The issue of asymmetric price responses matters for several reasons. At the technical level, estimates of elasticities derived from periods with both rising and declining prices will clearly be skewed if they try to impose an assumption of symmetry which does not exist. Gately (1993) also notes that such an assumption may lead to an underestimate of income elasticities from econometric data.
Second, as noted in the quote by Gately above, the issue can profoundly affect projections of energy demand. Companies and governments increasingly believe that energy prices may remain low over the next decade or two. If their models assume a response which is inverse to that of the price rise of the 1970s, demand estimates will be far too high.
Third, exploring the causes and components of asymmetric price responses opens up a rich field of research which may greatly enhance our understanding of energy economics and market behaviour as well as of the phenomenon itself. Some first steps in this direction are illustrated for example in the study by Walker and Wirl (1993) which seeks to divide responses into those due to technical efficiency and those due to consumer behaviour, and explores the implications.
Fourth, the indication from asymmetric price responses that energy price rises may induce technological development has important policy implications, e.g. with respect to global warming, because this technological development may have profound long-term impacts. If it is assumed that technology development is exogenous—the classical assumption—then prices have to rise substantially to hold down emissions in the face of continuing economic growth. This perspective has led some economists to conclude that stabilizing atmospheric concentrations would incur large costs. Near-term abatement may also have rather small benefits since it is such a long-term problem.
Conversely, if price rises stimulate technical development and in addition governments take further associated action to encourage energy saving, long-term solutions may emerge at relatively lower cost as a result of the accumulation of technical change in the direction of lower CO2-emitting technologies, infrastructure and behaviour. Furthermore, because short-term responses may have very long-term consequences, the benefits of near-term action may be much greater.
Possible implications of these different perspectives are illustrated in a study by the author (Grubb 1993) which developed a simplified dynamic optimizing model of abatement responses. The model allows abatement costs to be a function of both the extent of abatement in physical terms and the rate at which it is achieved in temporal terms. If it is assumed that most of the costs are associated with the extent of abatement and that price responses are reversible, the costs of deviating from the rising baseline emissions increase quadratically, and the standard—and pessimistic—result is obtained. But if many of the costs are associated with the rate of abatement rather than the degree, then there is no continuing cost pressure to reverse the initial abatement efforts. On the contrary, a continuing moderate cost pressure— seeking the benefits of reduced atmospheric change—results in emissions diverging steadily from the baseline, to the point ultimately at which first emissions and later concentrations, are stabilized. Furthermore, stronger initial abatement efforts may be justified because of their continuing long-term benefits. It should be noted that this result stems from an assumption of continuing induced technical development and is not a direct corollary of irreversible price responses. However, the existence of irreversible price responses suggests that the assumption may be plausible.
Currently, not enough is known about either the phenomenon of asymmetric price responses or the related determinants of induced technology development to reach clear quantitative conclusions. However, this chapter illustrates a new recognition of the phenomenon and demonstrates the importance of incorporating these issues and researching them further.
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