The Microeconomic Theory of the Rebound Effect: Nuances, Externalities, and Welfare

Abstract

Economists have long noted that improving energy efficiency could lead to a rebound effect, reducing or possibly even eliminating the energy savings from the efficiency improvement. Yet there are important nuances in the microeconomic theory of the rebound effect that have not been explored. This paper develops a generalized model illuminating the effects of an exogenous change in energy efficiency on energy use, external costs, and welfare. This model overturns conventional wisdom by showing how several identities that are frequently used to estimate the rebound effect no longer hold in a generalized setting. We clarify the relationship between the direct rebound effect and the indirect rebound, and highlight the importance of complement/substitute relationships between energy services. Furthermore, by including external costs in our model, we develop conditions under which the rebound is welfare-improving and show how the rebound influences the welfare consequences of energy efficiency policies.

Keywords: energy efficiency

JEL Classification: Q38, Q48, Q53, Q54