**1. Introduction**

264 Fossil Fuel and the Environment

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Fossil fuels as the most important kind of energy are inevitably linked with the economy and the environment. A stable and continuous supply of fossil fuels and alternative ones is needed while we develop. Economic activity is predominantly related to the energy use, principally fossil fuels, which account for over 60% of global greenhouse gas emissions. This implies an urgent need to decouple economic growth from energy use. Thus this chapter surveys the relation between energy and economy growth.

From development perspective, energy is important for eradicating poverty, improving human welfare and raising living standards (UNDP, et al. 2000). However, in many areas of the world the current patterns of energy supply and use are considered unsustainable, which limits economic development. In other areas, environmental degradation from energy production and consumption inhibits sustainable development. So, energy is critical in the context of sustainable economy and clean environment. It is therefore important for policy makers to understand the implications of different energy programs and alternative policies.

The existing literature on energy and development does show that energy development is an important component of broader development. So we have attempted to pull together some of the ways in which energy might exert a significant influence on the development process. Development involves a number of other steps besides those associated with energy, notably including the evolution of education and labor markets, financial institutions, modernization of agriculture, improving environment and etc. Nevertheless, it is hard to imagine overall economic development succeeding without energy development being one part of the evolution.

Traditional economic theory disregards the importance of energy, because it postulates that the contribution of energy to economic growth is essentially determined by the low share of energy cost in the total cost of capital, labor, and energy. Even if the cost of energy can be neglected, being one of the driving forces in the economic process, the biophysical aspects of the economy should be considered. Therefore, the role of energy in intensifying processes with increasing automation is taken into account, where energydriven machines replace human labor.

Energy and Economy Links – A Review of Indicators and Methods 267

This part reviews the background theory of production and growth. The role of energy in production should be considered in order to understand the role of energy in economic growth. Mainstream economists usually think of capital, labor, and land as the primary factors of production, while goods such fuels and materials are intermediate inputs (which are created during the production period under consideration and are used up

However, the theory of growth and its limitations of consideration of natural resource has been the subject of strong criticism. So the background theory of production and growth can

There are essentially three mainstream categories of neo-classical growth models (Stern and Cleveland, 2004). The first one focuses on technological change as the only means by which growth can be achieved (Aghion and Howitt, 1998; Solow, 1956; Stern and Cleveland, 2004). Economic growth beyond equilibrium level (where further returns to capital are no longer possible) is only achievable by increasing returns to existing capital

The second category focuses on the consumption of natural capital in determining sustained economic growth. These models assume a priori that it is technically feasible to substitute between physical and natural capital (Stern and Cleveland, 2004). Achieving sustained growth relies on the correct institutional conditions (including property rights, market structure, means of considering future generations) to ensure that any depleted natural capital is substituted for with the corresponding value of man-made capital (ockwell, 2008). The last category of growth model considers both natural resources and technological

In all three models of economic growth, the contribution of energy to economic activity is only considered relative to its cost within production process. In economic terms, the models consider energy to be an 'intermediate good' rather than a 'primary input' into production. This implies that decoupling economic growth from energy use is a possible subject, in the case of the latter two models. In the following the mentioned growth models

The basic model of economic growth that does not include resources at all is Solow model (1956). This model subsequently was extended with nonrenewable resources, renewable resources, and some waste assimilation services (Kamien and Schwartz, 1982; Toman et al., 1994). These extended models are, however, only applied in the context of debates about

Economic growth models examine the evolution of a hypothetical economy over time, as the quantities or the qualities of various inputs into the production process change. In Solow

environmental sustainability, not in standard macro-economic applications.

change as the determinants of growth. (Stern and Cleveland, 2004).

Finally after laying out some conceptual ideas, we examine some empirical evidence.

**2. Theory of production and growth** 

be reviewed from different points of view.

via improvements in technology.

are described briefly.

**2.1 The basic growth model** 

entirely in production).

While the mainstream theory of economic growth pays little attention to the role of energy or other natural resources in promoting economic growth, the impact of energy prices on economic activity has attracted significant attention during the last two decades. Resource and ecological economists have criticized this theory in terms of the thermodynamics implications for economic production and the long-term prospects of the economy.

Energy development or increased availability of energy is a part of enhanced economic development. But even with trends toward greater energy efficiency and other dampening factors, total energy use and energy use per capita continue to grow in the advanced industrialized countries and even more rapid growth can be expected in the developing countries as their incomes advance. Generally, economic activities, structural and technological changes are important factors influencing energy use. So some time there is evidence of mutual interactions between economy and energy.

While there is a lack of alternative model of the growth process, extensive empirical work has examined the role of energy in the growth process. The principal finding is that energy used per unit of economic output has declined, but this is to a large extent due to a shift in energy use from direct use of fossil fuels to the use of higher quality fuels.

The role of energy in production is described in the following using neoclassical concept of the production function. This production theory is very general in comparison to the specific models of economic growth including new factors (such as substitution between energy and other inputs, technological change, shifts in the composition of the energy input, and shifts in the composition of economic output) affecting production process (stern, 2004).

Furthermore, energy and economic activity both affect the environment. However, understanding these effects has important implications, while technology has been evolved and improved dramatically. The chapter is structured to cover the key points of energyeconomy- environment nexus, too.

The chapter is organized as follows. We begin with a brief review of theory of production and growth that describe the channels through which increased availability of energy might act as a "key" stimulus of economic development.

In the third part conceptual linkage between energy and development and also the role of economic activity in the energy use trend are described. Development of disaggregated energy indicators makes available a powerful set of analytical tools. Those tools reveal the relationship between energy uses and their underlying driving factors.

The next part reviews energy indicators, which are developed to describe the links between energy use and human activity in a disaggregated manner. After reviewing major indicators, we discuss the basic concepts of various indicators and the methodologies used to derive them. Then we review the use of decomposition methods to aid in the analysis of trends in energy use. The key factors in this analysis are (1) substitution between energy and other inputs within an existing technology, (2) technological change, (3) shifts in the composition of the energy input, and (4) shifts in the composition of economic output.

Then energy and economy are related to the environment. Therefore energy indicators can be extended to carbon emissions which play an important role in aiding negotiations over carbon reduction targets and evaluating progress toward meeting abatement goals.

Finally after laying out some conceptual ideas, we examine some empirical evidence.
