Verhoef, E. and Nijkamp, P. (1999). Second-Best Energy Policies for Heterogeneous Firms Energy Economics, 21:111--134.

This paper investigates second-best issues in the regulation of external costs of energy use by heterogeneous firms. The efficiency of regulatory energy policies depends in general on the policy incentives given for both output reduction and input substitution. The resulting endogeneity of firms' supply functions appears to lead to complicated policy rules. In contrast to earlier efforts, the analysis considers an arbitrarily large number of non-identical price-taking firms in a joint market; a large variety of possible production functions, including varying levels of economies of scale and possibilities for input substitution; and elasticities of market demand which may vary from completely elastic to completely inelastic. Two second-best instruments are considered, namely output taxes and energy-efficiency standards, and are compared to the benchmark of first-best energy taxes. The underlying market factors determining the relative efficiency of these second-best instruments, when used optimally, are identified.