PRODUCTION AND DYNAMIC DEMAND MODELING USING ENGINEERING MODELS AND PSEUDO DATA: THE EFFECTS OF TAX POLICY ON THE ACCELERATED SUBSTITUTION OF SOLAR ENERGY FOR CONVENTIONAL ENERGY

Since the advent of the 1973 Arab oil embargo, there has been an increasing interest in substituting solar energy for conventional non-renewable energy resources. Recently, the federal government (Energy Tax Act of 1978) and many state governments have attempted to accelerate the substitution process via solar energy financial incentives implemented through the tax mechanism.;The DHW stock-flow production function is a micro-micro production function defined at the process level. Empirical estimation is accomplished using physical laws and an engineering model which describes the underlying solar technology. Possibilities of using pseudo data approaches to empirical estimation are also explored.;Empirical estimates of the dynamic demand for solar energy capital are provided for the southeast region of the U.S. for two alternative fuels--oil and electricity--and for three scenarios: (1) base case (no tax incentives), (2) accelerated case (federal tax credits comparable to the Energy Tax Act of 1978), and (3) full acceleration (combined federal and state tax incentives). Intersector analyses indicate that in comparison to the residential sector, the commercial sector demand for solar energy is stronger and market penetration is potentially much earlier. Interfuel comparisons indicate that relative to the electricity using sector, additional tax incentives may be required to induce even a weak demand for solar energy in the oil using sector assuming that oil prices accelerate at a real rate of approximately two percent per annum. A further analysis of constant-price-variable-output demand functions indicates that the demand for solar energy is proportional to DHW energy utilization. Thus, differential tax incentives are necessary to induce energy intensive users to undertake proportionately larger scale solar energy investments, hence proportionately larger reductions in their demand for conventional non-renewable energy resources.;This study analyzes the possible effects of alternative tax policies on the solar for conventional energy substitution process in the production of residential and commercial domestic hot water (DHW). The method employed is an integrated approach to production and investment in a dynamic framework. Functional separability is utilized to derive the notion of multi-level production in which DHW is produced in a lower level subfunction production function separable from the master production function. The subfunction production function of interest is of the stock-flow type in which a conventional energy flow (current input) and solar energy capital stocks combine to produce a DHW energy output. Dynamic stock and flow demand functions are derived showing the optimal time path of cost-minimizing energy flows (conventional energy fuels) and energy stocks (solar energy capital). Effects of alternative tax policies on the dynamic stock demand for solar energy capital are captured in a present value user cost of solar capital term. The method enables one to simultaneously estimate the effect of alternative tax policies on both the optimal scale and optimal timing of the solar investment.