Role of Behavioural Economics in Energy and Climate Policy
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The Role of Behavioural Economics in Energy and
Climate Policy
Michael G. Pollitt and Irina Shaorshadze
December 2011
CWPE 1165 & EPRG 1130
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www.eprg.group.cam.ac.uk
EP
RG
WORKING
PAPER
Abstract
The Role of Behavioural Economics in Energyand Climate Policy
EPRG Working Paper 1130
Cambridge Working Paper in Economics 1165
Michael G. Pollitt and Irina Shaorshadze
This article explores how behavioural economics can be applied to
energy and climate policy. We present an overview of main concepts of
behavioural economics and discuss how they differ from the
assumptions of neoclassical economics. Next, we discuss how
behavioural economics applies to three areas of energy policy: (1)
consumption and habits, (2) investment in energy efficiency, and (3)provision of public goods and support for pro-environmental behaviour.
We conclude that behavioural economics seems unlikely to provide the
magic bullet to reduce energy consumption by the magnitude required
by the International Energy Agency's 450 climate policy scenario.
However it offers new suggestions as to where to start looking for
potentially sustainable changes in energy consumption. We believe that
the most useful role within climate policy is in addressing issues of
public perception of the affordability of climate policy and in facilitating
the creation of a more responsive energy demand, better capable ofresponding to weather-induced changes in renewable electricity supply.
Keywords behavioural economics, energy economics, energy demand,
energy efficiency, private provision of public goods
JEL Classification D03, D10, Q40, Q58
Contact [email protected] December 2011Financial Support EPSRC, Flexnet
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TheRoleofBehaviouralEconomicsinEnergyandClimatePolicy
MichaelG.Pollitt1
IrinaShaorshadze
ESRCElectricityPolicyResearchGroup
UniversityofCambridge
December2011
1. Introduction
While energy efficiency and conservation have been important tenets of energy policy for decades,
concernsaboutclimatechangehaveputthese issuesatthe forefrontofpolicydialogue. International
Energy Association (IEA 2010) estimates that by 2020, about 34% of the global decrease in carbon
emissions in a 450 scenario (limiting the longterm concentration of greenhouse gases in the
atmosphereto450ppmCO2eq)comparedtothereferencescenarioshouldstemfromdirectenduse
energyefficiency
measures.
This
goal
calls
for
astep
change
in
how
individuals
consume
energy
and
make energyefficiency purchases. Energy consumption, energyefficient investment, and pro
environmentalactionsinvolveconsumerdecisionmakingandbehaviour.Theseaspectshavegenerated
increasedinterestindesigningpolicyinterventionsthattargetenergydemand,andinterestinassessing
theresponsivenessofconsumerbehaviourtothese interventions.Behaviouraleconomicscanprovide
new perspectives that can inform policy design on how individuals evaluate options, make decisions,
andchangebehaviour.
Itisimportanttopointoutthatenergypolicyisnotjustaboutclimatechange,butalsoaboutsecurityof
energysupplyandabouttheaffordabilityofenergy.Climatepolicysignificantly interactswithbothof
theseelements
of
energy
policy
via
the
introduction
of
expensive
and
intermittent
renewable
electricity
andheat.Ifconsumerbehaviourcanbechangedtoreduceenergydemandortomakeenergydemand
more responsive in time and space to weatherinduced shortages of energy, it could be a significant
contribution to facilitating the introduction of climate policyinduced renewable energy. By contrast,
1ThispaperwillbeachapterintheforthcomingHandbookonEnergyandClimateChangeeditedbyRoger
Fouquet,tobepublishedbyEdwardElgar.TheauthorswishtothanktheEPSRCFlexnetprojectforfinancial
supportandRogerFouquetforhisencouragementtowritethepaper.Weacknowledgethehelpfulcommentsof
RogerFouquetandananonymousreferee.Theusualdisclaimerapplies.
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failure toaddresspublicconcernsabout the securityof supplyoraffordability implicationsofclimate
policymayjeopardizetheachievementofambitiouscarbonemissionsreductiontargets.
Behaviouraleconomicsusesinsightsfrompsychologyto increasetheexplanatorypowerofeconomics.
According to neoclassical economics, agents maximize expected utility using exponential discounting,
and they have access to information that they can assess freely and completely. While this is a
parsimoniousrepresentationofhoweconomicdecisionsaremade,experimentalsettingsandempirical
observations indicate that behaviour deviates systematically from what traditional models would
predict.Someofthepuzzlesthattraditionaleconomicsstrugglestoexplainarethefollowing:whyare
returnsonequitymuchhigherthanreturnsonbonds(equitypremiumpuzzle);whyarethereuntapped
opportunitiestoreduce(energy)expenditurethroughincreased(energy)efficiency(efficiencygap);and
whydoindividualsindulgeinimmediategratification,knowinglycompromisingtheirlongrunwellbeing
(substance
abuse)?
Behavioural
economics
challenges
one
or
more
of
the
assumptions
of
the
neoclassical economics, and offers an alternative way to model decision making. These alternative
modelsoftenbettermatchempiricalobservationsandhavehigherpredictivepowerthanmodelsbased
purelyonneoclassicalassumptions.
Whiletraditionaleconomicsassumesindividualsalwaysbehaverationally,behaviouraleconomistsoften
stress the irrational aspect of decision making, often referred to as behavioural failures. These
behaviouralfailuresmaymakeindividualsactagainsttheirownlongterminterest.ThalerandSunstein
(2008)arguethatifindividualsdonotalwayschoosewhatisbestfortheminthelongrun,itiswelfare
enhancingforpolicymakerstoensurethatthesetofchoicesthat individualsface issuchthata long
term,welfare
maximizing
outcome
becomes
more
likely.
This
may
be
done
through
proper
framing
choices, setting appropriate (limited if necessary) choice sets and providing appropriate default
options. In essence, individuals are nudged towards a welfaremaximizing outcome, even if their
freedom to choose is still respected. Thaler and Sunstein (2003) called this approach libertarian
paternalism. Libertarian paternalism would argue for policy interventions in the face of behavioural
failures,evenifmarketfailuresareabsent.
Traditionally,economicshasfocusedonhowchangesinpricesaffectbehaviour.Researchinbehavioural
economicsandpsychologyhasdemonstratedthatnonpecuniary interventionscompare favourablyto
monetary interventions in changing consumer behaviour. It was also shown thatjudiciously applied
pecuniaryinterventions
increase
the
impact
of
monetary
interventions
ifused
in
combination.
This
has
increasedinterestinresearchinbehaviouraleconomicsasaguideforpolicymakinginareasasdiverse
as public health, finance, and law. Thatbehaviouraleconomics can inform decision making inenergy
policy has increasingly been recognized by policy makers and researchers (Allcott and Mullainathan
2010;DEFRA2010;OFGEM2011).
In order to realize energy savings and emissions reductions necessary to address climate change,
decision makers have to consider tapping into behavioural transformation strategies. Behavioural
Economics provides insights that can inform this effort. Behaviours that are relevant to household
energyconsumptionencompassthreebroadareas(1)energyconsumption,curtailment,andhabits;(2)
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energy efficiency investments; and (3) contribution to public goods (i.e. green energy) and pro
environmental behaviour. These three aspects of energy consumption are interrelated; for example,
proenvironmentalattitudesmaymakeefficiency investmentsmore likely,andthese investmentsmay
reduceenergyconsumptioninthelongrun.However,thesetopicsdifferintermsofthedecisionmaking
andbehavioursinvolved,andwarrantseparatereviews.
The restof this paper is organized as follows. Section 2presents themajorconcepts that distinguish
behaviouraleconomics fromneoclassicaleconomics.Sections3,4,and5 form theheartof thepaper
anddiscusshowbehaviouraleconomics relates toenergyconsumptionandpolicy.Threebroadareas
related to energy are discussed: energy consumption, curtailment, and habits (section 3); energy
efficiency investments and purchases (section 4); proenvironmental behaviour and public goods
(section5).Section6providesconcludingremarks.
2. BehaviouralEconomicsvs.NeoclassicalEconomicsThemaindeparturesfromneoclassicaleconomicsproposedbybehaviouraleconomicscanbegrouped
underfourmainareas:(1)timevaryingdiscountrates,(2)prospecttheoryandimportanceofreference
points,(3)boundedrationality,and(4)prosocialbehaviourandfairness.Belowwebrieflydiscusseach
oftheseareas.
2.1. Time-VaryingDiscountRates
Experimentsshow
that
individuals
use
ahigher
discount
rate
over
alonger
time
horizon
than
over
a
shorter timehorizon (Thaler 1981;Benzionetal.1989;HolcombandNelson1992).Todealwith this
apparent anomaly, behavioural economics proposes hyperbolic discounting. Under hyperbolic
discounting, individualshavehigherdiscount rates for shorthorizons,but lowdiscount rates for long
horizons (Laibson 1997). This implies that people will be farsighted when planning if both costs and
benefits occur in the future. However, they will make shortsighted decisions if costs or benefits are
immediate (Camerer and Loewenstein 2004). Some of the manifestations of the timeinconsistent
preferencesareinabilitytoloseweight,stopsmoking,andsaveenoughforretirement(Wilkinson2007).
If individuals have timevarying discount rates, at somepoint in the future theirpreferences change.
Preferencesbetween
two
future
rewards
can
reverse
in
favour
of
amore
proximate
reward,
ifthe
time
tobothrewardsdiminishes.Anindividualmayprefer$110 in31daysover$100 in30days,butprefer
$100nowover$110tomorrow.(Fredericketal.2004).Thisisinconsistentwithexponentialdiscounting
used by neoclassical economics in expected utility models. If agents were to discount future utilities
exponentially,timepreferenceswouldnotreverse,becausethedelayof30daysissharedbetweenthe
two options. Timevarying discount rates could explain the tendency to procrastinate. When given a
choicebetweenperforming5hoursofanunpleasant task todayand5hoursofanunpleasanttask
tomorrow,mostpeoplechoosethesecondoptionanddelaythetask.Ontheotherhand,whengivena
choiceof5hoursofunpleasantworkinamonth,versus5hoursofunpleasantworkinamonthanda
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day, most people take the first option. However, ifan individualdecides todo thework inamonth,
whenthedaycomes,heorshewouldagainprefertodelayituntilthenextday(ODonoghueandRabin
2000).
Some individualsmaybeawareof theirtendency toprocrastinate,andmayvalue theopportunity to
make a commitment. The fact that people value commitment devices has been demonstrated
empirically. Ashraf et al. (2006) show that when given the choice of depositing money in a savings
account from which they can draw freely and a bank account that pays the same interest rate but
restricts when funds can be withdrawn, some individuals choose the latter option. Individuals who
chosecommitmentsavingaccountsincreasedsavingratesby82%.Traditionaleconomicsfindsithardto
explainwhysomepeoplewouldchoosean illiquidassetovera liquidasset,even iftheypaythesame
interestrate.
2.2. ProspectTheoryandImportanceofReferencePointsInstandardeconomictheory,an individualspreferencesamongdifferentcommoditybundlesdepend
onwealthandprices,butareindependentfromthecompositionoftheircurrentendowment(assets)or
theircurrentconsumption.Prospecttheory,developedbyKahnemannandTversky,statesthatwelfare
changesshouldbeevaluatedaccordingtocertainreferencepoints(KahnemannandTversky1979).The
followingaresomeofthemanifestationsoftheimportantreferencepointsforwelfareevaluation.
Lossaversion.Traditionaleconomicsassumes that individualsare riskaverseor riskneutralbutplace
thesame
value
on
losses
and
gains
of
equal
amount.
Kahnemann
and
Tversky
(1979)
argue
that
valuation of losses is the mirror image of valuation of gains and refer to this phenomenon as the
reflectioneffect.Decisionmakingwillexhibit the reflectioneffectwhenthe individual isriskaverse in
the face of potential gains, but riskseeking in the face of potential loss. It has been demonstrated
empiricallythat individualstendtovalue lossesmorethangains.This isfound incontingentvaluation
studies that show that willingness to accept (WTA) is typically higher than willingness to pay (WTP)
(ShogrenandTaylor2008).ShefrinandStatman(1985)demonstratedthatinvestorsholdontoolongto
thestocksthatlostvalue,butareeagertosellthestocksthatgainedinvalue,andarguethatthisisdue
toreluctancetosellataloss.Endowment
effect.
This
refers
to
the
extra
value
that
individuals
attach
to
goods
they
already
own
or
servicestheyalreadyreceive.Inessence,theendowmentpointisthereferencepoint,andagentshavea
kink in thevaluationaroundthispoint (Thaler1980).HeberleinandBishop(1986) foundthathunters
werewillingtopay$31foraparticularhuntingpermitbutwerenotwillingtoletgoofthesamepermit
forlessthan$143.
Statusquo bias. Individuals tend to stick to the default option chosen for them. For example, in
countrieswhereorgandonation isconductedunderpresumedconsent(i.e.consentbydefault,unless
explicitoppositionwasregisteredbydonor),participationratesare25%30%higherthan incountries
wheredonation isconductedunder informedconsent(i.e.noconsent ispresumedunless itwasmade
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explicit)(AbadieandGay2006).SamuelsonandZeckhauser(1988)showedthatwhennewhealthcare
optionswereoffered toHarvardUniversity faculty,new facultymembersweremore likely tochoose
them,butolderfacultymemberswereunlikelytomodifytheircurrentplans.
2.3. BoundedRationalityBoundedrationalityreferstothephenomenonthatagentsarerationalbuthavecognitiveconstraintsin
processing information(Simon1986).Thereforetheydeviatefromrationality incertaincircumstances.
Someofthemanifestationsofboundedrationalityarethe following: (1)choiceoverload,(2)heuristic
decisionmaking,and(3)failuretoassessstatisticalprobabilities.
Choiceoverload refers to the difficulty individuals have in making a choice when presented with too
manyoptions.
Studies
show
that
more
shoppers
make
apurchase
of
ajam
when
they
are
presented
with 6 choices than when they are presented with 24 choices (Iyngar and Lepper 2000). Traditional
economicsstruggles toexplainthis tendency,andassumesthatmorechoicesarealwayspreferred to
fewerchoices.
Heuristicsareshortcutstodecisionmaking,suchasviaaruleofthumb.Traditionaleconomicsassumes
that individualsuseconceptsofstatisticalsamplingandstatisticalrules(e.g.Bayesrule)forupdating
probabilitiesoffutureeventsinthefaceofnewevidence(CamererandLoewenstein2004).Experiments
demonstratethat individualsoftenmakechoices inawaythatdeparts from theBayesianassessment
thattheyaresupposedtomakeundertraditionaleconomics.Thisdeparturemaybesystematic(biased)
ratherthan
idiosyncratic.
Individuals
may
categorize
purchases
under
different
categories
and
have
different discount rates for these categories. For instance, higher oneoff expenditures may be
categorizedundera separatementalaccountandhavedifferentdiscount rates thanmultiple smaller
expenditures. Thaler (1999) showed thatan individuals willingness to spendearned income,windfall
income,orsavedincome isnotthesame,even ifmoneycanbeused interchangeably.Thiscontradicts
the assumption of traditional economics that money is fungible. Heath and Soll (1996) suggest thatmentalaccountingcanexplainwhyindividualsmakeapparentlysuboptimalconsumptionchoices.
There is some indication that consumers do not correctly process statistical information and
probabilities. They are swayed by vivid and salient information more than by simply convincing,
statistically
correct
information.
Research
shows
that
individuals
overstate
small
probabilities
of
catastrophiclossesorlargegains.JulienandSalanie(2000)findthatonhorseraces,thereisbiastowards
bettingonlongshots, implying thatgamblers like togamble,buttheyaredisproportionallyafraidof
small chances of losing when they bet on heavy favourites. Cook and Clotfelter (1993) find that
Lotteries are popular because players are more sensitive to largejackpots than to the probability of
winning.
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2.4. Pro-SocialBehaviourandFairnessNeoclassical
economics
assumes
that
an
agent
makes
choices
that
depend
only
on
his
or
her
own
monetarypayoffandconsumption(Pesendorfer2006).However, inexperimentalgamesandempirical
studies, it has been demonstrated that individuals seem to value fairness and often act prosocially.
Kahnemanetal.(1986)showthatconsumershavestrongfeelingsaboutthefairnessofafirmsshort
run price decisions, and suggest that this prevents firms from exploiting their full monopoly power.
Individualsoftenactprosocially,contribute tocharities,andengage inproenvironmentalbehaviour,
even if this imposescostsonthem.Behaviouraleconomicschallenges theview thateconomicagents
arepurelyselfish.
If individualsarenotasselfishastraditionaleconomicshasassumed,thisunselfishnesshas important
implications
for
understanding
the
private
provision
of
public
goods.
According
to
neoclassical
economics, individuals care only about their own consumption of public goods but do not directly
benefit from theirowncontribution,norare theydirectlyaffectedbyother peoplesconsumptionor
contribution(BernheimandRangel2007).Traditionaleconomicsclaimsthatpeoplewillhaveatendency
to free ride, and that public goods will be underprovided unless provisions are mandated through
taxation. Furthermore, only very wealthy are predicted to make voluntary contributions, and as
population increases contributions should converge to zero. These assumptions provide testable
hypotheses thatarecontradictedbyempiricalevidence (Andreoni2006;BernheimandRangel 2007).
Behavioural economics provides an alternative view to help explain why and when individuals make
privateprovisionofpublicgoods.
Two behavioural explanations relate to peoples attitudes towards providing for public goods. First,
individualsarenotpurelyselfish,butplacevalueonsocialgoods.Inessence,theyvaluenotonlytheir
ownconsumption,butalsotheconsumptionofothers(theyareotherregarding).Publicgoodsmaystill
beunderprovided,butthis isbecause individualsthink it isnotfairthattheybeartheburdenfortheir
provisionat the expenseofothers.Ostrom (1998) finds that inpublic goodsgames (i.e.experiments
where individuals are given the opportunity to contribute to the provision of a public good) most
individualsareconditionalcooperators theywillcontribute, iftheyare sure thatotherswilldothe
same.Second,individualscontributetothesocialgoodbecauseofthewarmgloweffect.Warmglow
effect refers to the idea that individualsmightparticipate inpublic goods (suchasa greenelectricity
program)because
it
makes
them
feel
good
(either
because
they
feel
better
about
themselves,
or
becausetheycareaboutwhatothersthinkofthem),butnotnecessarilybecausetheycareaboutthe
publicbenefitperse(Andreoni1990;BernheimandRangel2007).Inessence,besidesvaluingtheirown
consumptionofpublicgoods,individualsvaluehavingcontributedtopublicgoodprovision.
Themotivationsforprovidingforpublicgoodsarehardtotestempirically.Asaresult,warmglow is
often treated as a reduced form of deeper underlying processes (social norms, social signalling,
reciprocity, altruism, etc.). Disentangling these processes is challenging and their representation may
vary among different policies and contexts (Bernheim and Rangel 2007). Nevertheless, different
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underlyingmotivationsmayhavedifferentpolicyimplications.Ifanindividualwouldprovideforpublic
goodsonlywith theassurance thatothersdonot free ride (i.e.showingaconcern for fairness), then
increasedcontributionbyotherswill increasethe likelihoodofhisorhercontribution. If,ontheother
hand,anindividualcontributesasastatussymbol(e.g.becauseofadesireforawarmgloworprestige),
thenprovisionbyothersmaydecreasethelikelihoodofhisorhercontribution.Inthiscase,amonetary
incentiveforcontributingmaycrowdoutthealtruisticincentivetocontribute.
Researchers indeedfindthatmonetaryrewardssometimescrowdoutintrinsicmotivation,especiallyif
themonetaryrewardsaresmall.Forexample,whenasmallmonetarypaymentwasofferedforblood
donation,blooddonationsactuallydecreased (Titmuss1987[1971]). Itwasalso found thatvolunteers
performbetterwhentheyarenotcompensatedthanwhentheyreceivesmallmonetarycompensations
(GneezyandRustichini2000).These findingsarehardtoreconcilewithtraditionaleconomics,butcan
be
explained
by
behavioural
economics,
as
they
take
away
from
the
warm
glow
satisfaction
of
giving.
3. EnergyConsumption,Curtailment,andHabits
In this section we discuss topics that involve repetitive or continuous efforts to reduce energy
consumption or to change energyuse habits. The policy interventions discussed in this section focus
primarilyonpromotingenergycurtailmentinthehouseholdenergysector.Inaddition,wediscusshow
changingthetarifforbillingstructureaffectsenergyconsumptionpatterns.
3.1. RateStructure:Flatvs.DynamicTariffs
Themarginalcostofproducingelectricityvariesthroughtheday,andthewholesaleelectricityprice is
highduringthetimeofpeakelectricityusage.Traditionally,residentialelectricitycustomersfaced flat
electricity tariffs, and were insulated from fluctuating wholesale electricity prices through the day. If
electricitydemandbecomesflatter,utilitieswillsaveonenergycostsbyminimizingusageofpeaking
plants, which are usually less efficient and produce more carbon emissions. Further down the line,
havingasmootherdemandwillresult inreduced investmentsforbuildingpeakingplants.Costsavings
caneventuallyberecycledbacktotheconsumers.
Recently,policymakersandutilitieshavebeenlookingatthepotentialofintroducingtariffsthatvaryby
thetime
of
usage.
Some
possible
variable
tariffs
are
the
following:
(1)
time
of
use
tariffs
(TOU),
when
customers face different tariffs according to the time of day; (2) critical peak pricing (CPP), when
customers facehighertariffsduringcertaincriticalpeaktimesthroughtheyear;(3)peaktimerebate,
when customers pay flat electricity tariffs but receive rebates if the electricity usage is reduced
compared to a certain benchmark at critical times through the year; (4) realtime pricing, when
customerselectricitytariffsfluctuateinrealtimeaccordingtothewholesaleelectricityprices.
Timevarying tariffs requireadvanced (smart)meters thatcanmeasureconsumption inreal time.The
UnitedKingdom, Italy,andthestateofCalifornia intheUSAhave legislated largescaledeploymentof
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smartmeters,withotherjurisdictionsplanningtofollowtheirlead(FaruquiandSergici2009).Extensive
researchisunderwaybypolicymakers,utilities,andacademicstogaugethepotentialfordemandside
response(DSR)totimevaryingtariffs.ThevalueofDSRhingesonthepotentialofcustomerbehavioural
responseandisanareathatcandrawimportantinsightsfrombehaviouraleconomics.Belowaresome
of the concepts from behavioural economics that are relevant to the decision to implement variable
rates.
Endowmenteffect.Billpayerscurrentlyenjoythebenefitofbeinginsulatedfromvariableratesduring the day. Proper design and marketing of the dynamic tariffs will be critical for
overcoming consumers resistance to changing the costbenefit structure of the way they
consume electricity. Individuals are attached to their routines and daily habits and may be
inflexibletomodifythem,ordemandhighcompensationtodoso.
Statusquobias.Researchshows thatwhenpresentedwithautilitybillwithadefaultchoice,most consumers will not change it (Brennan 2006). Those who object to having the dynamic
tariffeitherasadefaultormandatoryoption,mentiondistributionalconsiderations.Theyargue
that most households will remain on the default plan even if it is not optimal for their
consumptionpatterns.Vulnerablehouseholds,suchastheelderlyanddisabled,willnotbeable
tovarytheirloadandwillbe losersunderthedynamictariffs, ifthatissetasadefault(Felder
2010).
Timevaryingdiscountrates. Introducingdynamictariffsraisesconcernsaboutshorttermcostversus
the
lag
in
long
term
gain
(Simhauser
and
Downer
2011).
Dynamic
pricing
will
result
in
a
rate shock, as bills of some consumers will skyrocket in the near term, before behavioural
adjustments,orbeforehouseholdsacquireenablingtechnologiesorreplaceoldapplianceswith
ones that better accommodate varying tariffs. Even if the long term costs of smart meter
infrastructure proves to be beneficial, the long term may be really long (Hanser 2010). Since
individualstendtohavehigherdiscountratesforthefuture,theymaynotthinkthatthecosts
areworththebenefits,especiallyifthesavingsareinitiallysmallornil.
Lossaversion.Ifindividualsvalue(negatively) lossesmorethantheyvaluegains,rate increasesduring peak periods may have tobe compensated with larger ratedecreases during offpeak
periods.
Concern for Fairness. Opponents of mandatory dynamic tariffs cite fairness considerationstowardsthevulnerable.Itisarguedthatvulnerablehouseholds(elderly,disabled,andpoor)will
notbeabletoshiftconsumptiontooffpeak,sincetheyhaveminimalelectricityconsumptionto
beginwithandareoftenhomebound.On theotherhand,proponents forthedynamic tariffs
statethatitisnotfairthatpeakyhouseholdsarebeingsubsidizedbylesspeakyhouseholds
throughflattariffs(Faruqui2010).
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Highelectricitybillsaresalientandraisevociferousopposition that results inamediaoutcry.Moving
customers en mass to dynamic prices may bring adverse consequences and may result in a strong
politicalbacklash.Alexander(2010)givesexamplesoflargescaleTOUtariffrolloutsintheUSAthatdid
notmeetexpectations:
Central Maine Power Company had implemented a mandatory TOU structure in the 1980s.However, in the1990s, theTOU rate structure was changed to reflecthigherpeakelectricity
costs,buttheincreasedbillscausedconsumeropposition,andTOUratesweremadevoluntary.
PugetSoundEnergyofWashington state implementedmandatoryTOUpricing for residentialcustomers in2001.However, theprogramactually resulted inhigherbillsunder thenewrate
structure.Theprogramwashaltedin2002.
Alexander(2010)suggeststhathavingapeaktimerebate(PTR)isamoreattractiveoptioncomparedto
mandatory CPP or TOU. A PTR scheme would leave the underlying rate structure unchanged, but
provide rebates or credit to those customers who reduce usage during critical peak hours. A rebate
option should be viewed as carrot only rather than stick only (Maine Public Utilities Commission
2007;Alexander2010).WithCPP,peakycustomerswillseetheirratesincreaseiftheydonotchange
behaviour.Ifconsumersfocusmoreonthedownsideriskofhigherbillsthantheupsidepotential,they
willdislikeCPP.MoreconsumerswouldchoosetotakeadvantageofPTRthanvolunteerforCPP.Letzler
(2007)arguesthatanincentivecompatiblerebateaddressestheheuristicsofconsumerdecisionmaking
betterthanCPP.
In2008,BaltimoreGas&Electric(BGE)conductedadynamicpricingpilotwhichshowedthatconsumers
respondedtoPTRaswellastoCPP.Asaresult,BGEabandonedCPPandconductedatrialofonlyPTRin
2009.FaruquiandSergici(2009)review15pilotexperimentswithdynamicpricingofelectricity.Across
therangeofexperimentsstudied,TOUrates inducedadrop inpeakdemandthatrangedbetween3%
and6%,andCPP inducedadrop inpeakdemandthatrangedbetween13%to20%.Whencombined,
thedropinpeakdemandwasinthe27%to44%range.
3.2. BillingandPaymentMethods
Howcustomers
pay
their
utility
bills
may
have
implications
for
how
they
consume
energy.
This
was
demonstratedbyastudyofconsumptionandmeter topupbehaviourof thehouseholds inNorthern
Irelandthatuseprepaymentmeters(Brutscher2011a,b).Brutscher(2011a)showsthatconsumerswith
prepayment meters tend to consume more electricity. Households tend to purchase relatively small
amountsoftopups,andadjusttoincreasesintariffsbyincreasingtheirnumberoftopups,ratherthan
by increasing the amount. However, exogenous increases in minimum topup amount result in
decreasedenergyuse.This suggeststhatconsumersperceivecostsdifferentlyaccordingtohow large
they are. They have different mental accounts for larger purchases, and are more aware of the
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consumptionaftertheyhavemadealargetopup.Increasingminimumtopupamountwouldtherefore
likelyresultindecreasedenergyconsumption.
Brutscher(2011b)findsthatlowincomehouseholdsuseelectricheatratherthanoilbecausetheyhave
liquidityconstraintsheatingoil requiresbulkpurchase,whereaselectricitymeterscanbeprepaid in
smallamounts.Asoilheating ismoreefficientandcheaper inthe longrun,thiscouldbeexplainedby
timevaryingdiscountrates,whichprevent individualsfromsavingforbulkheatingoilpurchase. Ifthe
bulkpurchasenecessary forheatingoil involvessavingmoney fora future largepurchase,themoney
being saved will be subject to temptation to make alternative purchases with more immediate
gratification.Ifindividualshavehigherdiscountratesforthefarfuturethanforthenearfuture,theywill
repeatedly succumb to temptation, even if they are aware that saving money will buy them a more
efficientsourceoffuelinthelongrun.Aheatstampprogram(whereconsumersbuynonfungiblecredits
towards
future
purchases
of
oil)
is
a
potential
solution
for
this
behavioural
failure.
Heat
stamp
programs,
currentlyoperatinginvariouscommunitiesinNorthernIreland,letsconsumersgraduallycollectstamps
thattheycanredeemforthebulkoilpurchase.
3.3. Non-pecuniaryIncentivestoConserveEnergyNonpecuniary interventionshavebeenattemptedtoelicitreductions inenergyconsumption,often in
combinationwithmonetary incentivesandinformationprovision.Whereinterventionswerecombined
withmonetaryincentives,consumptionfeedback,orenergysavinginformation,itishardtodisentangle
theeffectsoftheseinterventions.
Competitionhasbeeneffective in incentivizing individuals to reduceenergyconsumption.McClelland
andCook(1980)studiedtheeffectofcompetitionbetweenmastermeteredresidentialbuildingsatthe
University of Colorado, USA. The buildings, where occupants were not individually metered, were
competingonwhichbuildingwouldsavemoreelectricity.Contestantsreceived informationonhowto
saveelectricityand feedbackonsavingsof theirusage,aswellas theusageof theothergroups.The
winningbuilding receiveda rewardof$80.Thecontestgroupsused6.6% lesselectricity thancontrol
groups.However,thesavingsdecreasedwithtime,suggestingthattheeffectoftherewardwasshort
lived.Fourbuildingsand228familiesparticipatedinthestudy.
Pallakand
Cummings
(1976)
studied
whether
they
could
induce
reduction
in
energy
consumption
throughsolicitingpubliccommitment.ThestudywascarriedoutinIowaCity,USA.Peoplewhosigneda
publiccommitmentshowed lowerratesof increase ingasandelectricityusethanthosewhosigneda
privatecommitmentorthoseinthecontrolgroup.
Energy savings can also be motivated by assisting consumers with goal setting. Becker (1978) gave
households a relativelydifficult goal (20%) or a relativelyeasy goal (2%) to reduce electricity use. All
householdsreceived informationonwhichappliancesusedmoreelectricity,butonlysomehouseholds
receivedconsumptionfeedback.Onlythehouseholdsthathadthedifficultgoalandreceivedfeedback
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hadasignificantchange inelectricityconsumption(15%savings).Thisstudy involved100familiesthat
livedinidenticaltownhousesincentralNewJersey,USA.
Mostoftheresearchconductedonnonpecuniary incentiveshas involvedsmallsamples,and it isnot
clear if these interventions are scalable. Most of the studies do not monitor interventions for a
prolongedperiodoftime,anditisnotcertainifhabitswerechangedorbehaviourseventuallyreturned
to preintervention norms. Where followup studies were conducted, it was typically found that the
behaviouralchangeswerenotsustained. It isworthnotingthat intheFormerSovietUnioncountries,
wherepricesignalswere ideologically frownedupon,prizeswereusedextensivelytopromoteenergy
saving via goal setting, competition, and public appeals. However, anecdotal evidence suggests that
theseincentives,evenifinitiallyheeded,becameeventuallyineffectivewherepricesignalswereabsent.
3.4. InfluenceofSocialNormsonHouseholdEnergyConsumptionSocialnormsaffectindividualactionsthroughprovidingguidelinesastowhatisacceptableornormal
behaviour. Some behavioural interventions aim to influence consumer energy consumption through
increasing awareness of social norms. A number of studies have attempted to change energy
consumptionofhouseholdsthroughprovidingthemwiththeconsumptioninformationoftheirpeers,as
anindicatorofsocialnorms.
Nolan et al. (2008) left door hangers at 271 homes in San Marcos, California, USA, with different,
randomly assigned energy conservation messages. Door hangers that compared a given households
energydemand
to
that
of
their
neighbours
led
to
10%
more
energy
demand
reduction
than
door
hangersthatgaveonlyenergyconservationtips.Schultzetal.(2007)leftdoorhangersin286homesin
thesamecity.Residentswhohadlowerenergyconsumptionthanaverageincreasedconsumption(the
boomerangeffect).However,thiseffectwaseliminatedwhenasmileyfacewasdrawnnexttotheir
energyconsumption.Theauthorpostulatesthatthesmileyfacewas interpretedasanormativesignal
andresultedinbehaviouralchange.
While the above studies were based on small sample sizes, their findings were consistent with the
results of a program run by OPOWER, one of the largest randomized field experiments in history.
OPOWERmailedhomeenergyreportletterstocustomers,comparingtheirenergyusagetothatoftheir
neighbors.These
letters
also
gave
customers
energy
conservation
tips.
OPOWER
ran
aprogram
for
23
utilities,including6ofthelargest10utilitiesintheUSAand600,000households.Thestudyfoundthat
the interventionreducedaverageenergydemandby1.11%to2.78% fromthebaselineusage (Allcott
andMullainathan2010).
Itisnotclearifthebehaviouralchangesresultingfromtheseinterventionscanbesustainedinthelong
run, or if the novelty of the social comparison would eventually wear off. Costa and Kahn (2010)
analyzedtheOPOWERdataandfound,infact,thattheprogrameffectswereheterogeneous:whilethe
electricity conservation nudge of providing feedback to households on their own and peers home
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electricity usage works with political liberals, it backfires with political conservatives. The largescale
OPOWERexperimentgainedconsiderablemediapublicityandwashailedbyleadingpolicymakersasa
testament that behavioural economics should motivate viable policy alternatives. However,
Loewenstein and Ubel (2010) cautioned against being overly reliant on these types of interventions,
pointing out that the energy savings they generated were very small. They stated that traditional
mechanisms, such as a carbon tax would be far more effective even if politically more difficult to
implement,astheywouldincreasethepriceofcarboninlinetoitstruecost.
3.5. InfluenceofInformationProvisionProviding energysaving information and energyconsumption feedback is successful in eliciting
behavioural changes. The residential electricity market has traditionally suffered from asymmetric
information.Traditional
electricity
meters
provide
cumulative
consumption
information
and
individuals
donotalwaysknowwhichappliancesconsumemostelectricityandwhen.Newtechnologies,suchas
smartappliancesandsmartmetersprovideinnovativewaystoaccessconsumptioninformation.Having
accesstodisaggregatedconsumption informationthroughavarietyofmedia (i.e.the Internet)makes
electricity consumption more tractable and easier to manage. Information asymmetry is typically
assumedtobeamarketfailure,and isstudiedundertheparadigmoftraditionaleconomics.However,
behaviouraleconomicsfindsthatnotonlyistheinformationimportant,butalsothewayitispresented
orframed.
Ifthecommunicationof informationtakes intoaccountthebehavioural failuresandheuristicdecision
making
of
consumers,
messages
can
be
crafted
to
solicit
a
sharper
behavioural
response.
Since
individualsareaffectedmorebysalientinformationratherthansimplyaccurateinformation,thenvisual
cuesandvividdescriptionsareimportant.Forexample,ThalerandSunstein(2008)foundthatwhenthe
energycompany inSouthernCaliforniagave itscustomersanAmbientOrbthatglowed inredwhen
energy consumption was high (salient signal), orb users reduced peak energy demand by 40%. With
largescale deployment of new technologies that provide innovative ways of communicating
information, providing appropriate vivid cues will become increasingly important. If consumers are
affectedby lossesmorethangains,theeffectivemessageshouldstressmoneywastedbymissingthe
opportunity to save energy rather than emphasizing energysaving behavioural change. The former
formulationprovidesthesameinformationbutismoreeffective,althoughlesswelcomed,especiallyby
elderlyand
vulnerable
customers.
Thecredibilityandtrustworthinessofinformationsourcesmakesadifference.CraigandMcCann(1978)
showed that when consumers received identical letters giving energy conservation advice but on
different letterheads, the letter from the local energy commission had higher impact than the letter
from the local utility. In communication, simple, salient, and personally relevant information is more
effectivethandetailed,technical,andfactualinformation(WilsonandDowlatabadi2007).
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3.6. ChoiceofElectricitySuppliersorTariffsThe
unregulated
monopolist
does
not
have
the
incentive
to
keep
prices
down.
Competition
between
suppliersresults in lowerprices if thebuyersareabletoshop forthebestdealandchangesuppliers.
However,thereare indicationsthatwhenpresentedwithmanysuppliers,consumersdonotswitch. If
consumersdonotshoparoundforthebestsuppliers,openingmarketsthatwereformerlyregulatedcan
reduce welfare, if the incumbent supplier increases prices above those that were set by regulators
(Brennan 2006). Behavioural economics explains this phenomenon by status quo bias, and/or
informationoverload.
Traditionaleconomicsoftenassumesthatinformationiscostlessandfreelyavailable.Butwhenallowing
for cost of searching and obtaining information, traditional economics would explain consumers
unwillingnessto
choose
suppliers
by
the
fact
that
search
is
costly
(electricity
bills
are
notoriously
hard
to
read)andthattheproduct(electricity) ishomogenous.WilsonandWaddamsPrice(2005)providethe
behaviouralexplanation thatconsumersare irrationaland fail to switch.Thishas implications for the
offeringofmorechoicestoenergyconsumers,whichmightbefacilitatedbythedeploymentofsmart
meters. Having more choices implies more opportunities for mistakes to be made by customers by
selecting inappropriatesuppliersfortheirneeds.Itmayalsoreduceswitchingfrom incumbentsdueto
informationoverload.
4. Energy-EfficientInvestmentsandPurchasesIncreasing
energy
efficiency
can
play
asignificant
role
in
reducing
overall
energy
consumption
and
associatedemissions.Efficiency investments involveonetime, large monetarycostsbut result incost
savings over the long run through lower energy consumption. It has been shown that efficiency
improvements could result in substantial longrun cost savings. However the energy efficiency gap
puzzle remains. The gap normally refers to the difference between the observed level of energy
efficiencyandwhatisconsideredoptimalenergyuse(Jaffeetal.2004).Sometimestheenergyefficiency
gapis illustratedbycomparingthemarketdiscountrateandtheimplicitdiscountrateimputedfrom
appliance purchase decisions, taking into account cost of appliances and their energy efficiency
(Hausman 1979). Studies have shown that the implicit discount rate is between 25 and 100 percent
(Sanstadetal.2006;Train 1985).Belowwediscussbehaviouralexplanationsof theenergyefficiency
gapand
effectiveness
of
policy
interventions
that
aim
to
tackle
it.
4.1. BehaviouralExplanationsfortheEnergyEfficiencyGapItisnotcostlesstoassesshowanewtechnologyfitsintooneshome,ortofindareliablesupplierand
installer.Furthermore, futureenergypricesand futuresavingsareuncertain.The transactioncostsof
newtechnologyadoptioncanstillbesignificant,sothatthepurchasepriceisonlythelowerboundof
adoptioncost (JaffeandStavins1994).Belowwediscusssomeofthebehaviouralexplanationsofthe
efficiencypuzzle.
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Time inconsistency. Individuals have a high discount rate for future cost savings, but a smalldiscountrateforlargeinitialinvestmentoutlay.Alternatively,individualsmaywanttoinvestin
energyefficiencybutareprocrastinating,ordonothavethedisciplinetosavemoneytopayfor
theinitialinvestment.
Endowmenteffect.Householdsareattachedtotheappliancestheycurrentlyown,andarenotwilling to replace them, even if it is efficient to do so. This can partly be rationalized by the
certainty that the new equipment works, against the risk of problems in installation or
operation.
Salience. Yates and Aronson (1983) suggest that individuals place disproportional weight onvivid
and
observable
factors.
This
tendency
may
result
in
placing
too
much
emphasis
on
initial
investment costs, and underinvestment in energy efficiency. They recommend giving salient
examples of energy savings and state that energysaving advice should demonstrate the
experienceofahighlyefficienthouseholdforthemessagetobebetterretained.
Heuristics.KemptonandMontgomery(1982)useasurveyandfindthatconsumersusesimpleheuristics to assess their energy consumption, which leads to systematic underinvestment in
energyefficiency.Theyconcludethatthis istheexampleofboundedrationality,whenpeople
adaptknownmethodstosolvingnewproblems,eveniftheknownmethodsarenotoptimalfor
thenewsituation.Thismaybetheoptimalstrategy,asitavoidstheeffortofanalyzingthenew
situation(Simon
1955).
For
example,
families
used
current
energy
prices
to
calculate
expected
savings fromefficiency investment, thusnot taking intoaccount futureprice increases.When
comparing consumption over the years, households compared their highest utility bills to
estimatetheirconsumptiontotals.Kemptonetal.(1992)showsthatconsumerssystematically
miscalculatepaybackperiodsforairconditioners,andthisleadstooverconsumptionofenergy.
4.2. IncentivesforEnergy-EfficientInvestmentsSinceenergyefficiency investmentsaresubject tomarketandbehavioural failures,policymakersand
utilities have devised various incentives to overcome them. Behavioural economics can shed light on
whichefficiency
promoting
incentives
are
more
effective.
Since
high
upfront
costs
appear
to
discourage
efficiencyinvestments,policymakersoftenattempttoincentivizetheseinvestmentsthroughtaxcredits
orefficiencyprogramsadministeredbyutilities.
Income tax credits or deductions have been used in the USA as an instrument to encourage energy
efficientinvestments.Howeverevidenceoftheireffectivenessismixed.TheU.S.EnergyTaxActof1978
(ETA78) provided a federal tax credit for residential energyefficiency investments and encouraged
investment in solar, wind, and geothermal energy technologies. Carpenter and Chester (1988)conductedasurveywithover5,000respondents fromtheUSA.Around89%oftherespondentswere
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awareofETA78sfederaltaxcredit,butonlyaroundonethirdofthemfiledthisclaim.Outofthosewho
did file the claim, 94% were going to make the investment even without tax incentives (free riding).
However, Hassett and Metcalf (1995) found that tax credits do encourage efficiency investmentsa
changeof10percentagepointsinthetaxpriceoftheinvestmentincreasesprobabilityofinvestmentby
24%. Williams and Poyer (1996) found that tax credits have a significant effect in improving energy
conservation,evenwithfreeriders.Theysuggestthatthismaybeduetospillovers,assomehouseholds
maketheinvestmentbecauseofthetaxcredit,butthenfailtofileforthecreditwhenitcomestimeto
file their taxes. This explanation is consistent with timevarying discount rates and tendency to
procrastinate.
In summer 2011, the UK government ran a pilot trial of the Green Deala scheme to encourage
homeowners to upgrade their buildings by installing energysaving improvements at no upfront cost.
Repayments
for
these
investments
would
be
made
via
a
charge
paid
from
savings
made
on
a
customers
energybills.The trial tookplace in theLondonboroughofSutton,and involved400households that
respondedtotheadvertisement.Ofthe126householdsthateventuallyreceivedhomeenergyaudits,
only60signedupforthescheme,evenifthesubsidyrepresented40%.Thehouseholdsthatdidsignup
fortheschemeindicatedthatfinancialincentiveswerenottheprimarymotivation(BioRegional2011).
Studiesshowthatevenwhenautilityofferedtosubsidize93%ofthecostofhomeinsulation,consumer
takeupvariedfrom1%to20%,dependinghowthesubsidywascommunicatedtotheconsumer(Stern
et al. 1985). Stern (2000) suggests that incentives and interventions interact, and thejoint effect of
combiningthemisoftenbiggerthanthesumofeachinterventiononitsown.
4.3. AppliancestandardsandbuildingcodesIf consumers indeed make biased decisions in their efficiency investment, and they do not take
operating cost into consideration, then appliance standards may be welfare enhancing. Mandatory
appliancestandardscandefinetheminimumenergyefficiencystandardthatwillberequiredbylawfor
agivenappliance.Buildingcodeswoulddefinecertainminimumefficiencycharacteristicsthatbuildings
shouldhave.Inessence,consumerswillnotbeabletochoose inefficientappliancesorhomes,asthey
will not be on the market. Mandatory standards and codes will encourage manufacturers to provide
better
energy
efficiency
in
the
context
where
it
is
not
the
most
salient
feature
for
consumers
(DEFRA
2010).
Koomeyetal.(1999)foundthateachdollarofU.S.federalexpenditureonimplementingtheappliance
energyefficiencystandardscontributed$165ofnetpresentvaluedsavings to theU.S.economyover
the1990to2010period.Theyestimatedtheaveragebenefit/costratiosfortheseefficiencystandards
tobeabout3.5 fortheUSAasawhole.Howeverhouseholdsthatare lowapplianceusersmayprefer
lessefficientappliances,andsufferwelfarelosseswhenstandardsareimposed(Morss1989).
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5. PublicGoodsandPro-EnvironmentalBehaviourSupporting
green
energy
and
combating
global
warming
is
apublic
good.
Behavioural
economics
can
helpunderstandwhyandunderwhichcircumstancesindividualsarewillingtocontributetothesepublic
goodsvoluntarily.Thesecontributionsmaybemonetary(i.e.whenindividualspayapremiumforgreen
energy)ornonmonetary(i.e.whenindividualsactproenvironmentallybutsacrificetheircomfort).
5.1. ProvisionPointMechanismsandGreenEnergyBehaviouraleconomicsclaimsthatmany individualsareconditionalcooperatorsandvalue fairness.
Individualswouldbewillingtocontributetopublicgoodsiftheyknowthatothersdonotfreerideand
also
contribute
(this
is
what
a
tax
system
can
achieve
formally).
In
essence,
the
difference
between
a
behaviouralexplanationandatraditionalexplanation is thatunder the former, individualsdonot
wanttofreeride,theyarejustconcernedthatothersdoandthinkthatthisisnotfair;underthelatter,
individualshaveaninnatetendencytofreeride,andthatwillbethecaseevenifotherscontribute.
Moskovitz (1992, 1993a, 1993b) argued that customers would voluntarily sign up and pay higher
electricityratesiftheadditionalmoneycollectedwereearmarkedtosupportrenewableenergyprojects
andenvironmentalactivities.Sincethen,utilitiesinmanyjurisdictionshaveofferedgreenenergytariffs.
These green tariffs represent a contribution to public good. If individuals are indeed willing to make
voluntary contributions, public policy may harness this tendency through devising mechanisms that
makethese
contributions
more
likely.
Public economics has dealt with the problem of underprovision of public goods through such
mechanismsastaxes,andprovisionpointmechanisms(PPMs).UnderPPMs,individualsmakevoluntary
contributionstoaproject,withdisclaimerthatifthenecessarybenchmarkamountisnotcollected,the
contributionswillberefunded.Rondeauetal.(2005)comparedthevoluntarycontributionmechanism
(VCM)withthePPMinthelaboratoryandinasmallfieldexperiment,andfoundthatthePPMwasable
to achieve higher contributions. Traverse City Light and Power in Michigan, USA, successfully built a
windmillusingthismechanism(Holt1996a);thecityofFortCollins inColoradoraisedmoneyforthree
separatewindturbinesusingit(Holt1996b).
Roseetal.(2002)usedlaboratoryandfieldexperimentstotesttheuseofaPPMtofinancearenewable
energyprogramrunbyNiagaraMohawkPowerCorporation intheUSA.Inthe laboratoryexperiment,
the PPM increased the rate of participation in a green energy program substantially above that of a
treatmentgroup.WhenthePPMwastestedinthefield,signupratesobservedweremuchhigherthan
thosefromothergreenpricingprogramsthatsolicitvoluntarycontributions.
Oneoftheproblemswithsellinggreenenergy insomejurisdictions(suchastheUK) isthatofproving
additionality.Fixedtargetsforgivenquantitiesofrenewablessetbythegovernmentmeanthatbuying
greenelectricitysimplyassignsrenewableoutputthatwouldhavebeenforthcominganywaytoagiven
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groupofcustomers.Thisisbecauseallcustomerswillbemadetopayfortherenewableenergyanyway,
regardlessofwhetheranymakevoluntaryorconditionalcontributions.
5.2. CrowdingOutIntrinsicMotivationBehaviouraleconomicssuggeststhatifindividualsaremotivatedbythewarmgloweffect,thengiving
monetary incentives would decrease their motivation for contributing to public goods. On the other
hand, if individualspayafineforbehaviourthatdiminishespublicgoods,their intrinsicmotivationfor
avoidingthisbehaviourmaybereduced.Thiscrowdingouthypothesisisintellectuallyappealing,but
sofarfewstudieshavedemonstratedthiseffectempiricallyinthecontextofenergy.
Jacobsenetal.(2010)usebillingdataofparticipantsandnonparticipantsinagreenelectricityprogram
in Memphis, Tennessee. They find that households participating at the minimum threshold level
increaseelectricityconsumptionby2.5%afterenrolling intheplan.Theyexplainthiswiththebuyin
mentalityofthesehouseholds.Householdsguiltofgeneratinghighemissionsisreducedbybuyinginto
green electricity at the minimum threshold, and payment for green electricity crowds out their
motivation to reduce energy consumption. However, the effect was not large enough to offset the
environmental benefit of paying for green electricity. Therefore the net effect was a reduction in
emissions.
5.3. VoluntaryContributionsandPublicImageIndividuals
may
be
more
likely
to
provide
public
goods
if
their
contributions
are
publicly
acknowledged.Thustokengifts(i.e.pins,mugs,andstickers)giveninexchangeforthecontributionare
onewaytoencourageprovisions.
Yoeli(2010)conductedalargescaleexperimentincollaborationwithPG&E,aregulatedinvestorowned
utilityinNorthernCalifornia.Consumersweresent lettersinvitingthemtovolunteertoinstalladevice
intheirhomesthatwouldallowtheutilitytocontroltheirairconditionerswhenelectricitysupplywas
tight.Volunteershadtosignupfortheprogramonasheetthatwasdisplayedpubliclynearmailboxes.
Thetreatmentgroupofhouseholdswasrequestedtowritetheirnamesonthesignupsheet,whilethe
controlgroupofhouseholdsprovidedaunique,anonymousnumerical identifier.Householdsthathad
to
provide
full
identity
information
had
a
higher
signup
rate
(however,
the
difference
was
not
statisticallysignificant).
5.4. PublicAppealstoConserveEnergyWhenincreasingpricesisconsideredsociallyorpoliticallyunacceptable,governmentshaveoccasionally
resorted topublic appeals through themassmedia to induceenergyconservation. In theabsence of
price signals, traditional economics would not expect public appeals to change behaviour, because
individualswouldhavealreadyoptimizedtheirconsumptionchoicesforthegivenprice(andwouldfree
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rideonotherscontributionstothepublicgoodofavoidingblackouts).However,behaviouraleconomics
suggeststhatpublicappealsmayresultinincreasedawareness,andmayinducealtruisticallymotivated
individuals to conserve more energy. In addition, some behavioural economists postulate that public
appealsaffectsocialnorms.
Reiss and White (2008) used householdlevel data on energy conservation in California during theenergycrisisof20002001.Dataconsistedofa fiveyearpanelofSan Diego Gas & ElectricCompany
households utility bills. The sample consisted of 70,000 accounts. The prices increased sharply as a
responsetothecrisiselectricitypricesmorethandoubled inaspanofthreemonths.Asaresult,the
averagehouseholdelectricityuse fellmore than13% in60days.Following the initialprice increases,
prices were rolled back and capped, and consumption rebounded to former levels. Subsequently, to
avoid blackouts, the government used televised public appeals to urge households to reduce energy
consumption.
Public
appeals
were
accompanied
by
energy
saving
advice.
Public
appeals
resulted
in
a
7%
decline in energy use over six months. It should be noted that the households in California had
heightenedawarenessoftheconsequencesofenergyshortages.Electricitypriceshaddoubled intheir
recent memory. Therefore increasing prices was a credible threat for the consumers, and may have
madethemmorereceptivetosocialappeals.
IEA (2005)providessome internationalcasestudieswherepublicappealsweresuccessful in reducing
energyconsumptionquickly.Someofthesuccessfulsolicitationstoreduceenergyoccurred in2001 in
NewZealand,Australia,andBrazil,asaresultofshortfallscausedbydrought.AtthebeginningofNew
Zealands 2001 shortfall, the government calculated that blackouts could be avoided if everybody
reducedtheir
consumption
10%
for
10
weeks.
Thus
10
for
10
became
the
goal.
The
government
distributed advice on how to obtain those savings but gave no incentives towards more efficient
equipment or reduced bills. New Zealand employed public appeals through many extremely short
remindersontelevision.Theconservationgoalwasreachedwithin6weeks.
IEA(2005)statesthatwhileapriceincreaseisthefirstbestscenariotodealwithshortfalls,itmaynotbe
politicallyfeasibleintheshortrun.Indesigningsuccessfulpublicappealstoreduceelectricityquickly,it
is importanttoeducateconsumers,raisingtheirawareness,andmakingconservationamatterofcivil
duty or prestige. This is particularly important inelectricity markets where richer, less pricesensitive
consumers, by not reducing their consumption in a time of crisis, impose a negative consumption
externalityon
the
poor.
This
is
in
contrast
to
most
markets
where
consumption
of
the
rich
creates
a
positive consumption externality for the poor by allowing economies of scale to be exploited in
productionandfacilitatingincreasedcompetition.
5.5. PublicPolicyInstrumentsandEnvironmentalMoralsWhen economic activity has a negative externality, traditional economics suggests that following
instrumentscanbeusedtocurbtheextentofharmfulbehaviour:taxes,restrictions(i.e.quotasorbans)
and tradable permits. Taxes will discourage the harmful behavior through increasing its price, while
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quotasdiscouragethebehaviorthroughrestrictingthequantityofthebadallowedoravailable.Taxes
levied on the activity that generates negative externalities are called Pigovian taxes, and have
traditionallybeenappliedtogoodssuchascigarettesandalcohol,ortoactivitiessuchaspollution.With
tradablepermits, theoverallallowable levelofactivity isestablished,andthepermits forthisactivity
areallocated toentities (usually firms).Theseallowancescanbe traded, sothat theentitieswith the
lowestmarginalcostsofreducingtheactivitytowardstheallowable levelwillbetheonesthatdoso.
Tradable allowances have been used to regulate fisheries and air pollution (Frey 2005; Tietenberg,
2003). Traditional economics assumes that the difference among these three policy instruments is
purelyintermsofeconomicandadministrativeefficiency.
Psychologistsarguethatanother importantdistinctionbetweenthese instruments isthattheyvaryto
the extent that they send the signals that crowd out intrinsic motivation. Frey (1999) calls intrinsic
motivation forproenvironmentalactivityenvironmentalmoral.Heargues thatboth tradablepermits
andtaxes
will
have
two
opposing
effects
on
consumers
an
increase
in
price
of
activity
will
discourage
behavior,butintrinsicenvironmentalmoralwillalsogodownasaresult(crowdingout).Hearguesthat
environmentalmoralwillbereducedbytradablepermitsmorethanbytaxes:tradablepermitsmaybe
viewedasbeingsimilarto indulgencessold forsins intheMiddleAges (Goodin,1994).Thesepermits
mayconveyimpressionthatitisacceptabletosinaslongasonepaysthepriceforit.Freyalsoproposes
thatbothlowandhighenvironmentaltaxesaremoreeffectivethanmediumleveltaxes.Hearguesthat
withlowtaxes,consumersmayfeelthatprotectingenvironmentissomethingthathastobedonefrom
moral obligation. On the other hand, high environmental taxes make harmful behavior prohibitively
costly and dominate the crowdingout effect. Meanwhile medium environmental taxes result in
crowdingout intrinsic motivation,butare insufficient to cause reduction inbehavior due toextrinsic
motivation.
Withtheclimatepolicythenegativeactivitytobecurtailediscarbonemissions.Taxes,restrictionsand
tradablepermitsareusedasclimatepolicyinstruments,oftensimultaneously.EuropeanUnionhasthe
largesttradableemissionsschemeintheworld(EUETS).Sofar,tradablepermitshavebeenassignedto
the businesses, but not to final consumers. On the other hand, consumers in manyjurisdictions are
subjecttocarbonpricesdirectly(effectivelyataxonemissions)andquotasindirectly(throughemissions
standards).Unfortunately,theevidenceofcrowdingoutenvironmentalmoralduetothesignalingeffect
of taxes and tradable permits has not been evaluated empirically, but studies have established the
existenceofthephenomenoninthelaboratoryandfieldexperiments(FreyandJegen2001;Decietal.
1999).However,
its
relevance
to
the
actual
behavior
of
consumers,
as
well
as
the
magnitude
of
the
effectremainsyettobedetermined.Meanwhile,publicperceptionoftheeffectoftheseinstrumentsis
relevant for the political economy of public policy. To the extent that the public (particularly pro
environmental activists) perceive that taxes and tradable permits are morally inferior because they
seemtosanctionpollutionandemissions,governmentmay findpoliticallyharderto implement these
mechanisms.
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6. ConcludingRemarksEconomics
studies
how
agents
interact
and
allocate
limited
resources.
In
essence,
economics
is
about
behaviourbydefinition.Thetraditionaleconomicsdiscipline isbasedonbehaviouralassumptionsand
axiomswhichallowmodelstoexplainthekeyphenomenaofinterestparsimoniouslybutwithsufficient
clarity and accuracy. What is referred to as behavioural economics is the modification of traditional
assumptions by drawing insights from psychology. Normally, behavioural economists start from
observationsofhow individualsactuallybehaveandthenshowhowthisbehaviourviolatestraditional
assumptions.Researchers thenproceedtooffermodelsbasedonalternativeassumptions thatbetter
match theobservedphenomena.Behaviouraleconomics isagrowingand thriving field,butthereare
sometheoreticalandempiricalgaps,manyofwhichwerementioned inthissurvey.Belowwediscuss
someofthefuturedirectionsforbehaviouraleconomicsingeneral,anditsapplicationtoenergypolicy
inparticular.
Technological
innovations,
such
as
smart
meters
and
smart
appliances
(and,
in
the
future,
widespreaduseofelectricvehicles)providenewways tostudyhowconsumerbehaviour responds to
monetaryandnonmonetaryinterventions.
Theoreticalandempiricalworkaimedatsortingouttheinteractionsofvariousbehaviouralphenomena.
Behaviouralstudiesuncoveranomalies inbehaviourthatare inconsistentwithneoclassicaleconomics.
However,theseanomaliesareoftenstudiedonanadhoc,casebycasebasis.Synthesizingbehavioural
anomalieswithinaconsistent frameworkwouldbewelcome.Someof thequestions thatneed tobe
addressed are the following: How do we disentangle behavioural explanations from conventional
information effects? What are the interactions between the alternative behavioural insights and
betweenbehavioural
failures
and
market
failures?
For
example,
how
do
loss
aversion
and
hyperbolic
discount rates interact? Sorting out these interactions will be important in designing the optimal
packageofbehaviourchangeinducingmeasurestoreduceorshiftenergyconsumption.
Increased reliance on empirical research and impact evaluation. A lot of behavioural work has been
basedonexperimentalstudies.However,ultimatelyeconomics isconcernedaboutactualbehaviourin
markets, and some of the behavioural failures may no longer hold in a real market setting where
behaviouralanomaliescancelout.Itis importanttoconductempiricalstudiesinordertouncoverhow
relevantbehaviouralanomaliesaretothewaythemarketsworkinnonidealconditions.Thereseemsto
be good scope for linking experimental work with empirical trials to see the extent to which strong
experimentalresults
can
be
reproduced
in
fieldwork.
Studyoflargescaleinterventions.Alotofbehaviouralresearch,bothinexperimentalandfieldsettings,
hasbeencarriedoutonsmallsamplesizes.Thisraisestwoconcerns:Howscalablearetheinterventions,
and even if behavioural anomalies do exist, do they represent fundamental departure from the way
individualsmakechoices,orisitonlyaboutthetailsofthebehaviouraldistribution?Iftheobservation
is only regarding the tails of the distribution, how thick are the tails (Shogren et. al. 2008)? What is
needed is much more attention to whole population interventions (i.e. the general rollout of smart
meters)ornaturalexperiments(suchastheNewZealandscampaignforelectricitydemandreductionin
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2001). Conducting randomized, controlled experiments involving largescale interventions would help
provide answers to these questions. Widespread useof smart meters will make this sort of research
mucheasiertoimplementinthefuture.
Increasedstudyof the relationshipbetweenshortrunand longrunbehaviouralchanges.Whileshort
runbehaviouralchangesmaybeextremelyusefuland important inenergy,thereare important issues
todowithwhethercertainbehaviouralchangescanbesustainedoveraprolongedperiod.Withenergy
consumption this may be important in designing the school curriculum with a view to increasing
awarenessofenergyconservation,orinkeepingeffectiverepeatedinterventionsaimedatdealingwith
successiveshortrunenergyshortages.Moststudiesofenergyconsumptionbehaviourdonotresample
behaviouroveraprolongedperiod,butclearlytheremaybeopportunitiestodesignstudiestomonitor
theeffectsoflongterminterventionsinthefuture.
Integratingbehavioural economicswithin theframework of traditional economics. While behavioural
economics provides insights about the way decisions are made, some of the departures from
neoclassicaleconomicsarehardtoreconcilewithinthetraditionalframework.Forinstance,howdowe
evaluate the impacts of policy if we cant make neoclassical assumptions about discounting? If
individualsarereallyselfconflictedintheirevaluationofcostsandbenefitsovertimethenwhat isthe
rationaleforthepolicymakerstocatertotheirfarsightedselvesratherthantheirnearsightedselves?
Whilehyperbolicdiscountingisintellectuallyappealing,itmakesequilibriummodelsintractable.Further
theoreticalworktoreconcilethesedifferencesisneeded.Institutionaleconomics(followingNorth1990)
includesthestudyofthe impactoflongrunbehaviouraldifferencesbetweeneconomicagents.Itmay
bethat
behavioural
economics
is
away
of
understanding
how
short
run
behaviour
can
be
changed,
whileinstitutionaleconomicsstudieshowlongbehaviouraldifferencescanbesustainedviathecreation
ofappropriateinstitutions.Thusunderstandingtheprocessofinstitutionalizingbehaviouralchangemay
allowareconciliationofmoretraditionaleconomicswithbehaviouraleconomics.Thismaybeimportant
insuggestingwaysinwhichdifferencesinenergyconsumptionpercapitacurrentlyattributedtovaguely
definedinstitutionaldifferences(suchasbetweentheUKandDenmark)canbenarrowed.
Behavioural economics can provide valuable insights on how individuals make their decisions. These
insightscanbeusedtoincreaseeffectivenessoftraditionalinterventionsinenergypolicy.However,itis
important that behavioural interventions do not crowd out more effective traditional interventions
(Loewensteinand
Ubel
2010).
Behavioural
economics
should
complement,
not
substitute
for,
more
substantiveeconomicinterventions,suchasthosebasedoninfluencingenergypricing(e.g.viataxation)
orenergyinvestment(e.g.viasubsidyschemes).
Tocomebacktowherewebegan,behaviouraleconomicsseemsunlikelytoprovidethemagicbulletto
reduceenergyconsumptionby the magnitude requiredby the IEA (2010) recommended450 climate
policy scenario. However it does offer exciting new suggestions as to where to start looking for
potentiallysustainablechanges inenergyconsumption. Italsomaybethat itsmostusefulrolewithin
climatepolicy is inaddressing issuesofpublicperceptionof theaffordabilityofclimatepolicyand in
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facilitatingthecreationofamoreresponsiveenergydemand,bettercapableofrespondingtoweather
inducedchangesinrenewableelectricitysupply.
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