The visible hand in economics

Banning fossil fuel plants

Posted on: October 17, 2007

The government has decided to ban the construction of new fossil fuel plants for the next 10 years, as they believe that they are unnecessary.   However, I feel that this policy is unnecessary.

I do believe that if we left power generation to the free market, too much CO2 would be produced, and our liability under the Kyoto protocol would be ‘too high’.  But wasn’t that why the government introduced a carbon trading scheme?

In economics terms, the externality from fossil fuel plants is greater than the externality from Hydro, or wind power generation.  The government can try to fix this externality by putting an externality charge on unit production (which is what a tax or a carbon trading scheme does) or by directly regulating the industry.  As the carbon trading scheme is coming into place, the firm producing the power will have to pay the full social cost of producing the power.  In this case, if the firm still decides to build a coal power plant instead of a wind farm, it must be because the full social cost of the coal plant is lower than the full social cost of the wind farm.  As a result, banning the construction of fossil fuel plants seems unnecessary, as in this example, society is better off with this coal plant than with the wind farm.

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