ECONOMIC

of consumer durables. There is considerable scope for conserving energy byreducing household output: for example, lowering thermostat settings anddriving fewer miles. Unlike reductions in industrial output, these measuresgenerate little unemployment, and for this reason they play an importantrole in the Administration's energy conservation program. During 1974,cutting back on energy used in the household will be the best available meansof conserving energy without paying a high price in increased unemploymentor reduced incomes.Pricing PolicyBecause of these inflexibilities with respect to energy production and use,market equilibration of demand and domestic supply in the short run wouldrequire very large price increases, at least for a year or two. Even thoughprice increases would gradually stimulate additional production at highercost, profits would also increase—especially before the additional productionis forthcoming—and this raises problems of equity.If price increases are not allowed, however, there will be insufficient incentivesfor consumers to reduce demand and for producers to expand reservesand output. Substantial excess demand would then result, requiring an extensivesystem of controls, allocations, and rationing. Because of seriousdata limitations, it is impossible to design these measures so as to ensurethat resources are efficiently used. Heavy reliance on such measures is likelyto lead to an inefficient use not simply of energy resources but of all resources,and thus might delay our recovery from the crisis. One has reasontherefore to question the efficacy of such controls for more than a very briefperiod.In addition, holding prices down is likely to create expectations that priceswill rise in the future, thus further discouraging increases in production andsales. Because fossil fuels are exhaustible resources, sales made today are atthe expense of earnings in the future. If the rate of appreciation of the valueof a resource is expected to exceed the rate of return on alternative investments,there is little incentive to sell. A greater return could be earned byholding back production and building up inventories than by immediate sale.It has been argued that the domestic output of natural gas has been helddown during the past few years, partly because of expectations that largeprice increases would be permitted.These considerations argue for letting energy prices rise so that marketswill clear, and for initiating a tax to limit windfall profits. In this way, theprice system is permitted to play an important role in guiding productiondecisions and encouraging consumers to conserve energy.With respect to the price of domestically produced crude oil, a distinctionhas been made between "old oil" and "new oil," the latter referring toall oil produced on a property in excess of output in the same month of1972. To stimulate increases in production, the ceiling price has been removedfrom new oil production. The ceiling price on old oil was raised to$5.25 per barrel late in 1973 to reduce the widening gap between prices119