DARWIN C. HALL
Gross investment in U.S. energy industries equalled $119 billion in 1986, 18 percent of gross investment in the U.S. economy. 1 Economic efficiency requires that these investments deliver energy services at the lowest cost. Our economic system selects the combination of energy sources based upon relative prices, however, rather than costs. Prices of conventional energy sources, however, do not reflect all costs. Consequently energy use and production are inefficient. If the prices of coal, oil, gas, and nuclear power were increased by a premium to reflect the externality costs, national security risks, and economic risks of uncertainty, then the economically efficient combination of energy sources would be selected by the market. Moreover, prices including these premiums would include an incentive for the economically efficient level of investment in conservation.
Currently omitted costs must be reflected in prices for the market to efficiently select among energy sources and technologies. The premium necessary to achieve efficiency in a market economy equals an amount that equates the marginal benefit of reducing pollution and national security risks with the marginal cost of reducing environmental damage and national security risks. In order to determine this premium, estimates are needed for both the marginal benefits and the marginal costs of reduced risk to health, the environment, and national security.
Policies that achieve efficiency set environmental standards and enhance national security by an amount such that marginal benefits equal the marginal costs and the costs of these policies are incorporated in prices. Policies that are inefficient fail to balance the marginal benefits with the marginal costs or do not internalize the cost of the policy. To the extent that efficient standards are set, the