The Microeconomic Theory of the Rebound Effect: Nuances, Externalities, and Welfare

24 Pages Posted: 28 Jan 2014

Date Written: January 26, 2014


Economists have long noted that improving energy efficiency could lead to a rebound eff ect, reducing or possibly even eliminating the energy savings from the efficiency improvement. Yet there are important nuances in the microeconomic theory of the rebound eff ect that have not been explored. This paper develops a generalized model illuminating the eff ects of an exogenous change in energy efficiency on energy use, external costs, and welfare. This model overturns conventional wisdom by showing how several identities that are frequently used to estimate the rebound eff ect no longer hold in a generalized setting. We clarify the relationship between the direct rebound effect and the indirect rebound, and highlight the importance of complement/substitute relationships between energy services. Furthermore, by including external costs in our model, we develop conditions under which the rebound is welfare-improving and show how the rebound influences the welfare consequences of energy efficiency policies.

Keywords: energy efficiency

JEL Classification: Q38, Q48, Q53, Q54

Suggested Citation

Chan, Nathan and Gillingham, Kenneth, The Microeconomic Theory of the Rebound Effect: Nuances, Externalities, and Welfare (January 26, 2014). USAEE Working Paper No. 14-153. Available at SSRN: or

Nathan Chan

Yale University ( email )

New Haven, CT 06520
United States

Kenneth Gillingham (Contact Author)

Yale University ( email )

New Haven, CT 06511
United States
203-436-5465 (Phone)


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