BEHAVIORAL ECONOMICS AND ENERGY POLICY

							BEHAVIORAL ECONOMICS
AND ENERGY POLICY
BEHAVIOR, ENERGY, AND CLIMATE
CHANGE CONFERENCE

NOVEMBER 18TH, 2009
Hunt Allcott
MIT Department of Economics and ideas42
Behavioral Economics and Energy
Policy
      Agenda:
 1.        Putting the “economics” in behavioral economics
 2.        Gasoline Prices, Fuel Economy, and the Energy
           Paradox
      1.     Joint with Nathan Wozny (Princeton)
 3.        Aside: Upcoming experimental work
      1.     Joint with the ideas42 Energy and Environment Group:
             Sendhil Mullainathan (Harvard), Todd Rogers (Analyst
             Institute), Eldar Shafir (Princeton)
Putting the Economics in Behavioral
Economics
  Behavioral economics is about formalizing and
  demonstrating consistent deviations from the rational
  economic model.
  Understanding behavior is useful for many reasons:
    Marketing (to exploit behaviors)
    Properly modeling policy effects
      Rebound effect (rational “intensive margin elasticity”)
      (In)attention to energy prices
    Structuring regulations (e.g. choice architecture)
      MPG ratings vs. GPM (“MPG illusion”)
Using Behavioral Economics for
Policy
  Marketing has received substantial attention here:
    Use social comparisons to induce conservation?
    Default people into the green electricity supplier?
    How to induce pro-social (pro-environmental)
    behaviors?
  What are we maximizing?
    Yes, energy efficiency programs should maximize
    conservation
    But policymakers maximize welfare
The Economic Approach to
Behavioral Economics
1.   Identify a market failure (behavioral misoptimization)
2.   Provide empirical evidence
3.   Design policies to improve welfare

     Example: Organ donation/401k default options
       Identify a consistent misoptimization
       Make the default what the individual (or society) would
       have wanted
         Different than maximizing amount saved or organs donated!
Gasoline Prices, Fuel Economy, and
the Energy Paradox
  Provide an example of a policy-oriented
  behavioral economics research project related to
  energy consumption.
  Identify what may be a “behavioral failure”
    Failure of the individual consumer to maximize his own
    private utility
    Generates an “internality” which adds to the
    “externalities” from carbon dioxide emissions
  Analyze potential policies
Relative Vehicle Prices Change as
Gas Prices Change
New Vehicle Sales Change as Gas
Prices Change
What the Rational Model Predicts
  Higher gas prices reduce demand for low-MPG vehicles:
    Empirical evidence from used car prices and new car sales
  We can take this one step further: theory predicts how
  much demand should be affected!
  Our Hypotheses:
    H₀: Vehicle prices and quantities move as if consumers are
    indifferent between $1 in purchase price and $1 in PDV of
    gasoline costs.
    HA: The market undervalues (or overvalues?) gasoline costs
  {Inattention, myopia} is one leading interpretation of HA.
    Could help explain the “Energy Efficiency Gap”
    Economic justification for fuel economy standards
How to Think about the Problem
  What should happen when gas prices increases and
  demand for high fuel economy vehicles decreases?
    Vehicle prices change
    Quantities change: fewer new gas guzzlers sold, more
    scrapped
    The prices of substitute vehicles will change
  Fundamental intuition: If vehicle markets (i.e. market prices
  and sales) don’t respond very much to changes in gasoline
  price expectations, it suggests that consumers are
  inattentive to gasoline prices
  Our analytical approach: A discrete choice model
    . . . {skipping 20 slides of math}
      Nested logit taste specification
      Instrumental variables and fixed effects
Data
 New vehicle prices
   Power Information Network (JD Power)
       25 million transactions at 6,000 dealerships
 Used vehicle prices
   Used vehicle auctions (Manheim)
       50 million transactions; ½ of US auction market
 Vehicle market shares
   National Vehicle Population Profile (RL Polk)
 Microdata on vehicle usage
   2001 National Household Travel Survey (US DOE)
       25 thousand households, nationally representative
 Expected gasoline prices: NYMEX and ICE oil futures
Empirical Results
Magnitude of the Mispricing
Interpretation
  This analysis is equivalent to an “implicit discount rate
  estimation.”
  Is this literally a discount rate? Probably not
  Related economic literature frames this as inattention
    Tax salience
    Prices vs. shipping and handling
    Mutual fund returns vs. fees
    Add-on costs (printer and razor cartridges, hotel charges)
  Likely need laboratory experiments or very precise
  field experiments to learn more about attention
    Ethnographic research useful (I just won’t be doing it)
Comments
 What’s nice about this approach:
   Looking at price of same vehicle over time
     No unaccounted costs: unlike weatherization
     No worry about product features correlated with efficiency
   Observed market behavior, not lab experiment or stated prefs
     Vehicles one of the most important energy using durable goods
   Behavioral welfare analysis very new and usually difficult
     With energy, can use that consumers indifferent between a dollar
     now and a discounted dollar later!
 What’s not nice about this approach
   Assumptions about future gas price expectations, vehicle usage,
   discount rate, resale value, etc.
     Use rental car data
Policy Implications
  I am not yet convinced (at a level of policy
  recommendations) that consumers undervalue future
  energy costs. But if this were true:
  Labels as informational and attentional devices
  Would justify energy efficiency standards
  Minimum efficiency standards and fuel economy standards
      Move inattentive consumers to a more efficient good
  Problems:
  Do we know the standards are at the optimal level?
  Heterogeneous consumers
      Standards force some people to buy a good that is too efficient
Policy Implications: Nudges
  How do we sell energy efficient goods?
    Mandates/standards
    Price incentives
    Marketing/information
  Encourage firms to “nudge”?
    Pay the retailer for selling energy efficient goods
    Salesmen can be very effective at convincing,
    especially when they can “debias” a consumer in a
    way that saves money!
    Utility decoupling: utilities can “nudge” also
Aside: Related Experimental Work
  Use field experiments to understand the Energy
  Paradox
  With realtors
    Experiment with information provision programs for
    buyers and renters
  With in-home energy information devices
    Rigorously measure effects using randomized trials
    Why do they work? Information vs. drawing attention?
    How to maximize effectiveness?
Aside: Related Experimental Work
  At Best Buy or another retailer:
    Quantify beliefs about future energy costs. Biased or high-
    variance?
    What are best approaches to labeling and marketing?
    How does the cost effectiveness compare to the current
    large purchase rebates?
  With utilities
    Optimize rebate amounts through pilot rebate lotteries
    Field experiments with other energy efficiency programs
    Randomized encouragement for weatherization
      Simultaneously test both marketing and energy conservation
      effects
Recap
 Putting the “economics” in behavioral economics
   Not just marketing!
   Identify a behavioral failure, use to design policy
 Gasoline Prices, Fuel Economy, and the Energy
 Paradox
   Vehicle market acts as if consumers undervalue future
   gasoline costs when buying vehicles
 Upcoming experimental work
   Field experiments, including with utilities, to
   understand consumer energy choices