‘Normal’ markets, market imperfections and energy efficiency

Abstract

The conventional distinction between ‘economic’ and ‘engineering’ approaches to energy analysis obscures key methodological issues concerning the measurement of the costs and benefits of policies to promote the adoption of energy-efficient technologies. The engineering approach is in fact based upon firm economic foundations: the principle of lifecycle cost minimization that arises directly from the theory of rational investment. Thus, evidence that so-called ‘market barriers’ impede the adoption of cost-effective energy-efficient technologies implies the existence of market failures as defined in the context of microeconomic theory. Problems of imperfect information and bounded rationality on the part of consumers, for example, may lead real world outcomes to deviate from the dictates of efficient resource allocation. A widely held contrary view, that the engineering view lacks economic justification, is based on the fallacy that markets are ‘normally’ efficient.