We develop a general equilibrium vintage capital model with embodied
energy-saving technological progress and an explicit energy market to
study the impact of investment subsidies on investment and output.
Energy and capital are assumed to be complementary in the production
process. New machines are less energy consuming and scrapping is
endogenous. It is shown that the impact of investment subsidies heavily
depends on the structure of the energy market, the mechanism explaining
this outcome relying on the tight relationship between the lifetime of
capital goods and energy prices via the scrapping conditions inherent to
vintage models. In particular, under a free entry structure for the
energy sector, investment subsidies boost investment, while the opposite
result emerges under natural monopoly if increasing returns in the
energy sector are not strong enough.
JEL codes: E22; O40; Q40
Key words: Energy-saving technological progress; vintage capital; energy market; natural monopoly; investment subsidies
UNU-MERIT Working Papers ISSN 1871-9872