Does deregulation cause an under-investment in robust resilience? How would Professor Demsetz and Professor Stigler answer this "Chicago" Price Theory question? A Thread.…
When I was taught the Arrow-Debreu model of complete state contingent markets, we were taught that consumers made their consumption plans while forming rational expectations of the future.
One "state of the world (SOW)" contingent contract would be; "Anyone can purchase X KWH of power on a February 2021 day in Texas even if it is freezing outside for $Z dollars". This price is such that aggregate demand equals supply and no blackouts occur even in that SOW.
In this dynamic investment problem setup, forward looking consumers of electricity would see this extremely high $Z price in this state of the world and say to themselves, "If extreme freezes are now more likely to take place, I should self protect by insulating my home."
On the supply side, electricity suppliers would say to themselves; "Wow, during freezing times in Texas --- we can make $Z per KWH if we can generate some power during those times!" These demand side and supply side dynamic responses fuel adaptation.
The crisis unfolding in Texas in February 2021 occurred because we don't have the full set of Arrow-Debreu state contingent prices "posted". If this vector had been common knowledge, more ex-ante adaptation would have taken place --- as I sketched earlier.
If we expand the model to allow people and firms to have different expectations of the probability of a major February Freeze =>those who are most worried about this risk would be more likely to take self protection steps.
If enough people are concerned, this shaves peak demand. If enough firms are excited about the price spike, they will take costly steps to generate power during these key times. Together these demand and supply adjustments curb price spikes.
I recognize that we don't live in the Arrow-Debreu complete markets world. That's why I wrote this piece on the social benefits of scaling up critical peak pricing. The New York Times is not discussing this approach that fuels adaptation.…
Finally, PHD economists will note that the Texas freeze is identical to the economics that @dxzhao and I explore in this piece. Two Clark Medalists at MIT have told me that they like this paper.…

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More from @mattkahn1966

21 Feb
This important news article suggests a research topic related to Tiebout and local government competition. Charles Tiebout emphasized the benefits of political fragmentation as this offers a menu of bundles of taxes and services to choose from. (1/N)…
Some people who rely on private markets prefer a small government providing few services financed through low taxes. Others want a big government to heavily tax them and provide all sorts of services for them. Tiebout's vision accommodates this diversity.
What is missing in Tiebout is cross-boundary externalities (i.e the Texas grid affects others). We see with COVID policy co-ordination and the Texas freeze such spillovers. How do negative externalities affect the Tiebout logic about efficiency caused by decentralization?
Read 4 tweets
21 Feb
A great piece that highlights the adaptation pathway. As expectations shift, we invest in private and public goods that facilitate resilience.
"She said it’s hard to persuade taxpayers to spend extra money to guard against disasters that seem unlikely."…
Academics play a key role here helping the public to "connect the dots" to see past correlations between ugly outcomes and past weather events. Our 2020 NBER paper is one example.…
Academics play a key role here helping the public to "connect the dots" to see past correlations between ugly outcomes and past weather events. Our 2020 NBER paper is one example.…
Read 4 tweets
20 Feb
An excellent list but in any market, there is supply and demand. Use pricing incentives to shave peak aggregate demand (insulation investment etc) and blackout risks fall sharply. There are no economists on JJ's list. Incentives, Incentives, Incentives. (1/2)
In recent years the rise of Big Data and micro applied econometrics has creates a growing army of scholars studying heterogeneity. In the energy context, which energy consumers have an edge in adapting to price spikes? Energy planners must celebrate our diversity.
I sketch out how a smart electric utility can use an "opt in" research design to cost effectively enroll more customers in critical peak pricing. Such an incentive encourages insulation installation and reduces blackout risk.…
Read 9 tweets
20 Feb
Paul Krugman has written an important piece. A Silver Lining of this tragedy may be a new discussion of robust policy design. We will be better able to adapt to future shocks if we "know that we don't know" their probability of taking place. (1/2)…
In 1972, Ehrlich and Becker published this JPE paper. It forms the foundation of my new book "Adapting to Climate Change". Decision makers can self insure and/or use market insurance to offset risk. The Knightian Ambiguity of climate change is key here.…
Here is a .pdf version of the Ehrlich and Becker paper. They do not discuss robustness in their paper but the demand for self protection strategies (such as signing up customers for critical peak pricing) rises once we acknowledge Knightian uncertainty.…
Read 4 tweets
19 Feb
I agree. When I taught at UCLA, I proposed the following field experiment to @LADWP. Their team rejected this. In Los Angeles, many poor people rent apartments in older apartment buildings. These apartments feature old energy inefficient refrigerators. (1/N)
I proposed to LADWP that they go in replace the old fridge with a new energy efficient fridge and then rent the energy efficient fridge to the tenant. Given market power as a big buyer, LADWP could purchase 10,000s of these fridges at a lower price.
A renter in the treatment group would now face a lower electricity bill and would pay a rental fee for the fridge. If energy savings gains from an Energy Star fridge are large, the eligible poor would save $ and GHG emissions would fall. Energy inefficiency would decline.
Read 8 tweets
19 Feb
With the Texas freeze in mind, some are tweeting out that building energy codes and higher electricity prices are substitute policies for reducing aggregate demand for electricity. A thread about the implicit assumptions in this logic.
Building energy codes tend to be binding for new construction. Real estate is highly durable (75 year old homes in many cities). Such differential regulation of new versus old capital means the Gruenspecht Effect matters.…
When new capital faces binding building codes, it can take more than a decade for the average capital to start becoming more energy efficient. Think of adding hot water to a bathtub filled with cold water. In contrast, energy prices spikes incentivize all capital owners!
Read 5 tweets

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