Optimal Consumption and Investment with Energy-Efficiency Adoption

TL;DR

This paper develops a comprehensive model of energy consumption, efficiency adoption, and policy impacts, revealing how financial conditions influence technology adoption and welfare outcomes.

Contribution

It introduces a unified framework for energy consumption and efficiency adoption, including new welfare implications and an approximation scheme for policy analysis.

Findings

Energy efficiency adoption generally improves welfare.

Subsidy policies effectively reduce aggregate energy consumption.

Financial conditions significantly influence adoption thresholds.

Abstract

Despite many decades of research, economically grounded models that analyse energy consumption and energy-efficiency adoption within a unified framework remain underdeveloped. This article addresses this gap by proposing a model of consumption, investment, and energy-efficiency adoption under uncertainty. It develops new definitions of the rebound and backfire effects, and integrates their welfare implications into a model of optimal subsidy design. Macro-level technology diffusion and energy consumption across heterogeneous agents are also formalised. Explicit results for core objects are derived, including the adoption threshold and post-adoption strategies, and these are shown to depend on agent wealth, introducing a novel channel through which financial conditions influence technology-adoption decisions. An approximation scheme is proposed to estimate welfare implications explicitly. Adoption of energy efficiency is shown to be welfare improving in the main. A detailed case study of a representative German single-family home illustrates the theoretical results. Numerical analysis indicates that the subsidy policy effectively steers aggregate energy consumption.