The Frontal Cortex

Energy Efficiency

I think one of the most important tests of behavioral economics will arrive in the next few years, as we attempt to persuade consumers to improve energy efficiency in the home. Just imagine if, instead of installing granite on every kitchen countertop, we’d instead spent that money on better window seals and insulation. Of course, if people were rational agents, we wouldn’t need cleverly constructed “choice environments,” since the vast majority of efficiency improvements pay for themselves with reduced energy bills within a few years. (According to Energy Star, buying more efficient appliances, such as SEER 13 air-conditioners, can reduce energy usage by those appliances by nearly 30 percent. For instance, the incremental cost of a SEER 13 unit relative to a SEER 10 unit – that’s the current minimum allowed – is about $170. However, the average household will save nearly $50 per year in electricity costs, which means that the higher standard pays for itself in less than four years.)

So what’s the trick? How can we re-engineer human behavior? I think we’ve picked off the low-hanging fruit by redesigning those Energy Star labels, so that it’s now clear to shoppers in WalMart that buying the slightly cheaper water heater will lead, over time, to significantly higher heating bills. The same goes for air-conditioners, washer/dryers and refrigerators. Sometimes, better decisions result from more transparent information, so that people can translate abstract measurements of energy (watts, amps, etc.) into dollar amounts on an energy bill. If we’re asking people to make short-term sacrifices for long-term benefits, then we have to make those benefits more tangible.

But I’m not sure this approach is sufficient when it comes to the big and necessary improvements, which require a home retrofit that can cost thousands of dollars. Sure, there are hefty tax incentives but not everyone can benefit from a tax deduction. At moments like this, we need less asymmetric paternalism and more good ol’ fashioned liberal paternalism. In other words, it’s time for regulation.

The challenge, of course, is designing a regulation that dramatically increases home energy efficiency without pissing off homeowners. Here’s where behavioral economics comes in handy. One of my favorite human biases is what I call the “Ritz internet blind spot”. Isn’t it odd that fancy hotels can charge $12.95 for the internet but every Best Western gives you the internet for free?

The explanation for this consumer quirk has to do with something called mental accounting, which was first explored by Richard Thaler. For example, when Thaler asked people whether they would drive 20 minutes out of their way to save $5 on a $15 calculator, 68 percent of respondents said yes. However, when he asked people whether they would drive 20 minutes out of their way to save $5 on a $125 leather jacket, only 29 percent said they would. Their driving decision depended less on the absolute amount of money involved ($5) than on the particular mental account in which the decision was placed. If the savings activated a mental account with a miniscule amount of money⎯like buying a cheap calculator⎯then they were compelled to drive across town. But that same $5 seems irrelevant when part of a much larger purchase. This principle also explains why car dealers are able to tack on unwanted extras and why expensive hotels can get away with charging six dollars for a can of peanuts and $12.95 for twenty four hours of internet. Because these charges are only a small part of a much bigger purchase, we end up paying for things that we wouldn’t normally buy.

What does this have to do with home renovations? Here’s my proposal: when a home goes on the market, it should be tested for energy efficiency. If it doesn’t meet some basic standards, we should require an energy efficient retrofit before the home is sold. (Obviously, we can scale the regulations so that the mandate varies with purchase price. As a taxpayer, I’m willing to subsidize the retrofit of cheaper homes. That also seems like a useful way of generating green jobs for relatively unskilled workers.) But I can already hear the naysayers: Won’t homeowners object? Won’t that just add thousands of dollars to the cost of buying a home?

Enter mental accounting, an irrational bias that can be tweaked to produce positive outcomes. Because a home is already such a gigantic purchase, and because the home buying process is already so saturated in peculiar fees (inspection charges, loan points, escrow fees, mortgage broker expenses, etc.) I’d argue that consumers will be much less sensitive to the cost of a home renovation. They’ll barely even notice the $5000 “energy efficiency charge” when it appears on their massive bill from the real estate agent. (Besides, they’ll get a big chunk of the money back as a tax credit.) In other words, they’ll act just like me the last time I stayed at a fancy hotel, when I ordered the internet and ate the peanuts.

Comments

  1. #1 MA
    June 18, 2009

    You do not completely specify Thaler’s (1980) conditions – see the 4th page of this paper…
    faculty.chicagobooth.edu/richard.thaler/research/MentalAccounting.pdf

    People are buying both a jacket and a calculator. They are willing to drive across town to save $5 on the $15 calculator (or jacket), but are unwilling to drive across town to save $5 on the $125 jacket, or, more convincingly, the calculator if it is priced at $125.

    In both cases the savings is the same ($5 out of $140). But only when you are buying both can you reveal the psychologically “separate accounts” we seem to keep.

  2. #2 D. C. Sessions
    June 18, 2009

    For instance, the incremental cost of a SEER 13 unit relative to a SEER 10 unit – that’s the current minimum allowed – is about $170. However, the average household will save nearly $50 per year in electricity costs, which means that the higher standard pays for itself in less than four years.

    That only applies if they’re buying a new unit either way. The rather more common situation is: save $50 per year by spending $3000 to replace the existing unit.

    A bit harder to justify.

  3. #3 someBrad
    June 18, 2009

    “They’ll barely even notice the $5000 “energy efficiency charge” when it appears on their massive bill from the real estate agent.”

    This is asking the wrong question. Rather than consider: What will people notice once this proposal goes into place?, try: How will this proposal be caricatured by its opponents?

  4. #4 Anibal
    June 18, 2009

    We need more “nudges” in the right direction and i agree with your diagnostic in this disphoric times: better rules for the game (regulation)

    Never like the hyperbolic treatment and candy-science of Goleman because many experts from the fields he dares to enter, such as social neuroscience, theory of mind studies or developmental psychology, reject the simplified assumptions he took on EI etc.

    But in this case, with his “Ecological Intelligence”, maybe is right after all.

    Mr. Lehrer, i propose you the title of your next book: Why we buy the things we buy.

  5. #5 Moses
    June 18, 2009

    Ha! Your puny 13 SEER. I went to 17SEER! And if my lot would have been big enough for the drilling rig and trenching it would have been Geothermal…

    Anyway, even though I spent a huge amount of money on the unit ($13,000 as I completely removed the old system and retrofitted my 1920′s bungalow with all new ductwork). My utility costs dropped by 50% from that late 1970′s unit my house came with…

    At current energy prices, we expect the unit to completely pay for itself in about eight-and-one-half years and pay for it’s replacement (we won’t have to completely re-do the ductwork this time) in another five, or less.

  6. #6 Jim
    June 18, 2009

    To Anibal: Check out “Buying In” by Rob Walker.

    Mr. Lehrer, perhaps if the extra fee could be linked into the Mortgage amount, it would be much easier to encourage. So, you get an extra $5000 on your loan, with the understanding that will go towards “greening” your home. As someone who just went through the home buying process, I was wondering if there was some way to get a larger mortgage with the intention of using some of that money for renovations. In the end, I got lucky and purchased a house that is reasonably new, so the windows and appliances are all in good shape, and are pretty good with respect to efficiency.
    The problem with tax credits is always that you get the money later, not when you need it.

  7. #7 Peter Troast
    June 18, 2009

    Requiring energy audits at time of sale is coming, despite opposition from realtors. (see Austin TX) But we really can’t wait the years it will take for policy that now only has traction in the progressive communities. Nor can we hang tight for the various measurement systems–the MPG for houses–to come to fruition.

    Right now, the best answer is for clout-laden buyers to demand an audit as part of due diligence. Poor energy performers will be exposed; good performers will demonstrate enhanced value.

    Eventually the realtor BS about resale value of granite countertops and tiled showers will give way to real data about the ongoing energy costs of every house.

  8. #8 Anibal
    June 18, 2009

    Thanks for the reference, Jim.

  9. #9 Bob Nease
    June 18, 2009

    If you go this route, consider framing it as an additional charge to the buyer (rather than the seller). Buyers tend to focus on their monthly payments, and an additional $5k financed over 30 years will be a small delta. Sellers are concerned with paying off their loan and clearing a profit (those were the days!) and thus will be much more sensitive to the total amount.

  10. #10 Bob Nease
    June 18, 2009

    If you go this route, consider framing it as an additional charge to the buyer (rather than the seller). Buyers tend to focus on their monthly payments, and an additional $5k financed over 30 years will be a small delta. Sellers are concerned with paying off their loan and clearing a profit (those were the days!) and thus will be much more sensitive to the total amount.

  11. #11 Woot Wooter
    June 18, 2009

    The problem with this type of regulation is well known.
    Requiring the seller to increase his cost means they will pass it on to the consumer.
    I would (and could) list 100s of industries that were hurt from this type of “lets help someone at the cost of the seller”.

  12. #12 Philip Graves
    June 19, 2009

    It’s a nice idea to apply behavioural economics to help induce a positive environmental step, but I agree with a previous comment that you’ve misapplied the Thaler’s observations.

    In this instance you are proposing to add in a cost that has no current frame of reference; it is purely an additional cost.

    Whilst people do many irrational things when buying a home, a lot of them financial, they are nevertheless concerned with what they can get for their money. This proposal would have the potential affect of shifting them down a level in terms of the property they can purchase (i.e. previously they could buy a $200,000 house, now they can buy a $190,000 with a $10,000 environmental enhancement).

    That triggers the most powerful consumer behaviour trait of all – loss aversion.

    People would rather tell themselves they will do the work at some point down the line, and find a way of paying for it (although many won’t actually do so).

    I think the fundamental problem is that energy companies make revenue from selling energy, not from conserving it, and I don’t see an easy way round that one.

    If manufacturers of green products can demonstrate that they are genuinely cost effective they can sell their products in such a way that customers don’t have to pay anything for them (by instalment plans) and then everyone wins. If necessary the government could fund an initial loan, but that should be repaid and their should be profit for everyone.

    At present the reality is that many energy-saving products only work in an energy-ideal home, and many people have houses that aren’t constructed on those lines.

    Incidentally, here in the UK we have compulsory energy surveys of homes and they are a total waste of time and money. For all the well-intentioned theory, the fact is that consumers don’t take any notice of them with all the other considerations of house purchase.

    Philip Graves

  13. #13 Steve
    June 19, 2009

    Is there a threshold to Thaler’s argument? Overpaying for an item by $5 is one thing, overpaying by $5,000 is quite another. Given the outcome of Thaler’s study this may not be an important difference, but has anyone looked at this?

    Also, I wouldn’t discount the push by the realty industry to make an issue out of any additional charge to buying/selling homes. Reframing a $5000 fee to be noticeable (and negative) is not a difficult task.

  14. #14 Thomas Caruthers
    June 19, 2009

    FHA offers an Energy Efficient Mortgage that allows a borrower to add up to 5% of the value of the property to the loan to pay for energy conserving improvements.

    No additional loan qualifying is required, as the increase to the house payment is offset by a corresponding reduction in utility costs. Its basically free energy conservation. Plus the buyer gets new “stuff”, new HVAC, water heaters, insulation, dual pane windows, etc.

    The program has been around for years, but the real estate and mortgage communities have done a very poor job of educating the buyer about it.

    Thomas Caruthers

  15. #15 Jotaf
    June 20, 2009

    I should point out that this already happens in some European countries. You can’t buy/sell a home without it having been tested. The same experts that test for efficiency also offer suggestions to improve it – such as pointing out the major flaws so the most energy can be saved with the least investment.

    AFAIK, this had a real impact on the efficiency of new homes being built, since the constructors don’t want it to look back with a bad efficiency rating; with older homes being sold, the bias you describe usually helps.

  16. #16 Akupunktur Heidelberg
    September 2, 2011

    Da selbige wirkt. Und das exklusive Nebenwirkungen. Natürlich gibt es akute Krankheite, wo die Schulmedizin unmittelbar überlegen wirkt. Dagegen prophelaktisch ebenso wie bei chronischen Krankheiten ist Akupunktur bzw. Akkupunktmassage gerade ungemein positiv.

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