A Theoretical Model of Structural Change in the Energy Industry

In this chapter, a theoretical model is developed to study the transition from an established polluting to a new clean energy technology, if (i) the social rate of time preference stays below the private, (ii) the creation of new productive capital is time-lagged, (iii) emissions are negatively valued, and (iv) an end-of-pipe abatement technology is available. Section 3.1 introduces the model economy and specifies social and individual preferences. In sections 3.2 and 3.3, from the model necessary and sufficient conditions both for investment in the new and for replacement of the established technology are derived for the cases of the social optimum and an unregulated competitive market economy, respectively. It is shown that, in addition to that induced by the emission externality, a further distortion arises due to the split of the social and private rates of time preference, the extent of which positively depends on the time lag in capital accumulation. Section 3.4 shows how the two distortions can be corrected via environmental and technology regulation.