The chapter notes and seeks to explain why some economic models and engineering estimates suggest greatly differing potential for improvements in energy efficiency at current prices, with the low potential suggested by the models expressed by their low price elasticities of demand. The result is that these models indicate that high energy taxes and high costs will be necessary to reduce CO2 emissions significantly. The chapter first distinguishes between the fuels themselves and the energy services—heat, light, power—which they are intended to supply. The supply paths involve different fuels and different capital equipment. The elasticity of demand for basic energy services is likely to be low, but the way this converts into elasticity of demand for fuels depends not only on possible interfuel substitution but, more fundamentally, on possible substitutions between different supply paths. Investments to change the supply paths are the responsibility of different economic agents, who may have widely differing discount rates. The implication of this for energy efficiency is shown by comparing the cost-effectiveness of energy efficiency measures using a single low discount rate characteristic of some agents with the cost-effectiveness of the same measures using the widely varying discount rates of the agents actually responsible for the changes. In the former situation many measures are cost effective. In the latter few are. The take-up of energy efficiency measures can be increased either by changing the structure of the energy market, so that agents with low discount rates become responsible for such measures, or by direct government regulation which overrides inappropriately high discount rates.
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