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New America Foundation: The Price-Induced Energy Trap

Author: John A. Laitner
October 2011

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John A. Laitner explains why a shift is needed from price-driven energy policy towards one that focuses on income and investment.

Despite an anticipated 1.8 percent decline this year in gasoline consumption, for example, the overall expenditures for gasoline will increase 25 percent, rising from $391 billion dollars in 2010 to $489 billion dollars in 2011. Both the size of the U.S. gasoline bill, and its dependence on global events, impact the lives and well-being of individuals, families, and households – especially those from the middle and lower income levels. And as consumers' incomes, already shrinking in the after-effects of the recession, continue to be absorbed by high fuel costs, gasoline is becoming a drag on the economy.

How will U.S. policy makers navigate the future? For decades price has been the focus of policy-maker's attention. Policy-byprice has taken three approaches. First, policymakers have tried to keep prices low through subsidies for ethanol and biofuels, increased domestic oil production and an active foreign policy toward oil suppliers, while letting "the market" (i.e., rising prices), tell consumers when to change their habits or autos. Another approach has added CAFE standards for automobiles to the mix as a way of reducing demand in the fleet overall, while ensuring that consumers are steered towards more efficient vehicles in response to those prices. A third approach wishes to make gasoline price more truly reflect its external costs through taxes, carbon fees, and highway use fees. All approaches emphasize the role of "the price signal" in providing incentives that encourage a smarter use of energy. All strains of policy assume that consumers can and do respond to higher prices by reducing demand in an economically rational fashion.

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