EnergyPolicy199422 (10)811-818



# 'Normal' markets, market imperfections and energy efficiency

Alan H Sanstad and Richard B Howarth

The conventional distinction between 'economic' and 'engineering' approaches to energy analysis obscures key methodological issues concerning the measurement ofthe costsandbenefits of policies topromote theadoption of energy-efficient technologies. The engineering approach is infact based uponfirm economicfoundations: the principle of lifecycle cost minimization that arises directlyfrom the theory of rational investment. Thus, evidence that so-called 'market barriers' impede the adoption ofcost-effective energy-efficient technologies implies the existence ofmarketfailures as defined in the context of microeconomic theory. Problems of imperfect information and bounded rationality on the part of consumers,for example, may lead real worm outcomes to deviate from the dictates of efficient

resource allocation. A widely hem contrary view, that the engineering view lacks economic justification, is based on thefallacy that markets are 'normally' efficient.
Keywords:Energy efficiency; Economic analysis; Market imperfections

At the heart of current disputes over the formulation of energy and environmental policy are questions regarding the relation between energyefficiencyand economic efficiency. Inparticular, there is continued disagreement

overthe degree to which markets forvarious energy services as currently structured produce economically efficient outcomes, and the extent to which potential interventions in these markets would promote economic efficiency.These and related issues are critically important in formulating policy responses to global climate change: the cost ofgreenhouse gas emissions abatement

Alan H Sanstad iswith theEnergy Analysis Program, Energy and Environment Division Building 90, Room 4000, Lawrence Berkeley Laboratory, 1 Cyclotron Rd, Berkeley, CA94720, USA; Richard Howarth iswith theEnvironmental Studies Program, University of California, Santa Cruz, CA 95064, USA. mayhinge in largepart upon the efficacyofpolicies that seek to promote increased energy efficiency with little

orno reduction in energy services. This debate is often framed as a dispute between engineering and economic approaches tothe issues. This view, however, is generally misleading. The technology oriented approach to energypolicy isbased on the leastcost provision of energy services and the potential economic benefits available through technological improvements in energy efficiency. This is, in fact, fundamentally an economic perspective, and is appropriately analyzed using economic tools. To the extent that this view entails the promotion of policy interventions in energy related markets, it must include an account of why economic efficiency in this context is
not achieved through normal market processes. Alternatively, or in addition, proponents of this view
must explain why conventional economic reasoning is inadequate tothis task. Such analyses are logicallyprior
to the study of how particular policies should be designed and implemented. Technology analysts have long argued that certain market barriers prevent both privately and socially efficient levels of energy efficiency from being realized in the economy. With few exceptions, however, the concept ofmarket barriers has not been developed in terms ofwell established economic concepts or using standard economic techniques. Thishas opened the wayfor skeptics to argue that, in fact, there is at best a tangential relation between market barriers and market imperfections as the latter are defined in economic theory; this view is expressed, for example, in the writings of Sutherland.l A central themeraisedby Sutherland isthat the putative barriers are actually 'normal' market characteristics and thus categorically cannot result in economic inefficiency. More specifically, a careful reading of these skeptical analyses reveals that they tend to be based on a simple underlying proposition: 'normal' markets are efficient. The conclusions are that, with a few narrow exceptions, the market barriers concept is inappropriate for energy policy and that there is little

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reason to believe that markets for energy services are economicallyinefficient. Inthis paper, we aimtodefine a middle ground in this debate. While accepting the importance of economic analysis for studying problems of energy efficiency, we will argue that the more extreme variants of the skeptical view are based on an understanding of microeconomic theory that is inconsistent with recent theoretical developments - especially in the emerging field of information economics. We will argue that the equation ofnormal and efficientmarkets is a fallacythat

can only serve to distort energypolicy analysis. We will show that, in light ofcontemporarytheory,the intuitions expressed by the market barriers concept may in factbe closer to the theoretical mainstream than the views of the skeptics. Although we will discuss policy issues in general terms, it is important to emphasize that we will not seek
to provide a blanketjustification for particular policies related to energy efficiency. These must naturally be assessed on a detailed, case by case basis. In our view, such case specific analysis has been impeded by the a priori character of the debate. For whatever reason, an unfortunate tendency to argue over putative evidence obscures fundamental disagreements over theory and methodology. The outline of the paper is as follows. We begin by reviewing some basic themes ofthe technology view of energy efficiency and its economic content, and the evidence suggesting economic inefficiency arising from failures to adopt efficient technology. We go on to discuss the idea ofeconomic efficiency, the basic theory of welfare economics, different interpretations of this theory in light ofbasic theoretical progress in microeconomics and common misinterpretations of the theory in policy applications. Against this background, we review energy related market imperfections and show how normal conditions in these markets may entail different degrees of economic inefficiency. We then briefly discuss the problem of efficient technology adoption from the point of view of theories of diffusion. We conclude with a summary of our main theme, and some thoughts regarding the importance of research on the relation between energy and economicefficiency.



## On energy efficiency

It is the most commonplace of observations that people do not demand energyper se, but rather the services it

can provide; we do not consume electricity or gas directly, but rather heating and cooling, refrigeration, lighting and a host of other services. The fact that energy is a derived demand has important consequences for energy economics and policy. As an empirical fact, technological progress yields continued reductions in the energy input required to produce energy services. In the industrial sector, for example, energy productivity improvedrapidly even during periods such as the 1950s and 1960s, when energy prices were low and stable.2 More generally, Hogan and Jorgenson3 estimated that technological change would cause the US energy/GNP ratio to fall by 0.34% per year given constant relative prices. Given the continued development of new technologies, energy services may be produced using a range of possible technologies at any point in time. The cost of providing or consuming those services, all else being equal, falls with technological advance, and there are thus higher and lower cost ways of obtaining various energy services. That consumers and firms should choose the leastcost means ofobtaining energy services is a basic prediction ofeconomic theory: cost minimization is a necessary condition for profit and utility maximization.4 Over the last two decades, a large body of research has established that the observedbehaviorofconsumers and firms is apparently inconsistent with the cost minimization hypothesis. In many cases, agents pass up least-cost technologies in favor of more energy-intensive alternatives. Although there is considerable variation in the methods used in this research, the typical approach is based on iifecycle cost analysis, a method firmly rooted in economic principles. A recent authoritative survey of these findings was presented by the National Academy of Sciences,5 and found that a 20-50% reduction of electricity use in buildings could be achieved through implementation of cost-effective energy-efficient technologies. In the industrial sector, investments directed solely at manufacturing processes could result in electricity savings of 25-30%, while increased use of cogeneration and other measures to increase fuel-use efficiency in industrial plants could achieveoverallenergy savings of30--35%. Such aggregate findings are supported by numerous
case studies focused onenergy-efficiencyinvestments in households and firms.6 Meier and Whittier,7 for example, found that consumers rejected incremental efficiency investments in refrigerators offering rates of
return of40% or higher. And a study ofefficiencydecisions in firms found that even energy-efficiency investments with favorable cost-benefit characteristics

werenot undertaken.8 Critics of the idea that consumers and firms apparently do not minimize the cost of obtaining energy services have responded in several ways. The counterargument with which we are most concerned here is quite simple: with a few minor exceptions, the explanations ofthe so-called 'efficiencygap' offeredby energy

812 EnergyPolicy 1994 Volume22Number I0analysts do not make economic sense, so this phenomenon cannot be significant for energy policy. Note that this argument is categorical: it attempts to simply rule
out concern over levels of energy efficiencyby a priori appeal to economic principles. To evaluate this perspective, we begin by reviewing the basic first principles of welfare economics on which itisputativelybased.



### On economic efficiency and its policy implications
The concept ofeconomic efficiency is an elaboration of the great insight ofAdam Smith that the actions ofindividuals acting in a decentralized market setting can lead 

### to results that are collectively beneficial. The main results, known as the first and second theorems of welfare economics, can be described briefly and informally

as follows. Suppose thatresources are allocated bycompetitive markets where individuals and firms maximize utility and profits given preferences and the prevailing
state oftechnology. A 'competitiveequilibrium' is a set of prices and quantities solving all the maximization problems simultaneously so that supply and demand are equated for each good. A resource allocation is 'efficient' or 'Pareto optimal' if there is no feasible alternative that improvesthe welfare ofone ormorepersons while leaving none worse off. The first theorem then states that, under idealized conditions, every competitive equilibrium is Pareto optimal, while the second theorem states that, under ideal conditions, every Pareto optimum can be supported as a competitive equilibrium given somedistribution ofincome among individuals. This framework provides a benchmark for thinking about economic organization and the merits ofthe price system. To many, 

### itpresents an abstract picture of economic activity that is thought to be consonant with Western political traditions. This model, however, abstracts substantially from the realities of real world economic systems, a disparity rooted in the list ofidealized conditions required to ensure efficient outcomes, including:

• Agents must hold rational expectations regarding prices and product characteristics, that is, a common set of probabilistic beliefs based on rational assessment of information held by all agents ('perfect information' is a special case);

• markets must be free from externalities and public goods;

• production must be carried out by firms using technologies characterized by constant or decreasing returns to scale;

• a complete set of markets must exist for all present and future goods. Market imperfections andenergy efficiency:AHSanstadandRBHowarth
The violation of any of these conditions constitutes a market failure or market imperfection - a circumstance where competitive resource allocation will not yield efficientoutcomesin the absence ofpolicy intervention. It is not a deep insight to observe that, relative to the theoretical ideal, these market failures are common if
not pervasive in the real world. As Roberts notes in the New Palgrave Dictionary ofEconomics,

asthe ideaofperfect competition hasbeen made moreprecise and the conditions supporting it have become better understood, it has become completely evident that no important market fully satisfiestheconditions ofperfect competition and thatmostwouldnotappearevento come close?
If the mere existence of market failures implied a role for policy intervention, the role for government would be expansive indeed. More generally, the costs of intervention must be weighed against the benefits, and the achievementofa firstbest (ie efficient) outcome may be institutionally infeasible. Opponents ofgovernmentintervention to correctmarket failures sometimes argue that problems related 

### to transaction costs and imperfectinformation are 'normal' features ofeconomic lifethat impose natural frictions in economic affairs. Ostensibly, this normalcy obviates the need for policy action. From both a theoretical and a practical perspective, this argument is unconvincing. Transaction costs and informationalproblems are indeed pervasive, that is, normal. These factors, however, can have major implications for the achievement of efficiency through the marketmechanism. Externalities, for example, constitute a challenge to public policy precisely because transactions costs prevent market participants fromnegotiating efficientoutcomes.10 More generally, the view that the system of private enterprise produces optimal outcomes as a rule is very imperfectly supported by the theorems of welfare economics, a point made compellingly by Nelson.~l Instead, this view follows most naturally not from economic principles but rather from libertarian political theory. Accordingly, the most conservative 'economic'

case against the existence of substantial market imperfections relating to energy efficiency can be seen as primarilypolitical in origin.



### Market imperfections related to energy efficiency Engineering and behavioral studies provide prima facie evidence against the hypothesis that markets for energy services are free from imperfections. With this in mind,

we turn to a discussion ofkeymarket imperfections that may provide explanations for the 'energy-efficiency gap'. Recognition of these imperfections is useful in

Energy Policy 1994Volume22Number 10 813Market imperfectionsandenergy efficiency:AHSanstadandRBHowarth

interpreting the empirical evidence, guiding further research, and ultimatelyinpolicy formulation. print' of performance labels may fail to imbue consumers with aclearunderstanding ofthe choices they face.



### Theexistingregulatol~venvironment
It is widely recognized that existing pricing distortions impede socially efficient investments in energy efficiency. Average costpricing in the electric power sector and uninternalized social costs are two key flaws. Accordingly, there is widespread support among both technology analysts and energy economists for moving toward morerational pricingpolicies. Proper pricing is necessary to equate the private and social costs of individual behavior so that agents bear the full cost of their actions. Evaluating the empirical magnitude of environmental externalities, however, is a complex, often intractable problem. Simply knowing that prices 'should go up' to reflect these costs is an imprecise guide to policy.12Moreover, Pareto efficient

resource allocation requires that agents are able to respond effectively to the price signals they observe. If institutional failures bar such a response, non-price regulatory policies may be required to restore economic efficiency.13A further complication is that marginal cost pricing may not be optimal in the presence ofimperfect information.14



### Imperfect information
A large body of research has documented that consumers are oftenpoorly informed about marketconditions, technology characteristics and the impacts of their own behavior as they relate to household energy use.15As a result, programs - such as labeling - aimed at providing information to consumers have long been promoted by policy makers, technology analysts and economists. In general, however, such programs have a rather limited effect unless combined with more aggressive interventions,j6 A study of appliance labels in Canada, for example, found that labels have ambiguous effects on consumers' subjective beliefs concerning the choices they face. Similarly, Kempton 

### et a117found that consumers' estimates of the price they paid per kilowatt hour of electricity varied from the actual price by up to

an order of magnitude. It is not surprising that labels may not be particularly informative ifconsumers' informational background is so limited. At a more general level, the mere presentation offactual information that is technically accurate may be insufficient to induce consumers to make substantively rational decisions in the sense discussed by Simon.18 Cognitive processes - both the interpretation of factual information and the use of that information in decision making - need to be taken into account, and the 'fine 

### Asymmetric information
A special form of the imperfect information problem arises when parties to a transaction have access to different levels of information. Over the last several decades, the theoretical literature has explored various aspects of this problem. A central theme is that asymmetric information is extremely common in real world markets so that inefficient outcomes may be the rule ratherthan the exception.19 In the context of energy demand, producers of energy-efficientequipment will in general be much better informed about the characteristics and performance of equipment than prospective buyers. Consumers may havegreatdifficulty in evaluating the post-purchaseperformance ofequipment prior to sale, forming 'fuzzy' or 'noisy' estimatesbasedonobservableproduct characteristics. If improving the information held by consumers is difficult or costly, the problem of adverse selection may arise: givencompetitivemarkets,producers may be unable to market clearly desirable technologies since

consumers are unable to observe their superior characteristicspriorto sale.z° Consider, for example, decisions relating to the energy efficiency of new homes. Decisions about heating, ventilation and cooling systems are typically made directly by builders rather than occupants. The observed failure to implement certain cost-effective energyefficient technologies may result from the costliness of overcoming information asymmetries between builders and potential buyers rather than a supposed preference forinefficientequipment.21 A similar problem may inhibit the adoption of energy-efficient technologies in existing homes,zz If a home owner anticipates selling herhomebeforethe economic returns on an efficiency investment are fully realized, she will ignore returns that occur after the expected date of sale ifprospectivebuyers are unable to recognize the potential energy savings and account for them when makingprice offers. The 'split incentives' problem that arises in the rental housing market may also be understood using the concept of asymmetric information. In the typical case, landlords are unwilling to retrofit rental units because the resulting energy savings would be realized by tenants who paythe utility bills. Landlords are unwilling to pay for utilities since this would create an incentive for
renters to overconsume energy services. Tenants are unwilling toretrofit since they may move out before the cost savings are fullyrealized. Inthe absence oftransaction costs, landlords and tenants would presumablyenter

814 EnergyPolicy 1994Volume22Number 10into contracts to share the costs and benefits of energy

efficiency. But structuring efficient contracts is by no

means a simple task, and the net gains achievable through improved energy efficiency might be swamped bythe associatedtransaction costs. Asymmetric information problems may also account forless than optimal investments inenergyefficiencyon the part of firms. In an important paper, DeCanio23 shows how principal-agent problems between stockholders and managers or different levels ofmanagement could prevent profitable energy-efficiency investments from being undertaken. When managers cannot perfectly observe the behavior of employees, they may be unable toreward actions that would, all elseequal, serve to increase the firm's profits. Accordingly, firms may deviate fromthe idealized norms ofprofitmaximization, engaging in second bestpractices such as capital rationing that discriminate against investments in energy efficiency.24

Transaction costs Problems ofimperfect and asymmetricinformation may be viewed from the perspective oftransaction cost analysis: the economic gains available from increased energy efficiencymaybe outweighed by costs in gathering, assessing and applying information on the characteristics and performance of energy using equipment, installing such measures as thermal shell improvements, making decisions about energy efficiency and energy utilization, or reaching and enforcing agreements among interested parties. The analysis of such costs is frequently confused in the debate over 'hidden costs' associated with energy-efficiency improvements. The latter refer to the indivisible private
costs associated with such improvements, such as the 'hassle' associated with installing such measures as home insulation. Such hidden costs are, however, only a subset of the costs arising in undertaking efficiency investments, and many examples exist in which consumers and firms fail to undertake such investments even though these privatecosts appeartobeminimal.2s More generally, the problem of analyzing transaction
costs associated with energy efficiency is in the first instance conceptual rather than empirical. Taken at face value, the argument that incorporating these costs in engineering-economic estimates of savings available fromincreased energyefficiencywould cause these savings to 'disappear' is tautologous. These costs are indeed 'real' and must be considered in the design of policies. However, the argument that such costs are 'normal' and thus have no implications for economic efficiencyis a fallacy. The important question forpolicy purposes is whether there are possible interventions or Market imperfections andenergy efficiency:A HSanstadandR BHowarth alternative institutional arrangementsbymeans ofwhich such costs canbeovercomewhen they arepresent. The literature on environmental externalities is instructive on this point. In the absence of transaction costs, polluters and their victims would negotiate an efficientbalance between the costs and benefitsofpollution without any need for policy interventionfl6 In reality, however, the costs of contract negotiation and enforcement- indeed, the verynature oftorts law - precludes the achievement of this stylized outcome. The existence of transaction costs, rather than rationalizing externalities as a 'normal' outcome of competitive markets, provides an explanation for why government should intervene to reduce pollution when the benefits ofsuch action exceed administrative costs.

Imperfections in capital markets
The efficient allocation of resources over time by competitive markets requires that individuals have uniform

access to capital markets at common rates of interest. Under these conditions, interest rates constitute an appropriate measure ofmarginal time preference, or the
rate at which individuals would willingly trade between present and future consumption. In practice, imperfections in capital markets are a
common feature of economic reality that may impede certain investments in energy efficiency. Low-income households, for example, frequently must pay substantial premia to obtain loans from lending institutions; indeed, they may be unable to obtain credit at any price. Under these conditions, the poor might rationally use high discount rates in evaluating the merits of energyefficiency improvements. But the resulting resource allocation would fail to satisfy the requirements ofeconomic efficiency: the supply of all goods and services could be increased by reallocating investment to take advantage of the high returns available on energy-efficiency measures in low-incomehouseholds,

Bounded rationality in energydecisions
Most types of market imperfection, such as those we have just discussed, have to do with problems in the economic environment that impede economic efficiency

even with fully rational agents, that is, utility maximizing consumers and profit maximizing firms. In the case of energy related decisions, this hypothesis formally requires individuals and firms to solve what may be extremely complex optimization problems in order to obtain the least cost provision of energy services.2v While itisplausible thatthe appropriatetechnical expertise would be available within firms (subject to the
caveats raised above), it is much less obvious that

EnergyPolicy 1994 Volurne22Number I0 815Market imperfectionsandenergy efficiency:A H SanstadandR B Howarth

individual consumers can correctly solvethese problems when rendering routine decisions. As a result, it is natural to consider the consequences of 'bounded rationality' forenergy related decisions ie the possibility that

consumer decisions differ systematically from the conventions offormaloptimization theory. In comparison with standard theory, this idea might be expressed as saying that, while consumers often lack complete information about the energy decisions they
must make, they more importantly lack expertise in processing and applying the information that is availableto them. Alternatively, if the costs of an ex post optimal decision exceed the expected benefits, itmightbe 'rational' to base decisions on simple rules ofthumb that are impreciseyetcognitivelyefficient. This hypothesis finds extensive support in the behavioral literature on energy demand. Close study of the procedures actually used by consumers in making energy-related decisions has revealed systematic deviations from rational or cost minimizing behavior even when consumers are motivated to make careful decisions.28 Other studies have shown the complexities of consumers' processing of information relating to energy.29 Even when consumers are given technically
accurate information through appliance labels and related instruments, it is far from clear that they absorb and applyitin a 'rational' manner. In the context of the demand for energy services, the problem of consumer rationality constitutes a legitimate 'barrier' that is not easily fitted into conventional economic categories. Here, the analogy to the 'normal markets' fallacy is the idea that however consumers actually make energy related decisions; their choices merely 'reveal theirpreferences' so that no anomalies in decision making can be present. In the presence ofconsumers' documented failure to adopt certain cost-effective energy-efficient technologies, however, this amounts simply to a tautology: whatever consumers
are doing, it must be optimal or they would not have done it. Indeed, research on consumer decision making and energy demand raises theoretical and practical problems
atthe frontiers ofcurrent research, having to do in particular with the relations between economic models of behavior and those of other social sciences. One perspective on these problems is that economic concepts

are in principle insufficient for analyzing and understanding consumers' energy related behavior.3° Several researchers, however, have shown how bounded rationality in energy use can, up to a point, be modeled using the standard tools of optimization theory.3~ While research ofthis type is still at an early stage, itmayprovide a bridge between the economic and the behavioral perspectives. Itis important to note that results obtained thus far do show that problems related to consumer rationality in energy demand have implications for the design ofpolicy.



## Thediffusion perspective Although more widely applied, the basic framework of welfare economics isbest suited to static orcomparative static analysis ofequilibrium states. However, problems associated with energy efficiency are intrinsically dynamic, and therefore naturally analyzed using the

more specialized theory of technological change. The standard economic treatment here distinguishes three phases: invention, innovation and diffusion.32 In this framework, the apparent failure ofmany consumers and firms to minimize their costs of obtaining energy services is naturally viewed as a phenomenon related to diffusion of technological innovation that is already developed. That technological innovations in general take time to work their way into widespread use is certainly amongthe most 'normal' ofeconomic processes. Here again, however, the conflation of 'normal' and 'efficient' markets constitutes a logical fallacy with important implications for public policy. Efficiency is a property of market equilibria. Broadly speaking, however, technological advance is intrinsically a dynamic, disequilibrium phenomenon: the appearance of a new technology creates a situation in which at least some firms and consumers have an opportunity to increase their profits or welfare through adoption, and the adjustment process is a complicated one occurring in real time. The standard equilibrium theory serves to describe, in a sense, the outcome ofthis adjustment, but not the dynamic process itself.33This is not to say that diffusion processes are intrinsically 'imperfect' but rather that the economic analysis ofthese processes cuts

across usual distinctions between efficient and imperfect outcomes, and does not provide a unified picture ofdiffusion processes. This complexityisreflected in the variousmodelsthat

are applied in studying diffusion. There is no single theory of diffusion but instead a collection of approaches, each emphasizing different features of the process. One standard approach34 is derived from epidemiology, and in a sense has very little economic
content. Other models seek to demonstrate how gradual diffusion can result from rational decision making on the part of individual agents.35 These so-called equilibrium models of diffusion are based, however, on the assumption that all agents are well informed about the given technical innovation to begin with, which would appear to severely oversimplify the dynamics of the process. Yet another approach elaborates the role that externalities play in promoting diffusion, and is particu816 EnergyPolicy 1994 Volume22Number I0larly illuminating in that it shows how putative imperfections in the market may in fact be the driving force behind diffusion.36 Although interest seems to be increasing in applications of diffusion modeling to energy technology, surprisingly little work has been done along these lines. One recent and noteworthy effort is that of Jaffe and Stavins,37 who attempt to devise a balanced approach incorporating both market imperfections and 'normal' factors related to the gradual diffusion of energyefficient technology. Howarth and Andersson38 show how, in the context of a diffusion model with consumer uncertainty regarding the characteristics of new technology, rational consumers may be slow to adopt energy-efficient technologies that would yield them ex post benefits.



### Conclusions
The notion that full-cost pricing is the preferred approach to energy policy and that non-price regulatory interventions necessarily impose institutional distortions is a familiar theme in energy economics. This view is based on the rebuttable presumption that markets are efficiently structured so that individuals and firms are able to respond effectively to the prices they face. Without denying the general notion ofrationality or the well known virtues of competitive resource allocation,

we may relax the assumptions that individuals and firms

are perfectly informed agents who are able to solve complex optimization problems when rendering routine decisions concerning energy efficiency and related matters. Given existing limitations on the cognitive capacities of human beings, transaction costs may prevent market participants from negotiating perfectly efficient outcomes in the absence ofregulatory intervention. In such a world, first-best policy may require the joint implementation ofpricing and non-price regulatory policies.39 In this paper, we argue that recent developments in microeconomic theory - in particular, the economics of information - suggest that many ofthe 'marketbarriers'
to energy efficiency discussed in the literature may be understood as market failures properly construed. This claim is supported by empirical results that offer prima facie evidence against the proposition that markets for energy and energy using equipment are free from structural imperfections. It is also broadly consistent with behavioral studies of decisions relating to energy and energy-efficienttechnologies. With this in mind, we conclude that the debate between 'engineering' and 'economic' approaches to energy efficiency in fact involves an underlying conflict

over economic principles. To resolve this conflict, techMarket impelfections andenergy efficiency: A HSanstad andRBHowarth nology analysts must acknowledge that empirical findings are meaningful only when linked to a well articulated theoretical framework. Similarly, economists
must recognize that theoretical assertions are meaningful only ifthey stand uptoempirical scrutiny. The practical application of this approach involves considerations that extend well beyond the limits of this analysis. As we noted above, particular policies
must bejudged on a case by case basis, and the mere existence of a market failure does not imply that government intervention can improve the efficiency of

resource allocation. As one example, McMahon et al4° estimated that the US appliance efficiency standards will save 24 EJ of primary energy between 1990 and 2015, yielding net economic benefits of US$46 billion in present value terms. Those numbers are large by any measure, providing ample indication of the practical importance ofthis intellectually engaging problem.

The authors would like to thank Lee Schipper. Hill Huntington, Jon Koomey, Steve Stoft and Richard Sonnenblick for comments. This work was supported by the US Environmental Protection Agency under contract to the US Department of Energy, Contract No. DEAC03-76SF00098.

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818 EnergyPolicy 1994 Volume22Number 10