Optimal Energy Efficiency Subsidy Model

This paper develops an optimal energy efficiency subsidy model and analyze it. Consumer choice failure is necessary for subsidies to be warranted when electricity prices are too high. To deal with consumer choices failure, it portrays welfare effects of subsidizing efficiency by assigning the full welfare benefits of those investments through expansion of the set of individuals. Such an ascription is inconsistent with basing welfare on revealed preference, but the inconsistency is an inevitable consequence of assuming that consumers fail to act in their self-interest by under-investing in efficiency. Analyzing these models reveals that if the gain in surplus from those overcoming consumer choice failure is simply reduced spending on energy, and if no consumers make such investments on their own, then capping the revenues of a generator or utility selling electricity will induce it to substitute energy efficiency for generation when doing so is less costly.