Energy markets affect everyone, as anyone who has just begun driving is aware. The unfortunate reality is that the prices of oil and gasoline, as well as a number of other energy sources, have risen dramatically in recent years.
Politicians have responded to outrage over fuel prices with any number of schemes to get costs under control. But there are other reasons energy policy has come into such sharp focus. Increasing concern about pollution and global warming is tied to the way energy is produced. The sources of U.S. energy have also drawn attention because of their relation to national security issues.
For this reason, the Minneapolis Fed has decided for its 21st Annual Student Essay Contest to ask the question, "What role, if any, should the government play in energy markets?"
This is a question rich in economics. The following provides some basic ways to think about the problem.
The grounds for intervention
Markets are generally believed to allocate scarce resources efficiently. Competition among producers lowers prices and causes improved productivity, while competition among buyers tends to drive resources to those who value them most.
So if private markets in energy are functioning properly, there shouldn't be a need for government intervention, at least not in the name of improving economic efficiency. But the real world might not be so simple. There are three primary rationales for government intervention in energy markets.
The first is that real-world markets might not function like the ideal competitive ones in a textbook. Some real-world markets, including those for energy, might be subject to monopoly. A monopoly might supply less than the efficient level of a good to influence its price and increase profits. In these cases, policymakers often opt for regulation, public ownership or other interventions to produce outcomes more like those a competitive market would.
A second cause for intervention is market failure. Many of the issues discussed in energy policy boil down to one of the two well-known classes of market failure. For example, pollution is an example of an externality, and national security is a public good. You can read more about market failures in the Minneapolis Fed's document Economic Principles to Keep in Mind. Many other examples are available for your essay.
The third rationale for government intervention is that policies could be motivated by concerns that are not purely economic. For example, energy prices have a bigger impact on the poor than the wealthy, and this could be considered unfair. It might seem inappropriate to ask for an economic point of view on matters such as equity, which are moral or philosophical. But the economist's tool kit provides means for thinking about these problems too. For example, taking a policy goal as given, economics can help you think about the best way to achieve it, or what unintended consequences might occur.
Think hard and get creative
While the three rationales cited above are grounds for intervention, it will not do simply to point to an instance of one of them to justify government action. Public policies have costs of their own and often impose unintended consequences. If you want to make the case for new laws or regulations, you must be prepared to argue that these actions will improve the outcome.
In order to assess the outcomes of markets and policies, you need to specify what goals they will satisfy. Keep in mind that the more goals a policy has, the more difficult it will be to successfully fulfill them. This is especially true if one goal is in conflict with another.
The issues outlined above are fundamental when thinking about government and its role in energy markets. But your essay could take many other angles not mentioned here. Creative essay topics will receive special attention, so put some time into thinking up an original angle. Maybe you will come up with a solution that hasn't occurred to anyone yet. But whatever you decide to write about, make sure you keep your basic economic principles in mind. Good luck!
If you have any questions, contact Joe Mahon at Joseph.Mahon@mpls.frb.org or call 612-204-5254.