Energy efficiency is defined here to mean energy services provided per unit of energy input (for example, gallons of water heated to a specified temperature per British thermal units of natural gas input). Within this framework, energy efficiency is conceived primarily at the disaggregated, product level, rather than at a more aggregated sectoral level.
As with virtually all economic problems, the economics of energy efficiency is at its heart a question of balancing of costs and benefits. For the individual energy user, this involves weighing the higher initial cost of purchasing energy-efficient products against the expected benefits of future cost savings when operating the products, among other considerations. Due to this difference in the timing of energy efficiency costs and benefits, issues related to discounting feature prominently in analyses of energy-efficient technology adoption.
For suppliers of energy-using products, decisions regarding energy-efficient innovations likewise depend on the expected profits from such technology development. Profits from innovation depend in turn on the expected demand for energy-efficient technologies and the degree to which firms can appropriate the value created by their innovations.
On both the demand and supply side of this market for energy-efficient technology, potential market imperfections can lead to underinvestment in energy efficiency. This raises the possibility that corrective government policies could provide economic gains if they are practicable and provide net benefits after inclusion of all public and private implementation costs. The degree to which such opportunities exist in practice is the subject of significant debate. Finally, environmental pollution with energy production—particularly carbon dioxide emissions from fossil fuels—represents an additional reason why private markets might under provide energy efficiency if energy users do not face the cost of any resultant environmental impact harm.
