Dynamic models of industrial energy demand
Certain features of dynamic models of energy demand based on the economic theory of production are examined. Attention is mainly confined to first and third generation dynamic models. First generation models are partial adjustment models where energy Is treated largely in isolation from other inputs. Third generation models are based explicitly on dynamic economic optimization, incorporating the notion of costs of adjustment for quasi-fixed inputs. The analysis focusses on three main issues. The first is the characteristics of first generation models and how these models can be extended to the industrial sector. The second is the nature and empirical significance of alternative definitions of third generation models according to whether adjustment costs are treated as a function of net or gross investment. The third issue is whether first and third generation models are generically related and, if so, how. The work on first generation models is mainly confined to the Balestra-Nerlove framework. This specification generally has been applied to individual fuels in the residential/commercial sector but is also applied to aggregate residentidal energy demand and to industrial fuel demand. In terms of third generation models, recognition that adjustment costs may reflect not only net but also gross investment leads to a more complex model, with significant differences in the theoretical specification between net and gross investment formulations. These differences remain significant empirically. Application of the net and gross investment model specifications to Canadian data show that estimation of the simpler net investment version may well entail erroneous estimates of certain parameters. The energy functions of the first and third generation models are found to be generically related. The simplicity of a first generation model can under certain conditions be consistent with the richer, more complex framework of third generation models. However, empirical testing did not support the notion of treating a first generation energy function as tantamount to a reduced form specification of a third generation model.