Substitution between activities with different energy intensities

Abstract

An increase in the real price of energy will have both direct and indirect effects on the composition of activities with different energy intensities. Of the two effects, the direct one is the most intuitive. It is usually presumed to reduce participation in energy-intensive activities, e.g., reducing vehicle miles driven. We show that the direction of the (income-compensated) substitution effect is not known unambiguously but instead depends upon the energy intensities of the activities as well as the utility function. Then focusing upon the two-activity case, we show that (1) greater input substitution within each activity decreases this shift between activities, and (2) value-added measures of output are likely to bias the true substitution between activities. Under some conditions, an increase in the energy price can actually result in an apparent shift towards the more energy-intensive activity when measured in terms of value added.