San José State University
Department of Economics
Thayer Watkins
Silicon Valley
& Tornado Alley

Energy Efficiency and Lower Energy Use:
Sense or Nonsense?

Many people, particularly the retired, love to travel. When the price of an international tour is $3 thousand they may take one such trip per year. If the price were $2 thousand they might take two such trips per year. Those that did not take any such trips at $3 thousand per trip might take one trip per year when the price is $2 thousand. For both such groups the amount spent on travel would go up when the price per trip went down, from $3 thousand to $4 thousand in one case and from $0 to $2 thousand in the other.

The quantity of some commodity demanded depends upon the price. With all other influences on the quantity demanded held constant, if the price goes down the quantity demanded if anything goes up. The ratio of the percentage increase in quantity demanded to the percentage decrease in price is called the elasticity of demand. The effect of a decrease in price on the quantity of money expended on a commodity depends upon this ratio. If the elasticity is greater in magnitude than unity then a decrease in price will not mean less income is expended on a commodity; instead a greater expenditure will result.

Now consider automobile travel. One price of that travel is the amount of gasoline used per mile of travel. This price is just the reciprocal of the miles per gallon (MPG) for the automobile. The cost of this travel in terms of gasoline is the product of the miles of travel times the gasoline required per mile. Suppose the elasticity of the demand for travel is 1.5. This would mean that if MPG figure is increased by 10 percent the gasoline cost of travel would go down by 10 percent and the amount of travel would go up by 15 percent, resulting in a 5 percent increase in the amount of gasoline used.

The Congressional regulations of automobile mileage figures is justfied on the basis that they will reduce the amount of petroleum imported. This would be true only if the elasticity of automobile travel is is less than unity. Did Congress secure an estimate of the elasticity of demand before it passed such regulation? More than likely it did not. Did they establish that their past regulations had resulted in less gasoline being used? Undoubtably they did not since the amount of gasoline has continued to increase. In the face of the failure of the policies of Congress what do we get? Just more and more of the same policies.

Consider now the effect of energy efficiencies for such appliances as refrigerators and freezers. If consumers do not change the size of the refrigerators and freezers they use then an increase in energy efficiency will result in reduced energy use. However if a reduction in the energy cost of refrigerators results in consumers buying larger refrigerators or those who did not have a freezer buying a freezer then we do not know whether the increased energy efficiency will result in more or less energy use. Thus the effect of the energy efficiency regulations on energy use is uncertain.

Although the effects of improved energy efficiencies on energy use and petroleum importation are uncertain, there is an unambiguous benefit for consumers of the lower cost of energy. However whether this is a net benefit depends upon the cost of obtaining the improved efficiency. If the program for the increased gasoline mileage results in an increase in cost of General Motors cars of one thousand dollars per car it may or may not be a net beneficial gain. However, GM sells something on the order of twice as many cars as does Ford. The cost per car of the development of increased gas mileage for Ford would be spread over half as many cars as GM. Thus Ford's vehicles would have to increase by twice as much as GM's cars. And the cost for Chrysler's cars would have to be about twice that of Ford and thus four times that of GM. Thus the Congressional regulations on gasoline efficiencies puts extraordinary financial pressure on the smaller producers. The unintended effect of Congressional regulation is promoted industrial concentration. The lesson is that we should beware of dingbats with power.

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