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Consumer Rationality and Energy Efficiency Consumer Rationality and Energy Efficiency Alan H. Sanstad, Lawrence Berkeley Laboratory Richard B. Howarth, University of California Whether consumers behave rationally or optimally when making decisions concerning energy use and energy effi- ciency is sharply contested in both policy and academic circles. Two polar positions on this issue and its policy implications are readily identified in the literature. Economists typically view rationality as a fundamental axiom of human behavior; accordingly, energy-related decisions must be rational if analyzed correctly, and policy interven- tions such as equipment performance standards and demand-side management programs are likely to impair eco- nomic efficiency by depriving consumers of desired options. Behavioral researchers and technology analysts, in contrast, argue that consumers’ real-world decisions deviate from the ideals of preference maximization, providing a possible justification for government intervention. Extensive research over the past two decades on the characterization of energy-related decisions has failed to resolve the key questions surrounding this issue. We argue that a resolution and synthesis is unlikely to arise without due attention to underlying methodological issues. This paper examines the methodological disparities between rational choice theory and alternative approaches using examples drawn from the literature on energy- related decisions. Particular attention is given to the meaning of “bounded rationality” and the extent to which this concept can serve as an organizing principle in the study of consumer behavior in markets for energy and energy- using equipment. We critically examine the policy positions described above and elucidate the weaknesses in both. We present recommendations for partially bridging the methodological gap between the two positions in research and policy. Introduction Do consumers behave rationally in making decisions create “market barriers” to energy efficiency that drive a regarding energy use and energy efficiency? Do observed wedge between realized outcomes and the economic choices reflect an optimal balance between the costs and optimum. A standard argument is that consumers use benefits of energy-efficient technologies? Do people use excessive discount rates (perhaps as high as 800%/yr) economic criteria when purchasing appliances or automo- when making energy-related decisions (Ruderman et al. biles, or when considering building shell retrofits that 1987). would reduce household fuel consumption? Do households minimize the present-value costs of obtaining energy Some analysts argue that the interaction of producers and services? consumers in competitive markets should lead to the implementation of all energy-efficient technologies that are Debates over these key questions have continued unabated truly cost-effective; accordingly, the perceived “efficiency for two decades, becoming more intense in recent years gap” must be based on the mismeasurement of costs and due to growing concerns over the environmental impacts benefits (Sutherland, 199 1). Closer scrutiny, however, of energy use. An apparent answer is provided by studies shows that many of the “market barriers” identified by documenting the costs and benefits of energy-efficient technology analysts may be understood as market failures technologies. The National Academy of Sciences (1991), generated by problems of imperfect information and for example, found that energy-related emissions of transaction costs. Thus the existence of the efficiency gap carbon dioxide could be reduced by up to 37% using may be reconciled with the hypothesis that consumers technologies that are cost-effective given today’s prices make energy-related decisions in a fully rational manner and market conditions. Based on such results, technology (Sanstad and Howarth 1994, Jaffe and Stavins 1994). This analysts argue that departures from rational behavior line of reasoning, however, assumes that consumer Sanstad, Howarth — 1.176 decision-making conforms to the standard dictates of In our view, this line of attack overlooks a key aspect of economic theory. As such, it avoids a direct examination the problem: The quandary over consumer rationality and of the rationality hypothesis and its consequences for energy use is not empirical, nor even theoretical, but energy analysis and policy. methodological. That is, we must begin by addressing fundamental definitional and epistemological questions: For all the attention devoted to the topic, no widely- What does it mean to say that consumers are or are not accepted answers to the basic questions about consumer “rational” or that they do or do not “optimize”? What rationality and its role in energy-related decisions have counts in principle as a description or explanation of emerged in the literature. Moreover, there are few signs people’s behavior? What counts as evidence one way or that any are soon forthcoming. This is not to say that another? And how do the answers translate, in principle, strongly-held views on the subject cannot be identified. into guidance for policy makers? Among energy specialists, one can identify two polar positions to the question of whether consumers behave We believe that differences over these “meta-questions” rationally when making decisions regarding energy use lie at the heart of the debate over consumer rationality and and energy technologies: Economists say “generally yes” energy use. Without much-improved understanding of while technologists and behavioral researchers say “defi- these underlying issues, empirical findings are unlikely to nitely not. ” The middle ground is held by researchers substantively alter the debate. The aim of this paper is to from a variety of disciplines who argue that “more re- clarify these issues in the hope that truly interdisciplinary search is needed. ” approaches to studying consumer rationality and energy may emerge. This last opinion is the point of departure for our paper. We emphatically agree that more research is needed on While our focus is on first principles as opposed to the the nature of consumers’ decision-making related to immediate needs of policy analysis, the problems under energy. We believe, however, that such research is consideration are highly relevant to the design of effective unlikely to resolve this ongoing controversy in the absence energy policies. Particularly in the context of global of careful consideration of underlying disagreements over climate change, policies to restrain energy use and/or methodology and first principles. This argument is based promote the adoption of energy-efficient technologies are in part on a simple observation: Research over the past a matter of increasing urgency. The analysis of such twenty years has produced hundreds of papers on consum- policies depends critically on the role of rationality in er energy decision-making (Lutzenhiser 1992), yet debates consumer decisions relating to energy-efficient technolo- over consumer rationality and energy use continue to rage gies. Policy makers continue to be hampered by the re- today. Almost every aspect of the problem has been search community’s failure to reach consensus on this studied: different end-uses; technologies; types of deci- issue. sions; psychological, economic and social factors; and so forth. Energy analysts who call for more research typical- Two Polar Views ly fail to address this fact and to answer these fundamental questions: What is further research likely to uncover that It is useful to describe two polar perspectives on the ties has heretofore passed unrecognized in the literature? Why between consumer rationality and energy demand behav- has all the work done to date failed to clarify debates over ior. Although the views of most analysts would fall some- consumer rationality and its ties to energy efficiency? where in between these extremes, the distribution of beliefs is strongly bimodal. Proponents of the extremes One easy answer is disciplinary fragmentation: Research- are readily identified in the literature, so that these ers in one field ignore contributions from other disciplines characterizations are not easily dismissed as mere and thus do not appreciate that “true” answers have caricatures. already been considered and possibly found. Although there is some truth to this argument, our perspective is The first point of view is closely associated with neoclas- rather different. We see the controversy as stemming from sical economists. According to this view, producers and a scientific illusion regarding the study of rationality and consumers have stable preferences that they seek to satisfy energy demand. That is, energy analysts on all sides of through market transactions. Consumer choices thus the debate consider the question of consumer rationality reveal information about underlying preferences, and the amenable to the scientific method: If one wants to know acceptance or rejection of energy-efficient technologies what consumers are doing, one has only to go out and reflects a rational evaluation of the relevant costs and look—collect some data, perhaps formulate a model—and benefits. Market imperfections involving imperfect the answers will emerge. information or transaction costs might impede the adoption Consumer Rationality and Energy Efficiency — 1.177 of cost-effective energy-efficient technologies. But model of Brownian motion (Hassett and Metcalf 1993). deviations from rational behavior are ruled out by Such are the forms
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