price per heat equivalent of fuel should equal its value marginal product and, therefore, represent its economic usefulness. In theory, the market price of a fuel reflects the myriad factors that determine the economic usefulness of a fuel from the perspective of the end user.
Consistent with this perspective, the price per heat equivalent of fuel varies substantially among fuel types (Table I). The different prices demonstrate that end users are concerned with attributes other than heat content. Ernst Berndt, an economist at MIT, noted that because of the variation in attributes among energy types, the various fuels and electricity are less than perfectly substitutable, either in production or in consumption. For example, from the point of view of the end user, l Btu of coal is not perfectly substitutable with l Btu of electricity; since the electricity is cleaner, lighter, and of higher quality, most end users are willing to pay a premium price per Btu of electricity. However, coal and electricity are substitutable to a limited extent because if the premium price for electricity were too high, a substantial number of industrial users might switch to coal. Alternatively, if only heat content mattered and if all energy types were then perfectly substitutable, the market would tend to price all energy types at the same price per Btu.
Do market signals (i. e., prices) accurately reflect the marginal product of inputs? Empirical analysis of the relation between relative marginal product and price in U. S. energy markets suggests that this is
U. S. Market Price for Various Energy Typesa
Energy type Market price ($/106btu)
Bituminous Mine-mouth Consumer cost Anthracite Mine-mouth Oil
Wellhead Distillate oil Jet fuel LPG
Motor gasoline Residual fuel oil Biofuels
Consumer cost Natural gas Wellhead Consumer cost
aSource. Department of Energy (1997). Values are 1994 prices.
Marginal Product of Coal, Oil, Natural Gas, and Electricity Relative to One Another
indeed the case. In the case of the United States, there is a long-term relation between relative marginal product and relative price, and several years of adjustment are needed to bring this relation into equilibrium. The results are summarized in Table II and suggest that over time prices do reflect the marginal product, and hence the economic usefulness, of fuels.
Other analysts have calculated the average product of fuels, which is a close proxy for marginal products. Studies indicate that petroleum is 1.6-2.7 times more productive than coal in producing
industrial output, and that electricity is 2.7-18.3 times more productive than coal.