31C01300/31E01310

Energy & Environmental Economics

Lecture 11: Consumer behavior

Iivo Vehviläinen
Spring 2024
Week 6

Last week: Exhaustible resources & climate change

Learning objectives:

• key concepts: consumer choices, R&D

• applications: car markets, green innovations

Lectures:

1. Consumer behavior
2. New technologies

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Where do the consumption choices matter?

Directly: 1. Road transport and 2. Residential emissions.

Source: IPCC, AR5, Mitigation of climate change, 2014. Global emissions by sector.

2
Efficient policy: Three steps for the government

1. How much to reduce emissions?

• This is cost-benefit question: marginal benefits=marginal
abatement costs
2. How to reduce emissions?
• This is instrument choice question: prices or quantities or both
3. How to deal with distribution?
• In theory, distribution and efficiency can be separated:
monetary transfers can be made (e.g. permit allocations,
lump-sum transfers)

In what follows: we focus mostly on item 2

3
How to reduce emissions: the cost to consumers

Just like with firms, consumers have ”abatement costs”

4
Price incentives to consumers

Just like firms, consumers should respond to price incentives

5
Cost efficiency and consumers

Just like firms, price incentives lead to cost efficiency: different

consumers will limit driving-related emissions until the marginal value of
emissions is equalized

6
But policies in actuality often regulate actions of consumers

Regulations on: (i) driving, (ii) technologies, (iii) fuels. However, the
problem is the fuel-use and its pollution content → our theory tells us
that the price should be set on emissions (either tax or market price of
pollution permits)

7
Automobiles: types of regulations

Globally in actual use:

1. Price instruments
• fuel or technology purchase taxes but often not
pollution-related
2. Restrictions on use
• often congestion motivated
3. Technology standards
• have led to major changes in the fleet of cars offered
4. Subsidies
• on buying or scrapping (“cash for clunkers”)

If you are in to the topic, then for a fuller treatment as a presentation, see Link, focuses on congestion but covers
much more. From ca 03:45 onwards. Not required for the course, but provides perspective.

8
Price instruments: fuel taxes

Taxes vary across countries, and not pollution motivation

Source: Taxing Energy Use 2018 - OECD 2018 Database. This chart shows the fuel
taxes on gasoline and diesel in the Organization for Economic Co-operation and
Development (OECD) countries.

9
Price instruments: fuel taxes

Higher taxes → better fuel-economy (correlation)

Figure 1
Transportation Fuel Consumption per Capita versus Fuel Price

400

Gasoline/Diesel for transportation (gallons/year/capita) United States

300
Canada
Luxembourg

200 Australia

New Zealand
Iceland
Switzerland
Ireland
Sweden Greece
Japan
100 Denamrk
Finland
United Kingdom Norway
Germany Netherlands
Austria
Czech Republic Italy
Hungary Portugal France
Spain Belgium

0
2 4 6 8

Gasoline price ($)

Source: Data from Worldbank.org.

Notes: Size of the circle proportional to population. The line is the fitted value from a regression of the
log of consumption on the log of price.

Knittel, Christopher R. 2012. ”Reducing Petroleum Consumption from 10

Transportation.” Journal of Economic Perspectives, 26 (1): 93-118.
Illustration: Natural experiment of a fuel tax increase

War starts in Ukraine

2.5
Euros (nominal)

2.0
gasoline_95
diesel

1.5

1.0
2010 2015 2020

Figure 1: Fuel price shock: prices move from ca. 1.5 €/l to 2.0 €/l from
Q3/21 to Q3/22. This would correspond to a CO2 tax increase of ca. 200
€/tCO2 (Source: Liski, Nokso-Koivisto, Nurmi & Vehviläinen, 2024).

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Illustration: Consumer heterogeneity

10

8
density

income_decile
7 0.0175
0.0150
6
0.0125
5 0.0100

4 0.0075
0.0050
3

1 2 3 4 5 6 7 8 9 10
km_decile

Figure 2: Higher income is associated with more driving.

Sample of Finnish drivers for which we observe annual kilometers driven with the same car over the shock,
Source: Liski, Nokso-Koivisto, Nurmi & Vehviläinen, 2024.

12
Illustration: Consumer heterogeneity

10 10

9 9

8 8
predicted consumption
income_decile

income_decile
7 car price, euro 7 l/100
8.75
9000
6 6 8.50
8000
5 7000 5 8.25
6000 8.00
4 4
5000
7.75
3 3

2 2

1 1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
km_decile km_decile

Figure 3: Mean of i) predicted car prices (Left Panel) and ii) fuel economies
(Right Panel) by income and kilometers driven deciles.

Sample of Finnish drivers, Source: Liski, Nokso-Koivisto, Nurmi & Vehviläinen, 2024.

13
Illustration: market and individual responses

10 10

9 9

8 8
change in rel.
change in km
income_decile

income_decile
7 value, euro 7

6 100 6 0
50
5 5 −2500
0
4 −50 4 −5000

−100
3 3

2 2

1 1

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
km_decile km_decile

Figure 4: Mean of changes in car prices (Left Panel) and kilometers driven
(Right Panel) by income and kilometers driven deciles from 2021 to 2022.

Sample of Finnish drivers, Source: Liski, Nokso-Koivisto, Nurmi & Vehviläinen, 2024.

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Illustration 2: Response to technology standards

Emissions across vintages: Standards impact pollution for new cars.

Source: Jacobsen et al. 2022. 15

Illustration 2: Response to technology standards

But standards do not address emissions from old cars.

Source: Jacobsen et al. 2022. 16

Illustration 3: Response to technology standards

Alternative systems for setting the standard.

Source: Ito and Sallee, The Economics of Attribute-Based Regulation: Theory and Evidence from Fuel Economy
Standards, ReStat, 2018.

17
Illustration 3: Response to technology standards

Weight dependent fuel standard in Japan.

Source: Ito and Sallee, The Economics of Attribute-Based Regulation: Theory and Evidence from Fuel Economy
Standards, ReStat, 2018.

18
Illustration 3: Response to technology standards

Manufacturer response (to the old standard): increase the weights!

Source: Ito and Sallee, The Economics of Attribute-Based Regulation: Theory and Evidence from Fuel Economy
Standards, ReStat, 2018.

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Lessons from the survey of instruments in use

Standards, subsidies, and other non-ideal instruments can have big

impact emissions

• Standards on manufacturers in particular

• But they do lead to the inefficiency explained in the beginning
of this lecture! For example, in Finland the policy target was:
- by 2030: 700 000 electric cars (up from 250 000 in 2016)
- by 2030: 130 000 gas-fueled cars (up from 50 000 in 2016)
• However: the government has no information that this
allocation is the efficient way to reach the target. If there is
price on emissions, or a quantity quota for emissions, then the
market chooses the allocation → cost-efficiency!

Why is it the governments do not trust the market instruments?

20
Why governments do not trust the market instruments?

Consumer choices → choices of durables (cars, air conditioners,

heating devices, freezers,..). There is a belief and some evidence
that consumers are myopic. Used to justify significant regulations

• billions of dollars in subsidies for energy efficient durables such

as air conditioners and lightbulbs (NHTSA 2010)
• European Union: the Energy Performance of Buildings
Directive (EPBD)
• subsidy schemes for ”green cars”

Houde and Spurlock, 2016, EEEP provides further discussion on the perceived market failures.

21
Do consumers respond to economic incentives?

Are consumers sensitive to the expected cost of using

energy-consuming durables?

• Automobiles: changes in fuel prices should lead to changes in

the relative value of fuel-efficient cars
• Consumers should be indifferent between spending a dollar in
present value on energy and a dollar in present value on
purchase price
• Energy durables: future energy prices should affect the
equilibrium upfront purchase price

Policies change the cost of using the technologies, and thus they
are effective only if the consumers respond to these costs.

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Energy Paradox & Energy Efficiency Gap

Energy Paradox=consumers do not pay (enough) attention to the

energy costs.
• Hausman (1979): consumers have ”defective telescopic
faculty”.
• Dubin & Hausman (1984): 15-25 per cent interest needed to
justify the choices
• Explanations*:
– Uncertainty information
– Asymmetric information
– Market imperfections
– Inattention

However, new evidence with better data challenges this view, this
is discussed in the reading assignment Houde & Spurlock (2016).

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*) See Appendix for these slides for a stylized model.
Illustration: informing car buyers

(Alloct & Knittel, 2019) 24

Illustration: informing car buyers

Experiment finds no effect from giving comprehensive fuel

economy information to car buyers:

Figure 6: Effects of information on fuel intensity of purchased vehicles.

Source: Allcott and Knittel, AEJ Policy, 2019.

25
Illustration: information campaigns

/J f ( )

Fig. 1. Home energy reports: social comparison module.

Figure 7: Example of an information campaign based on social norms.

26
Illustration: information campaigns

Allcott: This paper evaluates a series of programs run by a company called OPOWER to send Home Energy Report
letters to residential utility customers comparing their electricity use to that of their neighbors. Using data from
randomized natural field experiments at 600,000 treatment and control households across the United States, I
estimate that the average program reduces energy consumption by 2.0%. The program provides additional evidence
that non-price interventions can substantially and cost effectively change consumer behavior: the effect is
equivalent to that of a short-run electricity price increase of 11 to 20%, and the cost effectiveness compares
favorably to that of traditional energy conservation programs. Perhaps because the treatment included descriptive
social norms, effects are heterogeneous: households in the highest decile of pre-treatment consumption decrease
usage by 6.3%, while consumption by the lowest decile decreases by only 0.3%. (Allcott, 2011)

27
Illustration: efficient policies in Finland

28
Illustration: efficient policies in Finland

29
Recap: three steps for the government

1. How much to reduce emissions?

• Marginal cost equal to marginal damages
• Also, balance across sectors: what part to assign to consumers
and what to the industry?
2. How to reduce emissions?
• Recent evidence supports increased reliance on (the right kind
of) price or quantity instruments.
• Sometimes additional measures, such as information
interventions, may be motivated. Sometimes they add little.
3. How to deal with distributional issues?
• Optimally use efficient instrument to solve the externality, deal
with distributional concerns through other means.

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Agenda

Today

• Consumer choices

Last lecture

• New technologies

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