The large increases in energy prices during the 1970s encouraged extensive interest in reducing energy use and in using energy resources efficiently. The common belief resulting from the energy crisis was that private markets would not provide an adequate supply of energy and would not conserve the use of energy resources. A particular concern was that households and businesses have insufficient incentives to invest in energy-saving technologies. A simplified investment model illustrates this point. The characteristic of any investment is that an initial commitment of funds is made with the expectation of a future payoff. Funds received in the future are of less value than identical funds today; hence investors must discount future cash flows.

Textbooks on investment present a simple model where the net present value (NPV) of an investment equals annual future revenues (R...