Are Energy Efficiency Standards Justified?

Abstract

This paper develops and parameterizes an overarching analytical framework to estimate the welfare effects of energy efficiency standards applied to automobiles and electricity-using durables. We also compare standards with sectoral and economywide pricing policies. The model captures a wide range of externalities and preexisting energy policies, and it allows for possible misperceptions - market failures that cause underinvestment in energy efficiency. Automobile fuel economy standards are not part of the first-best policy to reduce gasoline: fuel taxes are always superior because they reduce the externalizes related to vehicle miles traveled. For the power sector, potential welfare gains from supplementing pricing instruments with efficiency standards are small at best. If pricing instruments are not feasible, a large misperceptions failure is required to justify efficiency standards, and even in this case the optimal reductions in fuel and electricity use are relatively modest. Reducing economywide carbon dioxide emissions through regulatory packages (combining efficiency and emissions standards) involves much higher costs than pricing instruments.

Keywords: standards, energy taxes, market failure, climate, power sector, gasoline

JEL Classification: Q48, Q58, H21, R48