Analysis Of Microeconomic And Macroeconomic Influences On A Solar Energy Retail Business

Microeconomic Influences on Cindy’s Business

Any new business venture must keep in mind the basics of business investments in mind. Cindy is no different, except that she must look out for the specific factors that can impact her possible venture. As a subject the study of Economics can help her gain an insight into all the options, possibilities and fallouts of her decision.  

My training in various aspects of Economics can help her as I can divide the range of variables of her interest into two broad categories- Microeconomics and Macroeconomics. The first part of microeconomics covers demand and supply aspects of the product that she seeks to sell- solar panels. This will also tell her about balancing costs with revenues so that she can seek profits, and not sink into losses leading her to close her business. It can also tell her about her explicit and implicit costs along with the need to factor in opportunity costs.

The Macro part of theory is important as it tells her about the overall situation in the economy through macro variables like inflation, wages, employment, GDP that affect her procurement decisions and her prospective customers. It will also be helpful to get knowledge of the existing businesses that install solar panels, so that we know how competition is surviving and succeeding. We can formulate strategies that are effective, keeping in mind rivals’ strategies.

We start with Microeconomics part of the analysis. We look at solar energy as a commodity to be sold. This is because solar panels are not goods that are consumed for ‘own’ sake – no consumer will buy panels and keep them. Until they are installed and create solar energy the panels are useless. So the demand for panels is an ‘indirect’ demand that depends on demand for solar power. If there is demand for solar power the demand for solar panels and its installation will rise automatically.

We represent solar energy using a traditional demand and supply analysis. On the X axis we have quantity of solar energy, while the price of this energy is on Y axis. The demand curve for solar energy slopes down, while the supply curve slopes upwards. The equilibrium price is where demand equals supply. This is shown at E. If Cindy wants to get business she must consider the determinants of demand and supply to understand how she move E to a new point where quantity sold is higher, while price is lower for solar energy. This is ideal as lower prices encourage greater use of solar energy, which is possible only with installation of solar panels.

Price of solar panels: if the price of panels is higher, demand will be low for solar energy. High installation costs that include costs of panels, will discourage demand for solar energy. Solar panels and solar energy are complementary good that are used together..

Income of consumers. Like any other good, higher income will boost demand

Price of related sources of energy- oil, wind power and traditional energy sources. Since these sources of energy ‘compete’ with solar energy, a price rise for them will cause higher demand for solar energy

Demand Determinants

Preferences of consumers. This is a non economic factor that depends on many other factors. For example the choice of using panels will depend on the extent of awareness among consumers, the actual usage pattern, space available for the panels, environment friendliness of the user, among others. A public awareness and outreach program and/or NGOs can work towards changing these preferences in favor of solar energy.    

5 factors that affect elasticity:

Higher number of substitutes means higher elasticity.

Longer is the time period allowed, greater is elasticity.

When a greater share of income is spent on a good, the elasticity will be higher.

Elasticity is lower for necessity goods, as compared to luxury goods.

Elasticity also depends on income levels. In this case given the tax benefits for everyone and special schemes for lower income families, income factor loses significance for elasticity.

Elasticity of solar panels is linked to demand for solar energy, as panels are a requirement for it. Since there are many substitutes for solar energy we expect demand for solar energy to be elastic. Also we can expect, preferences to be in favor of solar energy as there is greater awareness as well as tax benefits for using this energy. But for panels there is no alternative, once you decide on solar energy the need for solar panels cant be changed. This is why demand for panels will be inelastic. There is no substitute for panels, neither can demand change with time ( unless new technology replaces them with something else).   These are the reasons for which we can argue that demand will be inelastic- demand curve is steep. There are no figures available for elasticity of demand for panels. 

The supply of solar panels can’t be considered independent of other costs of installation. Supply elasticity will depend on these cost as well.  Besides the supply curve slopes upwards, though there is little information on other factors that affect elasticity as this product is relatively new.  

• Price of equipment used along with panels. Higher is cost price of this equipment, higher is total installation cost and supply of panels will be lower.
• Cost of installation of equipment. If there are no workers trained in installation then supply of energy will be lower.   

Any increase in supply of solar energy due to changes in the above will shift the SS to new SS, causing quantity to rise and price to fall. This is perfect for Cindy.  In another case, as shown in figure 2, an increase in demand can cause higher price and demand for solar energy, which is also suitable for business.

We assume that Cindy works alone in terms of keeping accounts and making sales calls, as she is just starting out and does not want high fixed costs of  employees.

Fixed costs include cost of lease for the office space + phone expenses +Internet charges + stationary and advertising expenses. Variable costs include her expenses in travelling to clients + cost of labour that is employed for installation + cost of solar panels that she buys

As she is just starting out, volumes will be low which means that scale economies have not set in yet. Consider the table below for the short run analysis. We do not conduct a long term analysis because a lot depends on policy support and government initiatives to promote solar energy.  It shows fixed costs of $1000 per month .Units means the area covered by solar panels in square feet.  Scale economies exist at output of 900 square feet. This is also her optimum output level because profits are maximum at this point = 7200. We have used a price of 30$ per square feet of solar panels.  Any installation beyond 900 will lead to lower profits in short run. This figure should be Cindy’s goal/target in short run. We can show this using MR-MC approach also. The optimum point is where marginal revenue equals marginal cost as shown in the second table.  The accompanying graph shows that at Q=900 MR=MC as well, confirming the theory. 

Elasticity of Solar Panels

Units	FC	AFC	variable  cost	AVC	AC	TC	profits
0	1000				–
100	1000	10	4000	40	50	5000	-2000
200	1000	5	8000	40	45	9000	-3000
300	1000	3.333333	11000	36.66666667	40	12000	-3000
400	1000	2.5	13000	32.5	35	14000	-2000
500	1000	2	14000	28	30	15000	0
600	1000	1.666667	14000	23.33333333	25	15000	3000
700	1000	1.428571	15100	21.57142857	23	16100	4900
800	1000	1.25	15800	19.75	21	16800	7200
900	1000	1.111111	18800	20.88888889	22	19800	7200
1000	1000	1	27000	27	28	28000	2000

Units	revenues	MR	MC
0
100	3000	30	50
200	6000	30	40
300	9000	30	30
400	12000	30	20
500	15000	30	10
600	18000	30	0
700	21000	30	11
800	24000	30	7
900	27000	30	30
1000	30000	30	82

Let us now consider some real facts that fit into our analysis:

As the chart shows clearly the prices of a substitute source of energy- gasoline –have been rising since Jan 2016. This is good for Cindy as higher price of a substitute portends higher demand for solar energy as an alternative.

As per reports in some newspapers, between 2015 and 2016, solar energy use rose the highest among all sources of energy-38 percent.  

1. The cost for photovoltaic panels (PV) and turbines has dipped between 41% and 94% since 2008. This is good for Cindy as lower costs of panels will allow her higher margins.
2. Changes in designs are also likely to increase the use of panels. The development of frameless solar panels and clear solar panels makes it more appealing to users.
3. The costs of ‘solar panels have dropped 9% between 2016 and 2017’.(Energy sage.com, How much does a solar installation cost in US?) This allows Cindy to keep her costs low. The chart below shows a rise in PV installations (in blue bars) while a fall in cost of PV since 2009. This hints at a healthy environment to develop installation business with cost price going down, but total volume of users rising.
4. The pie chart below shows that solar panels take up only 30% of total cost of installation, while labor charges, operational costs, permit fees form the bulk of total costs. Cindy must try and reduce some of these other costs like operational costs and labor costs by learning how to install. She can be helpful to her labor/worker and even save on the costs of additional labor.
5. The graph below shows a healthy trend of rise in residential installations, which exceeds non residential installations after 2014. Utility installations are of little use for Cindy as her target market is residential user of solar energy.
6. As per Conserve-energy-future.com, the top 15 companies in solar installation business are there because of their innovative thinking of use of solar energy. Some of them are providing solutions in niche categories, while others service large clients. As new provider Cindy must be innovative in her approach, in terms of target segment, method of reach, and servicing. Only the highest level of satisfaction will keep her alive, and get her referrals to sustain the business. 

It must be understood that the business of installing panels that Cindy wants to get into depends heavily on solar energy prospects, as well as State support to this industry. Solar panels are in demand because of the demand for solar power, rather than directly. Panels have no use on their own- they are demanded because solar power is demanded. Any policy that supports solar power as a source of energy will impact on demand for solar panels.

• The US is the biggest market for solar energy in the world, and ‘it is set to grow by 119% as per estimates of GTM Research’ (Seia.org, US solar market set to grow) .
• The solar industry in US is fully supported by the government. Federal tax incentives have been extended to 2021. A 30% tax incentive on all solar projects is given, which means that you can deduct 30% of your solar power system costs from your federal taxes using an investment tax credit (ITC). If you do not pay any taxes this year, the 30% credit is extendable to the next year, much like a rollover policy.
• California has agreed to ‘net metering’ which encourages electric utility customers to generate own solar power.
• The Clean Power Plan includes solar power as a potential source of clean and green energy form. The government’s commitment to the Pan is indirectly a commitment to solar energy.
• Under the National Community Solar Partnership, the government has sought to help in installation of solar energy equipment on subsidized housing facilities. It has set a goal of 300MWs towards this.
• One federal program works in collaboration with Department of Energy and other private partners – CivicPACE conducts a workshop that brings together solar business owners and managers, project developers, financial institutions, and other stakeholders working in the non-profit sector.

All these incentives and support have yielded results as the chart shows below, in terms of massive rise in installations in 2016, and the trend is expected to continue over the coming years. 

Looking beyond the solar energy industry, we turn to the state of the US economy to determine how macro variables can impact on demand and supply and profit considerations of the business venture. A good starting point is to look at US GDP, which gives us an overall indication of the direction in which the economy is heading. Tax cuts, along with new investment spending by the Trump government is set the carry the momentum in the economy. GDP rose by 1.9% in 2016, and is expected to get better with the effects of2008 recession fading off fast.  Consumer spending, which is the largest part of GDP is rising at a clip of 3%, better than the expected 2.5%. This is good news for Cindy as such consumers are the backbone of her business.

As per estimates for 2017 from US Economic Outlook:

• GDP is set to rise at 2.1%. In broad terms GDP refers to the income of a household. It is expected that a rise in GDP improves incomes for most households in direct or indirect ways. Income is a determinant of demand for solar energy, and higher incomes will contribute to higher demand for solar panels and their installation.
• Unemployment is to drop to 4.5%. Lower unemployment has works in a similar way as GDP. When less number of workers are unemployed, it amounts to more demand for all goods and services, including solar energy.
• Inflation is lower at 1.9% as compared to previous years. Lower inflation will allow consumers to keep more money aside for non essential spending like vacations, and solar installations.
• US manufacturing is set to rise faster on the back of Trump’s promise of creating new jobs for domestic workers.
• The Bureau of Labor Statistics predicts that total employment will rise by 20.5 million jobs between 2010 and 2020. The maximum gain will be in healthcare, personal care and social assistance and construction sectors. More jobs implies prospective customers for Cindy. This information can fit in with her strategy to get more customers from these sectors.
• Experts believe that oil prices will rise by $10 in 2017, which is good news for Cindy. Higher oil prices will force consumers to shift to cheaper energy sources, like solar energy.

All these point to the fact that US is in recovery mode after 2008 crisis. A healthy recovery will make demand rise, while the institutional and State support to this sector can help new entrepreneurs like Cindy to get technical support   

Conclusion

As a person familiar with Economics, I would recommend Cindy to set up her business in the present economic conditions. This is because the solar energy sector which is the back bone of her business is poised to leap in the coming years. The US government has shown consistent support to this sector, in financial and institutional terms. The commitment to clean energy is expected to show up in new measures and new initiatives in the future. The recovery of the US economy is an indicator of rising and healthy demand from retail consumers. This overall positive trend in consumer spending will have similar effects on demand for solar energy, as it allows cost savings and makes the user environment friendly. On the macro front it is a rosy picture for the business of installing solar panels, as higher awareness about clean energy sources exists along with economic push from predicted higher GDP ( and therefore incomes), more job creation, expected higher oil prices and lower inflation.  

It is recommended that Cindy pay attention to the ‘micro’ aspects of the business as well. She can be innovative in her business by:

Offering discounts/schemes for lower income group who lives in subsidized homes.

She could focus on segmentation of demand, as we are told that specific sectors are set to grow faster and get more jobs created than others.

Help her customers connect with tax experts who can detail the cost savings from solar energy generation.

Educate prospective customers on the financial and environment savings from solar energy.

A referral program from older existing consumers can work to expand her reach.

She must participate in workshops that deal with technical aspects of installation, so that she can stay updated on the latest technology, and possibly cut her costs and be more cost efficient.

She could offer solar power based products like hand held fans, baby bottle warmer, barbecues powered solar energy, torches that are convenient and handy, as add-ons to her customers who order installation.

She must keep herself abreast of rivals pricing, and match their offers if possible.