Microeconomics of Solar Panels: Demand, Supply & Subsidies

Introduction and Investment Context

This paper considers an investment decision regarding a new business centered on the installation of solar panels. In the current period, this has been perceived as a profit-making venture. The world continues to shift increasingly toward renewable sources of energy, of which solar power is one of the leading options. Another key factor is that the government has created incentives for the industry by providing subsidies to suppliers in this market in order to increase the number of solar panels being produced.

Bearing this in mind, two decisions must be addressed. First, there is a need to review the probable profit or loss that could arise from this business in the future by accounting for the emerging prospects of this industry. A careful examination of the macroeconomic and external environment is required to reach a sound resolution. The second decision is whether to invest personal capital or instead borrow funds if the business is pursued. For this particular aspect, no specific financial information has been provided.

The article under review offers a strong examination of the solar power industry and the solar panel market. It informs us that the government is fully supportive of solar power and intends to make it a key source of energy in the future. As a result, the government has provided substantial subsidies to the solar power industry. The high cost of panels is considered a barrier to the industry's growth, and the government is responding by distributing financial assistance. For instance, the government extended $150 million as a loan guarantee to a company known as 1366 Technologies, a manufacturer of solar wafers, on the basis of its extraordinary technological innovation. The Department of Energy also provided $12 billion in loan guarantees to sixteen solar projects. The forthcoming growth of this market is therefore very nearly assured.

Considering the impact of these subsidies, it is clear that they affect the forces of solar power demand and supply. Government and Department of Energy subsidies shift the supply curve to the right, as manufacturers increase the supply of solar panels due to the financial assistance available to offset their high production costs. Based on the natural forces of demand and supply, a rightward shift of the supply curve causes prices to fall while the quantity of panels rises. This is because a decrease in price reduces production costs, which in turn increases the level of supply in the market.

Demand Determinants for Solar Power

The law of demand holds that, with everything else remaining constant, an increase in the price of a commodity brings about a decline in demand, while a decrease in price brings about an increase in demand.

Determinants of demand can be described as the factors that affect demand — in other words, the factors that cause a shift in the demand curve. A change in any demand determinant will bring about a change in demand even if the price remains constant. Some of the key demand determinants for solar power include the following.

A change in the number of consumers directly impacts the quantity of a commodity demanded at every price level. When the number of consumers increases, demand is expected to rise; if the number of buyers decreases, demand is expected to fall. Solar power is gradually becoming a prominent source of energy not only in the United States but around the world. It is an economical, clean, reliable, and suitable source of energy. The number of solar power consumers has grown particularly in recent years, driven in part by the financial crisis increasing the prices of fossil fuels (Frankel, Ostrowski, and Pinner, 2014).

There are two kinds of related goods: substitutes and complements. Solar power is a natural renewable source of energy. A change in the price of a substitute commodity generally impacts the demand for a good in a direct manner. For instance, a decrease in the price of solar power technology will bring about a decrease in the demand for conventional electric power. On the other hand, demand for a commodity changes inversely with a change in the price of a complementary good. For instance, a decrease in the price of drilling for fossil fuels will increase the demand for fuel.

Changes in consumer income affect demand directly in most circumstances. An increase in buyers' income allows them to purchase more, thus increasing demand, while a decrease in income limits their consumption and therefore reduces demand. Currently, with respect to solar power, consumers' income appears to have increased due to the gradual decrease in the price of oil. It is well established that high oil prices can have a dampening effect on the demand for other commodities because they reduce consumers' real income (Brown, 2006). The decrease in oil prices can be interpreted as a lower effective tax level on consumers (Ponce and Neumann, 2013). The extra money that consumers no longer need to spend on oil may be redirected toward installing solar panels, which many regard as the technology of the future and which are expected to become increasingly affordable over time.

Price Elasticity of Demand and Demand Curves

Price elasticity of demand refers to a measure of the degree of responsiveness of the quantity demanded of a commodity to changes in its own price. It is calculated using the following formula:

Price elasticity of demand = Percentage change in quantity demanded / Percentage change in price

Using the midpoint formula, the elasticity of demand is calculated as approximately 0.8222. Therefore, the price elasticity of demand is inelastic.

Solar panels continue to be manufactured in different nations, including the United States and China. In this analysis, the assumption is that initially all solar panels used are manufactured domestically. The demand curve is labeled D_S. We assume the global price, P₀, is $200 per solar panel, which is equal to the domestic price in the absence of trade. The quantity demanded and quantity supplied are assumed to be equal at 4,000 panels per week.

However, with the entry of Chinese firms into the market, the global price decreases to $170 per panel. Since domestic producers are unable to compete at this price, they are forced to cut production to 1,000 panels per week. The total quantity installed in homes rises to 5,000 units, of which 4,000 are imported.

This situation prompts the use of tariffs and subsidies as government tools to protect the local industry, causing the domestic price to rise back to $200 per panel. At this price level, domestic production increases to 3,000 panels per week. Due to the forces of demand and supply, the quantity being installed decreases by 1,000 units, effectively eliminating the imported share.

Figure 1 shows the demand curve D_S. Due to the entry of new suppliers and demand determinants such as technology and the price of related goods, the price decrease causes an increase in the quantity demanded.

Figure 2 shows the demand curve D_S after the imposition of tariffs and subsidies. The resulting price increase causes a decrease in the quantity demanded.

The following data is hypothetical and is used to conduct a cost analysis of fixed costs, variable costs, and marginal costs. The cost table includes output levels (Q) from 0 to 5, with a total fixed cost of $50 at every level of output. Total variable costs and total costs vary with output, and marginal costs are derived accordingly.

The profit-maximizing or loss-minimizing output level is obtained where marginal cost equals marginal revenue. This is likewise the output level at which the highest level of profit or the minimum level of loss is achieved.