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Policies influencing decisions of energy consumers

Energy transition means, amongst other things, that individual consumers are given incentives to deviate from their privately optimal decisions regarding the use of energy. The policy measures to influence the decisions of consumers can be distinguished in four categories: information provision, regulation, subsidies and market-based instruments.

By informing people about the benefits of, for instance, insulating houses, some of them may indeed take measures to insulate their houses. The rationale behind this type of policy measures is that people are not aware on how much they could save by making an investment in energy saving. The effectiveness of such policies appear, however, to be modest. Just informing people about the benefits of a specific action is generally not sufficient to realise a change in behaviour. Apparently, consumers have good reasons to act as they do. In order to influence them, these reasons should be changed. In economic terms, the incentives for consumers need to be changed.

One way to change the incentives is to implement regulations which prescribe, for instance, the minimum level of energy efficiency of houses. This type of policy measures may result in changes in the decisions consumers make if the enforcement of the regulation is effective. The drawback of such regulation, however, is that the costs can be high. These costs refer to the costs of the type of measures which are being enforced as well as the costs of enforcement.

Just as implementing regulation, giving subsidies to consumers in order to stimulate them to change their choices can be effective. If the subsidy is sufficiently high, many consumer may make use of the subsidy and, hence, realise the change in consumption. The drawback here is also related to the costs. Subsidy schemes easily result in free-riders, which means that also consumers who already have decided to install a specific asset, for instance, receive the subsidy. This free-rider effect may seriously reduce the net effect of subsidy schemes.

Theoretically, the most efficient way to influence consumers is to use market-based instruments. These instruments are market-based as they are directed at changing the market prices of goods, for instance by imposing a tax on electricity. If this tax is related to the costs of a market failure such as an environmental externality, the resulting net price for consumers reflects all social costs, resulting in optimal decisions. The drawback of using market-based instruments is that the effect on the behaviour is uncertain as this depends on how consumers react to price changes. This response depends on the price elasticity. If the price elasticity of energy is close to zero, a tax on energy hardly has any effect on energy use. Although this may be the optimal outcome from an overall welfare outcome, it may have an adverse effect on the distribution of welfare, since the main effect is that consumers pay more taxes to the government.

If the price elasticity of energy is low, imposing a tax on electricity hardly affects energy use

Author: Machiel Mulder

To get more in-depth insight in the behaviour of energy consumers and how they respond to policy measures, the publication by Gillingham and Palmer can be helpful. It deals with one of the key issues in this field, which is the energy-efficiency gap. The link can be found below.

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This article is from the free online course:

Solving the Energy Puzzle: A Multidisciplinary Approach to Energy Transition

University of Groningen