Production efficiency and opportunity cost of the American Clean Energy and Security Act of 2009

This economics post discusses a common question going around the web.  I am not aware of any "right" answer, so feel free to comment and contribute below:

“If the American Clean Energy and Security Act of 2009 becomes law, it will limit greenhouse gas emissions from electricity generation and require electricity producers to generate a minimum percentage of power using renewable fuels. Some of the rights to emit will be auctioned. The Congressional Budget Office estimates that the government will receive $846 billion from auctions and will spend $821 billion on incentive programs and compensation for higher energy prices. Electricity producers are projected to spend $208 million a year to comply with the new rules.”

Will this new law achieve production efficiency?


To achieve “production efficiency”, it is necessary to be at a level in the economy where no more of one good can be produced without lowering the amount produced of another good.  Another way to think of this is an economy operating ON their production possibilities frontier.

Technically, a market economy will result in production efficiency when left alone.  Any involvement by the government will change the equilibrium price and quantity resulting in a deadweight loss, and possible movement away from production efficiency.  With respect to this quote, it is unknown whether production efficiency was acquired before, during or after the law.  My best guess would be that this law forces companies to invest their money through taxes and subsidies rather than what is most profitable.

Looking at it strictly in dollar terms, companies will pay $846 billion and only receive $821 billion back in the form of incentives and compensation.  This means private firms end up losing about $25 billion overall, in addition to the $208 million per year they spend on compliance.


Is the $821 billion that the government will spend on incentive programs and
compensation for higher energy prices part of the opportunity cost of producing
electricity?

An “opportunity cost” is the value of the next best alternative.  So the opportunity cost of producing electricity is what you had to “give up” in order getting that electricity.  

From the firm’s perspective:
So in this example, the opportunity cost of producing electricity is everything given up, including the original cost of production, the $846 billion given to auctions, and the $208 million a year to comply with the new rules.  The $821 billion given will actually REDUCE the opportunity cost of electricity production.

From society’s perspective:
The opportunity cost of producing electricity has gone up by $25 billion now (because of the difference the government is keeping to do whatever they do with it) as well as the $208 million per year paid by the firms to comply with the new rules.

So this means that the opportunity cost of producing electricity has increased, and we may have moved away from productive efficiency.  HOWEVER, it is important to remember that social welfare, or total economic surplus COULD increase due to the negative externalities associated with pollution or environmental degradation that could be reduced due to this type of law.