This study estimates an energy sector model consisting of interfuel substitution model and an aggregate energy and non-energy input demand system that incorporates short-run and longrun structural adjustment parameters. The study finds that all fuels in the energy aggregate are Morishima substitutes and that there are significant sectoral variations in magnitude of the elasticities. This indicates that economic instruments should be considered for energy policy but such policies should take into account not only differences in technology used across sectors but also the systematic distribution of costs when the relative prices of fuels change. Estimates of long-run elasticities for aggregate input demands indicate that energy-capital input ratios adjust faster than labour-capital input ratios. This suggests that investment policy should take into consideration tradeoffs between environmental gains and employment implicit in the production structure of the Malawian economy as both capital and labour demands have dynamic interactions with energy in the long-run with potential significant cumulative impacts on the environment. Using results and gaps noted from the partial equilibrium analysis, the study also evaluated general equilibrium impacts of reducing fossil and biomass fuel use by production activities while investing in more hydroelectricity. The results show that carbon emissions and forest resource depletion due to energy use, respectively, can be reduced by imposing environmental taxes aimed at inducing a shift from biomass and fossil fuels to hydroelectricity. More significantly, there are at least three dividends from inducing a shift in the energy mix in that the economy can attain GDP at least equal to the value before imposition of environmental taxes in addition to reducing carbon emissions and deforestation. Further, redistributing the environmental tax revenues to reduce direct taxes on households leads to better income distribution. These findings have direct policy relevance to the contemporary challenges to sustainable development under the added burdens of climate change. Most importantly is what developing countries can do to strategically position themselves in global agreements on financing for climate change adaptation and mitigation. The general equilibrium estimate of direct environmental cost associated with the use of fossil and biomass fuels is close to the moderate estimate of social cost of deforestation in the National Environmental Action Plan (NEAP). This is significant because in the absence of estimates of damages of secondary impacts of both carbon emissions and deforestation, the optimal energy tax as inferred from the general equilibrium model corresponds to the annual growth rate in the economy’s energy intensity. In addition, since short-run to medium term environmental impacts are critical when data on secondary damages are unavailable, it would be prudent to target growth in intensities of use of fuels that contribute to the economy’s footprint on the environment. The study also proposes alternatives to carbon emission taxation that could complement the current legislation on land use by agricultural estates.