How Rebates for Energy-Efficient Appliances Destroy Wealth
In the free market, supply and demand intersect at the point of equilibrium. At this point, the amount that individuals pay for an appliance equals its value. If more individuals were willing to buy an energy-efficient appliance but the suppliers were producing at full capacity, then the price would increase. For some individuals, the higher price will exceed the amount that they value the appliance, and they will not buy one. Additionally, the higher price will incite more firms to enter the market and manufacture energy-efficient appliances, which will push the price back to its equilibrium level.
By offering a rebate, the government distorts the market for energy-efficient appliances, resulting in a loss to the economy. I made the following graph to demonstrate how this happens. (Please keep in mind that I was an economics major, not an art major!) The critical error that many make when evaluating this policy is ignoring this loss.
Graph of Supply and Demand for Energy-Efficient Appliances
Let’s assume that the price of an energy-efficient appliance is $500. At this price, a certain number of people will buy one. For the sake of this example, lets assume that 1,000 individuals will buy one appliance at $500. Next, the government provides a rebate of $175 to incite additional people to buy them. At this lower price, a greater number of people will buy one.
Let’s say that 1,200 people are willing to buy them at this price. Now, these individuals consume a product that the economy-wide equilibrium values at $500, but which the individual values at $325. This means that there is a cost to the economy of $175 (the amount of the rebate) for each appliance sold under the new program. This number, multiplied by the number of additional of appliances sold, roughly equals the dead-weight loss to the economy. In this example, the dead-weight loss equals $175 * 200 = $35,000. In this simplified example, this represents the goods and services that would have been bought in the absence of the rebate, which constitutes destroyed wealth.
Another factor that contributes to the economic loss is the amount of the old appliances that are destroyed despite still being operable. This, too, is represented in the graph.
What’s more, this distortion does not increase the number of energy-efficient appliances sold in the long run. This is because the rebate incites transactions that would have occurred anyway in the future. As old appliances break down, individuals will replace them with new appliances that use improved technology.
Ultimately, the rebate program will destroy wealth and fail to hold down energy prices in the long term. Missourians would be better off if the state and federal governments considered the long-term negative consequences of this policy and let the price system work its magic without this kind of short-sighted intervention.
I created the same graph just yesterday on mspaint. Sadly, mine was not in color. You have me beat.
Comment by Abhi Sivasailam — June 29, 2010 @ 4:54 p.m.
Yeah, but you didn’t fit the social and environmental cost of global warming and pollution in your Econ 101 model. Moreover, old appliances have entropy and use more energy as they degrade. This increases the cost of running them. Thus you have “destroyed wealth” in higher energy bills.
Comment by Douglas Duckworth — June 29, 2010 @ 5:56 p.m.
What if the cost function contains nonlinearities?
Comment by Eapen Thampy — June 29, 2010 @ 7:50 p.m.
These aren’t cost functions, Eapen. They’re basic supply and demand curves.
Nonlinearities don’t change the point of the post. Just integrate them.
Comment by Christine Harbin — June 29, 2010 @ 8:05 p.m.
Douglas, evidence suggests that when people save money on energy costs, they tend to consume more energy. Increasing energy efficiency is a worthwhile goal, but government policy is not an efficient route to achieving that goal — and it’s certainly not a magic bullet for saving the environment.
Comment by Eric D. Dixon — June 29, 2010 @ 8:36 p.m.
You’re right. In my haste, I used unspecific terminology.
Let me rephrase. You present a partial equilibrium model of a good in a market. Let me ask you if there are nonlinearities that exist (and if your analysis accounts for that) when we incorporate this specific market into a more general equilibrium model.
Comment by Eapen Thampy — June 30, 2010 @ 12:46 a.m.
Or let me rephrase again. In the real world (where different markets interact with each other) does the wealth destruction that happens in this market translate to a net reduction in wealth?
Wealth is a stock, not a flow. If it is the case that your answer to the above question is yes, does the same hold true for income?
Comment by Eapen Thampy — June 30, 2010 @ 12:50 a.m.
Elementary price theory shows that, ignoring externalities, subsidizing appliances is a transfer from taxpayers to appliance manufacturers which also generates dead-weight loss. If the appliances are more energy-efficient, the cost savings will be factored into demand. The only reason for subsidizing energy-efficient appliances that can have any economic merit is accounting for externalities (such as greenhouse emissions). As for the reliability of such a subsidy, I refer you to the work of Hayek again, and remind you that information is the relevant scarce resource in this situation. Coase is also useful here, I feel.
Comment by Josh Smith — June 30, 2010 @ 10:02 a.m.
Can you cite other people besides Hayek, Friedman, Cato, or yourselves?
Externalities, like global warming through pollution, are a major facto why we subsidize energy efficient appliances. I don’t understand how you think energy efficiency will be rolled out, especially the transition to alternative fuels, without government action. The transition from wood to coal took many decades. This isn’t something the private sector will invest in, but rather keep drilling deeper wells and increase exploration in other areas such as ANWR.
So energy efficient cars or automobiles increase demand or allow it to remain constant at your equilibrium? If I purchase a Hybrid, then I’ll move even farther away from my job and drive more, since I am seeing a cost savings per mile? I don’t think you factor in consumer preferences and why, independent of cost, people would chose green. They do so because they are conscious of their impact upon the environment. Many can’t afford to go green presently and a subsidy brings them greater access to the green market. It might be a “transfer” to the manufacturers, however I think that’s a worthwhile industry to invest in given the decline in traditional manufacturing and that it’s our future. Given the revenue needed to purchase green capital, the government should encourage demand — that is if we want to complete globally with other countries who have no problem creating dead-weight losses by investing in their domestic green entrepreneurs.
Comment by Douglas Duckworth — July 1, 2010 @ 5:32 p.m.
Private sector deregulation set us 30 years back in energy efficiency. When “The Limits to Growth” was published, the impact of endless resource extraction was on the public’s mind. Yet the answer to the Oil Embargo became not installing solar panels on the White House, but drill baby drill — only Reagan was more eloquent in his jingoism. Unfortunately, now, the consequences of our rational action are once again obviously apparently today in the Gulf of Mexico.
Blind consumption today isn’t within our even selfish interest as it effects our future standard of living and economic productivity. If you believe in a public interest, then it’s the governments obligation to ensure this remains preserved. If not, I would like to hear how private sector deference will bring about the proliferation of efficient infrastructure which benefits everyone. Historic examples only show the removal of streetcars for the automobile. If gas prices hit 4-5 dollars a gallon tomorrow, whether due to increased consumption (unlikely), a terrorist attack, natural disaster, or the cartel colluding to increase profits, what would the private sector do in response to these increasing prices?
Comment by Douglas Duckworth — July 1, 2010 @ 5:50 p.m.
“then it’s the governments obligation to ensure this remains preserved.”
What crystal ball does the government have that tells it what and how much to extract for the use of the people?
This says that the people are just too stupid to know what they need and require overseer “experts” to tell them what they need.
In other words…central planning. The real goal of the warmers and econuts.
Comment by Robert — July 31, 2010 @ 1:11 a.m.