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| Type | Other Publication |
| Scope | Discipline-based scholarship |
| Title | Energy-Using Durables: The Role of Time Discounting in Investment Decisions |
| Organization Unit | |
| Authors |
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| Language |
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| How Published | Swiss Federal Office of Energy, Publication No. 290417 |
| Date | 2011 |
| Abstract Text | Markets for energy-using durables seem to be characterized by an “energy efficiency gap”, the phenomenon that consumers could save on total costs if they bought high-efficiency products but often decide not to do so. This fact has been attributed to consumers undervaluing future cost savings relative to the upfront purchase price, possibly due to their high discount rates. Factors influencing discounting behavior include the following: 1. Individuals’ rates of pure time preference, i.e. the rate at which future utility is ex- changeable for present utility 2. Uncertainty concerning product life, service reliability and future energy costs 3. Individuals’ limited access to capital markets resulting in liquidity constraints 4. Difficulties obtaining and processing information regarding future running costs The objective of the current research was to develop a descriptive model of discounting be- havior which disentangles the effects of pure time preferences from other potentially decisive factors in the context of financial decision making and to test the model with novel experi- mental data. The data was collected from a representative sample of the German speaking Swiss population. We elicited discount rates, measures of risk aversion and other individual data relevant for decisions on energy-using durables. There were two different treatment groups: One group of the participants responded to hypothetical questions and received a flat participation fee, the other group was paid depending on their decisions in an incentive compatible manner. The following results emerged: 1. We found a substantial incentive effect: People who responded to hypothetical ques- tions exhibited an average discount rate of 47.5% p.a., compared to 36.4% p.a. of the incentivized group. Model estimates show that there is no significant difference between groups’ preference parameters other than their levels of pure time preference. The incentive effect can be traced back to the behaviors of comparatively small subgroups of people in the hypothetical treatment who reacted strongly to two factors: skepticism about the certainty of future payments and liquidity constraints, both of which drove up discount rates considerably. We did not find any evidence whatsoever that participants in the hypothetical treatment did not do their best to respond conscientiously and honestly. We conjecture that the incentive effect is due to people’s inherent difficulty of foreseeing how they will behave when they actually face real consequences of their choices. For this reason we recommend that the design of policy measures should be principally based on the analysis of real decisions. 2. Liquidity constraints are an important factor affecting people’s behavior in the incentivized treatment group. We estimate that discount rates are 40% higher for liquidity-constrained individuals than for unconstrained ones who exhibit an average rate of time preference of more than 30% p.a. The magnitudes of these rates suggest that there are considerable obstacles to investment in energy-efficient durables even for people with unlimited access to capital markets. 3. Participants reported to be concerned about uncertain future energy costs and to have difficulties with assessing monthly energy costs. Both factors may play a crucial role in people’s undervaluation of future energy cost savings. Product- and consumer-specific information on present values of expected running costs may help consumers in their decision making. 4. If our estimates of time preference rates are indeed manifestations of people’s innate preferences, information and education will most likely not alter people’s behavior. In this case, policy could influence relative prices of high-efficiency and low-efficiency durables directly via feebates, a combination of fees and rebates. This idea can be transferred to other aspects of the purchase decision, such as service, warranty and leasing contracts. In order to be able to quantify the relative magnitudes of fees and rebates, the extent of undervaluation of future costs will have to be assessed on a market-by-market basis. |
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