Increasing marginal costs and the efficiency of differentiated feed-in tariffs

Abstract We study optimal subsidies for renewable energy (RE) generation to internalize external benefits from inter-temporal learning-by-doing spillovers, taking into account increasing marginal costs at the industry level due to limited availability of sites suitable for RE. We find that the optimal RE subsidy is differentiated according to productivity and derive a condition on production and spillovers under which less efficient, i.e. more costly, technologies should receive higher support, as common in actual policy-making. We show that such a support of technological diversification is optimal if (i) productive sites are scarce, which limits future utilization of knowledge and if (ii) technologies mature rapidly with little further scope for learning. Prima facie evidence for these elasticities for Germany, Denmark and UK suggests that support for technology diversification is the optimal approach for these countries.