The Microeconomic Theory of the Rebound Effect and its Welfare Implications∗

Economists have long noted that improving energy efficiency could lead to a rebound effect, reducing or possibly even eliminating the energy savings from the efficiency improvement. This paper develops a generalized model to highlight features of the theory of the microeconomic rebound effect that are particularly relevant to empirical economists. We demonstrate when common elasticity identities used for empirical estimation are biased, and how gross complement and substitute relationships govern this bias. Furthermore, we formally derive the welfare implications of the rebound effect to provide clarity for on-going policy debates about the rebound.