Mr. Welker,

Could you please read my article and tell me if the evaluation is sufficient or not?

Also, are overconsumption and underconsumption of goods/serviaces (above socially optimal level or below it) a market failure?

I. Abstract
Currently, a number of firms are developing commercially viable clean energy, and the article focuses on LiveFuels, a firm currently working to create biofuel from algae’s natural photosynthetic ability. Because such ventures are costly, venture capitalists and hedge funds have invested more than $2.4 billion in the clean energy business just last year.

II. Analysis
Although developing cleaner alternate sources of energy on a commercial scale is a costly project, “hundreds, if not thousands” of firms have begun to do so for two major reasons. Firstly, oil prices have surged to “high levels” lately (P1 à P2). As a result, the demand for alternate sources of energy has increased (D à D1). This is because oil is a substitute to alternate sources of energy, and a substitute’s price is one of the product’s determinants of demand, which can shift the product’s demand curve outwards: if a substitute’s price increases (P1à P2), the demand for the product will increase (DàD1).

Market for Oil Market for Clean Energy

Secondly, many are recognizing the negative externalities created by conventional forms of energy (oil). Negative externalities occur when the production or consumption of a good or service adversely affects a bystander, who is neither involved in the production nor the consumption. In the case of oil, its consumption creates pollution, which may adversely affect society (the bystander) through problems such as global warming, worsening health conditions, or the destruction of natural ecosystems. Because these problems are caused by the consumption of oil by the consumers, oil consumption creates negative externalities of consumption. As a result, the marginal social benefit (MSB) is less than the marginal private benefit (MPB) at all levels of consumption as observable in the diagram to the right (MPB is the demand curve based on the consumer’s utility, while MSB is the demand curve which includes MPB and the external costs or benefits of consumption). This is because private benefit diminishes in the society level as a result of the negative externality. Thus, although consumers will maximize their utility by consuming at Q1 (where MPB = MSC), the socially optimal (or efficient) level will be at Q2 (where MSC = MSB). Because Q1 is greater than Q2, there is an over-consumption, and hence a market failure. In the “over-consuming levels” (between Q2 and Q1), MSC will be greater than MSB, creating a welfare loss to society (shaded green).

(I have no idea why the image is so small)

In order to help decrease consumption of oil (so that consumption level will drop to the socially efficient level of Q2), many firms are now developing cleaner alternate sources of energy, such as algae. Unlike oil, algae biofuel may yield positive externalities of consumption. Unlike negative externalities of consumption, this occurs when the consumption of a good or service benefits a bystander. In the case of algae biofuel, its consumption benefits society (the bystander): it may reduce pollution and may be renewable unlike oil. Because the benefits society face is greater than the benefits an individual face due to external benefits, the MSB will be greater than MPB at all levels of consumption as observable in the graph below.


(TIRED OF POSTING GRAPHS; I HATE HOW THE SCRIPT KEEPS SCREWING UP THE FORMAT)

As a result, while consumers will maximize their utility by consuming at Q1 (where MPB = MSC), the socially optimal (efficient) output is at Q2 (where MSB = MSC). Because Q1 is less than Q2, there is an under-consumption, and hence a market failure. In the “under-consuming levels” (between Q1 and Q2), MSB will be greater than MSC, creating a potential welfare gain to society.

III. Evaluation
However, because of a lack of consumption, such potential welfare gain may not be achieved. That is why the government should intervene in order to increase the consumption of this merit good and hence the benefits to society. Merit goods are underprovided and under-consumed (by the free market) goods, which the government believes provide benefits to the consumers and society (positive externalities) and thus should be provided and consumed at a greater level. To do so, the government should firstly subsidize the algae biofuel firms; this will shift the MSC curve outwards, so that the consumption increases from Q1 to Q2 (graph below), increasing societal welfare. Secondly, the government can try to shift the demand curve (MPB curve) outwards through the determinants of demand. Increasing consumers’ preference for algae biofuel through campaigning; decreasing the cost of complements (such as biofuel-run machines) by subsidizing them; or increasing the cost of substitutes (such as oil) by taxing them are all viable methods the government can employ. This may then shift the MPB curve up to where the MSB curve is (graph above), increasing the supply and consumption from Q1 to the socially optimal level of Q2; this will increase societal welfare gain.