Energy efficiency improvements face some challenges with respect to both adoption, due to the energy efficiency gap, and efficacy, due to the rebound effect. These concepts are explained in the next section.
The Energy Efficiency Gap
Even though consumers can often save money from investing in energy-efficient devices, research suggests that consumers do not tend to do so, leaving many apparent cost-saving investments on the table. This phenomenon is referred to as the “energy efficiency gap,” since investment in energy efficiency should theoretically be higher than it is today.
In addition to the gap from a consumer perspective, which focuses on costs to individuals, there is also an efficiency gap from a societal perspective, which considers both private costs and external costs (such as the environmental costs of energy production). Society would generally benefit from investing in energy efficiency improvements when the sum of private and environmental costs of an energy-efficient investment is lower than for an alternative investment. For example, in some cases, it could make more sense for society to reduce energy consumption rather than invest in a new gas plant that will have higher combined economic and environmental costs for society. Therefore, as energy efficiency has public benefits that may not count toward a consumer’s personal benefit, the optimal level of energy efficiency adoption is higher for society overall than for private consumers, and thus the societal “gap” is even larger than the private one.
Possible Explanations for the Gap
There are many potential explanations for the energy efficiency gap.
Market Failures: Sometimes, consumers act rationally (in their own best interest), but markets fail to account for other factors that prevent an efficient outcome from being reached. An example of a market failure is the principal-agent problem, where, in the energy efficiency context, differing incentives between owners of energy-using equipment and those who use the equipment result in perverse incentives (incentives with effects that are the opposite of what is intended) for energy efficiency investments. For example, if a landlord purchases the home’s appliances but their tenant pays the electric bill, then the landlord is not incentivized to invest in sometimes costly energy-efficient appliances because they will not benefit from the resulting energy savings.
The principal-agent problem can be especially common when the rental market does a poor job of signaling differences in energy costs to consumers. Theoretically, a landlord should be able to raise the rent if they invest in energy-efficient appliances because the tenant would benefit from lower electricity bills. However, prospective tenants may not realize the energy savings advantage and choose to rent elsewhere due to the higher rent price, thus discouraging the landlord from making the investment. This type of misalignment prevents the market from reaching the optimal outcome.
A lack of information is also considered to be a market failure if its absence prevents a consumer from making a rational decision. For example, if a used car salesperson misrepresents information on the gas mileage of vehicles to a potential customer, the customer may purchase a different vehicle than if they had correct information. Economic theory assumes that consumers will make rational decisions given the information at hand, so if relevant information is not available, consumers may underinvest in energy efficiency.
Credit constraints are another example of market failures that may explain the energy efficiency gap. If consumers are unable to purchase more expensive equipment that would lead to energy savings over the long term, it could be indicative of a failure of the market if consumers are unable to obtain credit for investments that have high associated savings (see Gillingham and Palmer, 2014).
Behavioral Failures: Behavioral failures occur when a consumer does not act rationally. One example of this type of failure is loss aversion, which describes an overweighting of losses over gains. A consumer could be averse to purchasing an appliance with a higher upfront cost, even if the lifetime energy savings benefits outweigh the costs, because they are averse to the immediate monetary loss (for example, see Greene et al, 2013).
Another type of behavioral failure is inattention, which refers to a consumer either ignoring or misunderstanding information relevant to the decision they are making and, consequently, making an irrational decision. For example, information on a product’s energy usage may be available, but the customer may choose not to read or consider it when making a purchasing decision.
Hidden Costs: In some instances, the energy efficiency gap may be overstated due to factors that are unaccounted for. For example, a consumer might prefer a gasoline car over a more efficient electric car for non-energy-related reasons, such as vehicle performance or lack of availability of charging infrastructure. Once these factors are accounted for, the market does in fact reach the efficient outcome. While hidden costs could explain some of the energy efficiency gap, studies suggest it is likely only part of the answer and offer additional explanations as being either market failures or behavioral failures (see Gerarden et al 2017 and Gillingham and Palmer 2014).
The Rebound Effect
In addition to the barriers present for adoption of energy-efficient technologies, some challenges exist for reducing overall energy consumption even after energy efficiency has improved. The rebound effect refers to the phenomenon that improved energy efficiency can lead, to some extent, to an increase in energy use because the cost of the energy service declines. Energy services have a downward-sloping demand curve, meaning that if the price declines, consumers will purchase more of it. This rebound effect thus offsets some of the savings associated with energy efficiency improvements.
One hypothetical example of the rebound effect is a household that upgrades their washing machine to a more efficient model. Because the new model is more efficient and thus cheaper to operate, the household may end up running the washing machine more often, which therefore offsets some of the energy savings associated with upgrading to the more efficient model.
The rebound effect can vary significantly by sector and type of efficiency improvement, and various studies have found different estimates for the rebound effect. Some studies find very large rebound effects that arguably mitigate the benefits of improving energy efficiency. Frodel et al (2012), for example, find a rebound effect of 57 percent in transportation (meaning 57 percent of the energy savings are offset by the increase in energy use). Other studies find much smaller rebounds in other sectors. Gillingham et al, 2013, for example, argue that the rebound effect for household appliances is around 5 to 10 percent. While many studies have various findings, most agree that the rebound effect does not offset all of the energy reducing gains from switching to energy efficiency technologies, and thus there are still benefits from improving energy efficiency.
