Synoptic Economics Revision - Solar Energy Policy

In this revision video we look at how to shape an answer to this synoptic essay question. "Assess the possible micro and macroeconomic impact of new regulation that every new house in the UK must have solar panels installed."

KAA Point 1: Higher prices and profits for suppliers

One microeconomic effect of a law requiring all new homes to have solar panels installed would be a significant increase in market demand for solar panels and a potential increase in market price for consumers leadingtohighersupernormal profits for suppliers. This is shown in my analysis diagram which illustrates an outward shift in AR and MR leading to an increase in the profit maximising level of output from Q1 to Q2. Firms supplying panels would be able to raise their prices at the new level of output and my diagram shows that their profits will also rise. This might then allow them to increase capital investment in expanding their supply capacity which, in the long run, might actually cause solar panel prices to fall because of the effects of economies of scale from a significant increase in output levels.

Evaluation Point 1: Low elasticity of supply

The effect of the new regulation on the prices charged and profits of solar panel manufacturers depends on many factors. For example, in the short run, the supply of panels might be price inelastic due to a low level of spare capacity and limited stocks of finished panels and the components and raw materials needed to make them. As a result, solar panel manufacturers might find it difficult to expand production and higher prices for their inputs would then lead to an increase in variable costs. Depending on the strength of competition within the market, they might not therefore be able to pass on higher costs to consumers which in turn would mean a lower level of profit. Some solar panel firms might leave the market if they don’t make enough profit perhaps leaving customers in a difficult situation if installations go wrong and the equipment is faulty.

KAA Point 2: A stimulus to economic growth?

One macroeconomic impact of a regulation requiring all new homes to have solar panels installed could be to stimulate increased economic growth. Growth is a sustained rise in a country’s productive potential and the regulation would likely see a significant increase in capital investment spending by solar panel manufacturers and installation companies. Higher investment adds both to AD and can also stimulate a rise in long run aggregate supply. Increased investment would create new jobs which in turn might lead to positive multiplier effects. If the regulation is successful, the supply-side capacity of the renewable energy industry will grow, lowering prices for consumers and costs for businesses. It also contributes to long-run sustainable growth by addressing the impacts of climate change, and reducing greenhouse gas emissions.

Evaluation Point 2: Costs, inflation and trade

A counter argument is that regulations such as these add to the costs of the building industry which can be shown by an inward shift of short-run aggregate supply and might lead to a rise in inflation. Although the regulation would likely increase the derived demand for solar panels, in the case of the UK, the vast majority of solar panel electricity systems (photovoltaics) are imported from countries such as China which has a comparative advantage. In this case, a high marginal propensity to import will cause a widening of the UK’s trade deficit with China and reduce the impact on growth. It also lowers the size of the multiplier effect. The positive impact on growth might be cut by the knock-on effects on other industries such as energy sourced from natural gas and from coal. We would expect a contraction in output and employment in these industries.