Market barriers to energy efficiency

Discussions of energy policy in an environmentally constrained world often focus on the use of tax instruments to internalize the external effects of energy utilization or achieve specified reductions in energy use in the most cost-effective manner. A substantial literature suggests, however, that significant opportunities exist to reduce energy utilization by implementing technologies that are cost-effective under prevailing economic conditions but that are not fully implemented by existing market institutions. This paper examines the theory of the market for energy-using equipment, showing that problems of imperfect information and transaction costs may bias rational consumers to purchase devices that use more energy than those that would be selected by a well-informed social planner guided by the criterion of economic efficiency. Consumers must base their purchase decisions on observed prices and expectations of postpurchase equipment performance. If it is difficult or costly for individuals to form accurate and precise expectations, the level of energy efficiency achieved by competitive markets will vary from the socially efficient outcome. Such market barriers'' suggest a role for regulatory intervention to improve market performance at prevailing energy prices.