Energy and Economics

“In reality, economics is about "stuff," and the supply of services, all a part of the biophysical world and all requiring energy for their production and use.”

Image addapted from C. Hall.

Energy Sources and Raw Materials

Natural energies drive geological, biological, and chemical cycles that produce natural resources and public service functions. Extractive sectors use economic energies to exploit natural resources and convert them to raw materials. Raw materials are used by manufacturing and other intermediate sectors to produce final goods and services. These final goods and services are distributed by the commercial sector to final demand. Eventually, non recycled materials and waste heat return to the environment as waste.

Cultural Transformations

"The human economy uses fossil and other fuels to support and empower labor and to produce and utilize capital. Energy, capital, and labor are combined to upgrade natural resources to useful goods and services. Therefore economic production can be viewed as the process of upgrading matter into highly ordered (thermodynamically improbable) structures, both physical structures and information. Where the economist speaks of “adding value” at successive stages of production, one may also speak of “adding order” to matter through the use of energy. The perspective of examining economics in the “hard sphere” of physical production, where energy and material stocks and flows are important, is called biophysical economics. It must complement the social sphere perspective."


   ~ Hall and Klitgaard, Energy and the Wealth of Nations

Energy and the Economic Model

The basic model used in neoclassical economics does not include boundaries that indicate the physical requirements or effects of economic activities. We believe that at a bare minimum these models should be reconstructed to include necessary resources and generation of wastes. Taking this assessment one step further, we believe that something like the above diagram should be used to represent in more detail the physical reality of an economy's working. It shows the flow of energy and matter across the boundary separating the reservoirs of these “gifts of nature” from the realm of cultural transformation within which sub boundaries indicate the different stages of their further transformation into the goods and services of final demand. Another way of reflecting thenecessary changes is that shows the standard economist’s view of one person’s role in the economy. While the above figure gives the biophysical perspective of what biophysical materials are actually needed to operate the economy for one person for one year.

Economic Growth

Economic production and growth, the usual indices of material well-being, requires physical work and consequently a steady and consistent flow of energy (Figure 1.1). Historically intervals of economic growth have been punctuated by numerous periods of recession. In general, the growth of real GDP is highly correlated with rates of oil consumption. According to Hamilton and others four out of the five recessions experienced in the US since 1970 can be explained by increased oil prices (Hamilton, 2009, Jones et al. 2004). During periods of recession, oil prices decline, eventually encouraging renewed consumption. Alternatively, during periods of expansion oil prices increase and higher energy consumption, and hence economic expansion, are eventually constrained by these higher prices (Jones et al. 2004.

​© 2014 by Next Generation Energy Initiative, Inc.

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