The Tradeoffs between Energy Efficiency, Consumer Preferences, and Economic Growth

Abstract

The traditional economic rationale for government intervention in the economy is market failure. Underlying the market failure concept is the idea that, because of certain market frictions known as transaction costs, beneficial gains from trade are prevented from occurring that would otherwise increase social welfare. In recent years government agencies and academics have begun justifying policy interventions on the grounds that an additional form of market failure exists, known as a “behavioral market failure.” They extend the standard list of “neoclassical market failures” to include instances of suboptimal individual decision-making that occur because of various cognitive biases afflicting individuals. This chapter walks though the theory underlying behavioral market failures and provides a brief overview of the “energy efficiency gap,” which is a potential behavioral market failure often asserted to exist in markets for energy-consuming devices. Since regulators now sometimes assert behavioral bias when they justify regulatory interventions, the chapter also provides an example of an energy efficiency regulation where behavioral market failure forms an implicit rationale for the regulation. The article concludes with discussion of limitations of static market failure theory as a basis for regulatory interventions generally.

Keywords: market failure, behavioral economics, energy efficiency, behavioral market failure

JEL Classification: D03, K23, Q41, Q48