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Opportunity Cost

Introduction to Environmental Economics

Page 5:  Opportunity Cost
“The concept of opportunity cost is commonly used in economics; it is measured by reference to the opportunities foregone at the time an asset or resource is used”
— 
OECD Glossary of Statistical Terms
“Calculation of the costs according to the opportunity cost principle is based on the alternative usage of the production factors. According to the opportunity cost principle, the costs are equal to the earnings lost (lost opportunity) by not using the production factors in question in the best alternative way. The opportunity cost principle is the key basis for all economic planning (a cost concept pointing to the future).”
— 
Svend Rasmussen, Production Economics, p. 56

Opportunity cost in economics is the cost of not having taken a better choice. That is the definition we refer to here. An alternative definition is used in accounting, which refers to the cost of the alternative and is covered in James A. Buchanan, “opportunity cost”, The New Palgrave Dictionary of Economics. Either way, opportunity cost occurs when a decision is made:

“opportunity cost exists only at the moment of decision when choice is made. It vanishes immediately thereafter. From this it follows that cost can never be realized; that which is rejected can never be enjoyed.”
— 
The New Palgrave Dictionary of Economics

More precisely, the unchosen opportunity is lost forever. What may be portrayed as choosing the unchosen opportunity later is actually choosing a different opportunity later that may not be as efficient or even possible (for example skilled persons/businesses switching to a different skill and no longer available, etc.).

Returning to the quote of P. K. Rao, Sustainable Development, p. 88: “the time frame over which the self-correction feedbacks might happen is not expected to be synonymous with that relevant to preserve the ecosystem resilience. The attainment of such a pseudo-sustainability could be consistent with massive environmental degradation.”


Hydropower

Hydropower is the use of moving water to provide electricity and other forms of energy. According to the International Hydropower Association (hydropower.org), “In terms of generation capacity, hydro accounts for eight of the world’s ten biggest power stations.”

Hydropower produces 7 percent of U.S. electricity, and 20 percent of the world’s electricity. Hydroelectric power has very little operating costs, and no fuel costs (generates electricity from water that occurs naturally, not purchased on markets).

Nuclear and fossil fuel power plants, on the other hand, require fuel purchased on markets. Another problem with nuclear and fossil fuel plants is waste and limited lifespans. Hydroelectric plants that are properly designed may last indefinitely and not require to be replaced. Limited lifespan is particularly a problem for nuclear power plants because they do not generate enough income in their lifespan to cover construction of the plant.

Fossil fuel power plants do cover their cost of construction, but are not as cost effective as hydro and solar thermal electricity using parabolic troughs, which in that order are the two most cost effective forms of electricity generation.

Solar thermal electricity using parabolic troughs is very much like hydro, except it only stores energy (as heat) for one night, while hydro may store energy (as water) for weeks. The two work well together near Ouarzazate, Morocco. Both technologies have near zero marginal costs (costing almost nothing to produce each extra watt), since there are no fuel costs or replacement costs; both last indefinitely if properly designed and constructed without extremely high precision required; and both can use the same HVDC transmission lines (which are widely used for hydroelectric power).

Hydroelectricity has environmental impact, flooding land, thus limiting its potential growth. Solar thermal electricity using parabolic troughs has less impact.


Rent Seeking

One problem with hydroelectricity generation is the potential for rent seeking when privately operated (or when transmitting to another country). Conventional rent seeking applied to hydroelectricity would spill water instead of generating electricity with the water, creating scarcity to raise prices. However, spilling water is obvoius to the public which may have helped subsidize construction of the plant and likely create countervailing power against the rent seeking and its opportunity costs.

Instead of spilling water to raise prices, a private (or international) operator may manipulate opportunity costs to trick a public that is not paying attention to pay below a possible fair equilibrium price for extended periods and way above the equilibrium price occasionally, evening out to higher (unfair) cost overall. This would be less possible with solar thermal electricity which has only one day of storage, just enough to be useful but providing less opportunity to increase opportunity costs.

“One reason for concern about potential market power abuse of hydro producers is that it may be used without any spilling of water and not so easy to detect by regulators, because market power is typically exercised by a reallocation of release of water between periods compared with what would be the socially desired release pattern. Measuring existence of market power by comparing price and marginal costs does not work for hydropower because variable cost is virtually zero. The relevant variable cost is the opportunity cost of water, but this is an expected variable and not directly observable.”
— 
Finn R. Forsund, Hydropower Economics, p. 181

Photovoltaics creates opportunity costs by tying up hydroelectric production to manufacture PV panels, instead of for example using the electricity from PV panels themselves to manufacture more PV panels, which PV is not efficient enough to do (or else they would be doing it).

Hijacking another electricity generation technology, in this case PV tying up hydroelectric production, prevents other uses of the hydroelectricity, making those potential other uses an opportunity cost (not allowed).

For example, historically the U.S. used hydroelectric power to start its aluminum industry. Aluminum requires a lot of electricity to manufacture from scratch, and much less electricity (more than tenfold decrease) to make aluminum from recycled aluminum. But at first there was not much recycled aluminum, and the industry needed cheap electricity to get started. The cheap electricity that started the U.S. aluminum industry was hydroelectric power.

After the aluminum industry gets started, it will require less electricity to produce the same amount of aluminum because it will use recycled aluminum as part of its production which requires less electricity to manufacture new aluminum from.

But it may never have started if the cheap electricity was not available when it was needed. Photovoltaics is proposing to tie up hydroelectricity permanently. That would have prevented the aluminum industry from starting. The opportunity cost of the photovoltaics industry would have been to prevent the aluminum industry from starting, and now going forward denying any industry that temporarily needs cheap electricity to get started. Further opportunity costs are incurred by denying the subsidies themselves to other technologies that are more likely to reduce nuclear and fossil fuel electricity generation.


Countervailing Power

Countervailing power to advocate elimination of government subsidies that incur substantial opportunity costs is the most viable way to stop incurring those losses. For example, public advocacy should demand (and is demanding) that governments stop subsidizing sales of photovoltaics after another “lost decade” in which photovoltaics did not reduce nuclear and fossil fuel electricity generation, and in which it denied other technologies opportunities.


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