Discussion
Aggregation using price has its shortcomings. Prices provide a reasonable method of aggregation if the aggregate cost function is homothetically separable in the raw material input prices. This means that the elasticity of substitution between different fuels is not a function of the quantities of nonfuel inputs used. This may be an unrealistic assumption in some cases. Also, the Divisia index assumes that the substitution possibilities among all fuel types and output are equal.
Another limit on the use of prices is that they generally do not exist for wastes. Thus, an economic index of waste flows is impossible to construct.
It is well-known that energy prices do not reflect their full social cost due to a number of market imperfections. This is particularly true for the environmental impact caused by their extraction and use. These problems lead some to doubt the usefulness of price as the basis for any indicator of sustainability. However, with or without externalities, prices should reflect productivities. Internalizing externalities will shift energy use, which in turn will change marginal products.
Moreover, prices produce a ranking of fuels (Table I) that is consistent with our intuition and with previous empirical research. One can conclude that government policy, regulations, cartels, and externalities explain some of the price differentials among fuels but certainly not the substantial ranges that exist. More fundamentally, price differentials are explained by differences in attributes such as physical scarcity, capacity to do useful work, energy density, cleanliness, amenability to storage, safety, flexibility of use, and cost of conversion. Eliminate the market imperfections and the price per Btu of different energies would vary due to the different combinations of attributes that determine their economic usefulness. The different prices per Btu indicate that users are interested in attributes other than heat content.
