Investment, technological progress and energy efficiency

In this paper we propose a theory to study how the aggregate demand of energy responds to energy prices and technical innovations that affect the price of energy services. In our theory, energy use is determined by the interaction of the choice of Energy Saving Technical Change with energy prices and Investment Specific Technical Change (ISTC). The key mechanism is that the energy saving technology is embodied in capital vintages as a requirement that determines their energy intensity. We show that higher ISTC that increases the quality of capital goods is an energy saving device and, therefore, a substitute for Energy Saving Technical Change (ESTC). However, higher ISTC that rises the efficiency in producing capital goods is energy consuming and fosters ESTC to compensate for the amount of energy required by the new investment. A higher price of energy also induces a higher level of ESTC, but the aggregate amount of energy used may not be affected as investment does not change. These effects are amplified with rising prices of energy. Thus, our theory can be used to test when and how we should see a rebound effect in energy use at the aggregate level and to evaluate the aggregate effect of any policy aiming to reduce energy use.