Energy Efficiency and Economic Approaches

Introduction

The economics of energy efficiency form one of the highly debated topics on natural resource economics. Natural resource economies focus on the efficient utilization of natural resources, which include energy deposits, minerals, water resources, land, forests, and fish, among others. Public reliance and control of these resources, their significant addition to the economy, and competition of these natural stocks lead to exploitation and depletion through human activities. Such activities involve over-extraction of energy stocks and misuse, which may cause depletion of energy reserves or even extinction of these major environmental assets (Loughran & Kulick, 2004). This paper examines energy efficiency and conservation since the two aspects have been the key tenets of energy policy discussion for decades. This goal will be achieved by analyzing some of the economic approaches that can be applied to generate suitable models for efficient energy resource use. Such models can be behavioral economics, which can inform decision-makers on how energy consumers predict, weigh options, and decide on what to use.

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Matters on climate change have been of key focus by policymakers. By reducing energy consumption, studies have shown a decrease in carbon emission and other greenhouse gases, hence reducing the effects of global warming in the long term (Field, 2008). In a bid to attain this objective, policymakers have identified the need by individuals and firms to limit energy consumption and seek efficient energy measures. Consumers’ market behavior and purchase decisions influence the adoption of the economics of energy efficiency largely. In addition, the paper will analyze efficient conditions by looking at where markets fail to distribute resources effectively coupled with the roles of microeconomic tools in determining energy efficiency economics.

Benefits of energy efficiency

The significance of energy efficiency surpasses the usual idea of limiting demand. Energy efficiency has the capability of enhancing sustainable economic growth, promoting social welfare, ensuring environmental sustainability, avoiding energy resource depletion, and assisting in wealth generation. Energy efficiency can improve the economy potentially and maintain an upward trend despite cutting on energy demand (Field, 2008). However, individuals and entity consumers may not realize the potential growth in energy efficiency since they seem to be overridden by the market competition, and they end up undervaluing the significance of energy efficiency in economic sustainability programs. Energy efficiency is the key means of reducing human greenhouse gas emissions. Making homes, industries, and vehicles more energy efficient is one of the solutions to addressing energy security and global heating (Fischer & Newell, 2008). However, with the many benefits of limiting energy use by individuals and industries, this paper examines the behavioral economics model that influences the consumers’ purchasing behavior coupled with facilitating or harboring energy efficiency and conservation.

Behavioral economics

Behavioral economics involves the reactions of consumers towards making the decision on what to purchase and in what amounts. According to Fischer and Newell (2008), behavioral economists borrow insights from the individuals’ psychology to expound the analysis power of conservation economics. Consumers rely on information that they can get free prior to purchasing commodities of their interest. However, the pertinent question is why consumers, despite having the information, prioritize the immediate gratification of utilizing energy whilst intentionally compromising with the long term effects of improper use of energy resources. Behavioral economists emphasize the irrational decision-making by consumers, which may cause individuals to go against their long-term projections and interests.

Unlike the traditional economists that assume individuals act rationally, behaviorists argue that individuals will opt for what satisfies their needs in the short-term, as opposed to what ought to influence the future (Wilson & Dowlatabadi, 2007). Therefore, policymakers should ensure that the choices that consumers have in place are restricted in a bid to cushion the long-term consequences. On matters of energy use and conservation, policymakers should come up with choices and, where possible, make default options to energy consumption. Even if the freedom to consume energy is granted to consumers, there should be set abatement measures to increase the incentive of energy use. For instance, the carbon tax, which ensures that individual polluters bear extra costs, in environmental conservation measures.

In a bid to achieve energy preservation and curtail pollutant emissions, which are crucial to counter atmospheric imbalances, policymakers should focus on applying the consumers’ behavioral transformation approaches. Some of the key traits that are linked to the consumers’ energy use involve the following important dimensions, energy use versus preservation, energy efficiency application, and the use of alternative energy like green energy (Wilson & Dowlatabadi, 2007). These measures to energy preservation vary in the case of decision-making by different consumers. The next section will discuss some of the factors that influence the consumption of energy, thus leading to curtailment of consumption.

Billing and payment procedures

Individuals’ incentive to consume is largely determined by the way they pay their utility bills. Studies indicate that individuals who use prepayment methods to surface their utility bills tend to use more electricity as compared to those that use postpaid methods (Pollitt, & Shaorshadze, 2012). Consumers have the motive to buy little amounts of electricity, and thus when tariffs go up, they will respond by spending more on top-ups, but hold on increasing consumption. This aspect implies that individuals’ motive to purchase electricity is affected by costs. When consumers purchase top-ups at increased prices, they become highly conservative to consumption. Therefore, raising the minimum price for electricity will force consumers to use less energy in most cases. Low-income earners will adopt by using the most affordable source of energy. For instance, though oil heating is more efficient and affordable than electricity, consumers will opt for electricity, since they can make relatively little top-ups. As oil heating is cheaper when purchases are made in bulk, despite the future benefits and savings made after the bulk purchase of heating oil, consumers will tend to choose electricity, which has more immediate satisfaction (Pollitt, & Shaorshadze, 2012)..

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Energy market trends

Energy constitutes both final demands of goods as well as services, whether consumed directly or as intermediate products, which are used as inputs in the production sector. Based on the aspects of the production function, it lays the basis for the theory of costs, which influences the theory of supply. However, the utility of energy influences the demand for intermediate inputs. These concepts of microeconomics will be useful in the analysis of energy consumption and efficiency with respect to market behaviors. Energy market prices largely determine consumer behaviors and decisions on how much energy to use, coupled with whether investing in energy efficiency gadgets, creates an incentive to save.

If there is an increase in market prices for energy during the short run, consumers will respond by limiting consumption, and this move will help to conserve some energy. However, if the energy prices stay high in the short run, energy efficiency will be limited since consumers will consume more upon the drop of the prices. In cases where energy prices increase consistently, then consumers will be compelled to respond by adjusting to energy efficiency mainly through replacing older capital appliances with energy efficiency equipment. However, corresponding energy efficient innovation is catalyzed largely by energy costs. Substantial rise in energy prices prompts energy efficiency technology to come up with highly advanced tools to help in saving energy (Metcalf, 2008).

Financial incentives are other necessary motivators to invest in energy efficiency products. Financial incentives may be inform of loan subsidies, rebates, or tax cuts. During times when energy prices go high, governments and other funding institutions provide subsidized energy-efficient products for affordability to consumers. Research firms take advantage of financial incentives to invest in researching and innovating technologies. Prizes are also given to motivate energy efficiency innovators on top of encouraging consumers to invest in the energy-efficient products (Metcalf, 2008).

Advocacy

The provision of information on energy saving techniques has been given little concern for the past decades and numerous information problems persist in the energy efficiency literature. Energy conservation knowledge and relevant feedback has a significant role in alleviating undesired consumer behaviors. Certain energy-efficiency information gaps include the consumers’ lack of knowledge about savings accrued from energy efficient equipment and the lack of the belief to learn through using (Fischer & Newell, 2008). For instance, the replacement of the traditional electricity meters with modern ones with the capacity of recording consumption information for specific appliances can help consumers to limit on consumption. The communication agent should consider the behavioral failures by consumers and provide messages via visual cues and visible inscriptions. For instance, if consumers end up losing money and gaining less utility, the advocacy should insist on showing consumers how to save costs, maximize outcomes, and save energy (Brookes, 2000). Information sources should be credible in a bid to win the consumers’ trust.

Energy conservation/efficiency investments

Maximizing energy efficiency has been beneficial in decreasing energy use and potential effects of climate change. In most cases, efficiency purchases have scared consumers as they involve one-time huge spending, which lead to cost saving and reduced energy use, and thus savings are done in the long-term. Energy efficiency choices become difficult for small-scale consumers or low earning households since investments trade off huge initial capital inputs and the perceived low future energy costs remain uncertain (Field, 2008). However, behavioral incentives by consumers to focus on immediate benefits and knowingly compromising the long-term effects remain a challenge. Influence through information on saving energy use becomes necessary in a bid to achieve the goal. Individuals are not willing to invest in new appliances even if they are energy efficient.

In addition, these appliances need to be predetermined to show how suitable they fit in their new roles, and this aspect comes with a cost for installation or operation. In order to create awareness and motivate consumers to invest in energy efficient appliances and avoid market and behavioral failures, policymakers have developed means to counter these shortcomings. Tax credits have been one way that policymakers use in a bid to encourage efficiency investments. For example, deductions have been highly incorporated in many countries; for instance, the United States’ Energy Tax Act of 1978 devised a federal tax credit to encourage home energy-efficiency purchases, and this idea was to motivate residents to adopt solar, wind, and geothermal energy appliances (Loughran & Kulick, 2004). Even with subsidies, consumers remain reluctant to invest in energy conservation products, and thus effective communication should be conducted.

Encouraging green energy helps in reducing greenhouse gas emissions, which is necessary for human welfare. Behavioral economists provide insight to why consumers voluntarily contribute to the public good of environmental conservation and under what circumstances. These measures may involve money contributions, viz. individuals or firms bear costs for green energy or through indirect ways such as when people voluntarily limit themselves by restricting energy use or using alternative energy efficient appliances. Behaviorist economists argue that voluntarily limiting is not always possible since most consumers are conditional cooperators in the essence that they insist on fairness (Wilson & Dowlatabadi, 2007). Consumers tend to voluntarily contribute to environmental and energy conservation if they know that there is equity in sharing costs. This goal can be achieved through a tax system since it spreads responsibility to all consumers and alleviates free riding.

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Policy formulation

In a bid to understand certain policy measures, this section first seeks to highlight the characteristics of property rights and their importance in efficient allocation and utilization of energy resources. Property rights can be viewed as set of policies that control the consumption of property or resources, which are deemed as valuable or important (Fischer & Newell, 2008). The protection rights and trends in their enforcement are regulated by the economic forces of supply and demand. Individuals or firms will tend to demand more energy with the intent of maximizing returns. Since policies will restrain excessive use of energy, the demand of energy will assume varying forms with intent of swaying public policies coupled with lobbying policymakers to get more energy. A good case in point is the development of protection rights to access and use of energy stocks. In the past decades, the call of property rights to energy efficiency or even consumption was not high as it is today. This scenario was so because energy was not abundantly consumed and it was not cost-effective in initiating limiting policies since energy burning activities were less. Today, with the influx of industrial activities and technological advancement, energy has become one of the most utilized natural resources and it faces the danger of depletion. This scenario has resulted in a decline in energy stocks, energy has become more valuable, and the need to have proper property rights is inevitable (Brookes, 2000).

Energy efficiency policies are formulated to increase economic efficiency by ensuring that the market and behavioral failures are minimized successfully. Effective policies should ensure that the energy efficiency benefits surpass the cost of formulating and implementing these policies. The forces of demand and supply persist throughout the economy and they create an incentive for development of policies like patent rights or property protection, subsidies on energy efficient products, and financial support to innovation of energy efficient facilities. However, policymakers should ensure that consumers are prevented from overusing energy in cases where market failures are not recorded. For the policymakers to prevent the environmental externalities such as greenhouse gas emissions, policies should curtail energy use by adding energy costs to the product prices through carbon tax or cap-in –trade models (Pollitt, & Shaorshadze, 2012). The resultant effect would be a decline in energy demand and more energy efficiency purchases.

Microeconomic theories view property rights as a bunch of determined entitlements to regulate the consumption of certain assets or resources. For energy as a rare commodity, the degree of these entitlements determines the comprehensiveness of the property rights. These entitlements largely determine the extent that energy efficiency and conservation is attained and they include exclusiveness, comprehensiveness, time span, and transferability and accrued benefits (Loughran & Kulick, 2004). Exclusiveness is a concept that defines who is entitled to accessing a property and if others can come in at will and have the right to the same. For example, some firms enjoy monopolistic control of energy stocks and the rights to extract and supply energy are limited to specific firms or individuals to manage the supply to manageable levels. This aspect creates the incentive to consume less and promote energy-efficient investments. On the other hand, if anyone is granted the opportunity to supply energy, competition will go up due to the impact on market forces of supply and demand. Supply of power will be more than demand, thus forcing suppliers to lower the prices, hence consumption shoots up, and the consumers develop the disincentive to invest in energy-efficient appliances (Field, 2008).

Secondly, comprehensiveness determines the range of activities that a firm is allowed to carryout with the resource. For instance, certain energy firms have the right to generate electricity energy, but the right to supply is given to other entities. This aspect means that the generating company will not be lured by market forces to alter generation. However, the supply agents are governed by policies, which ensure that the products create the incentive for consumers to save on energy use (Metcalf, 2008). Thirdly, time span is the duration that a certain firm or individual is granted the right to energy stocks. For example, a one-year license to generate or supply energy will compel firms to limit themselves voluntarily in a bid to have the chance of renewing their contracts. On the contrary, if entities have perpetual rights to energy stocks, they are easily manipulated by market and consumer behaviors. Fourthly, transferability defines if the rights can be sold to others. In most cases, the rights to energy stocks are restricted to specific entities in a bid to promote conservation. Lastly, the share of benefits will determine what an entity reaps from a given activity. If an energy-generating firm is required to pay loyalty fees, it will mean that it retains a portion of the total returns (Wilson & Dowlatabadi, 2007). This aspect translates to energy efficiency and conservation since the firms have the motive to self-regulate.

Conclusion

The goal of energy efficiency economics is complicated due to the numerous kinds of market failures such as lack of complete property rights and unpredictable consumer behavior. However, markets lack the potential to utilize energy stocks to optimal economic gains, whilst ensuring energy efficiency and conservation. In this case, the paper has identified various measures to govern energy use such as financial incentives and regulating consumer behaviors. Since public policy to govern energy stocks in these dimensions come with a cost, a critical analysis in economic efficiency is necessary to ensure that the cost of management does not overwhelm energy efficiency benefits. Nonetheless, energy efficiency investments are a key factor in limiting energy use. This assertion is fundamental since the outcomes are far reaching and it inhibits global warming largely, hence consumers are in a position to make savings in the long-term and achieve maximum efficiency economic benefits.

References

Brookes, L. (2000). Energy efficiency fallacies revisited. Energy Policy, 28(2), 355-366.

Field, B. (2008). Natural resource economics: an introduction. Long Grove, IL: Waveland Press.

Fischer, C., & Newell, R. (2008). Environmental and technology policies for climate mitigation. Journal of Environmental Economics and Management, 55(2), 142-164.

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Loughran, S., & Kulick, J. (2004). Demand-side management and energy efficiency in the United States. Energy Journal, 25(1), 19-41.

Metcalf, G. (2008). An empirical analysis of energy intensity and its determinants at the state level. The Energy Journal, 29(3), 1–26.

Pollitt, M., & Shaorshadze, I. (2012). The role of behavioral economics in energy and climate policy. Web.

Wilson, C., & Dowlatabadi, H. (2007). Models of decision making and residential energy use. Annual Review of Environment and Resources, 32(1), 169-203.

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