Prospect Theory and Energy Efficiency

54 Pages Posted: 21 Aug 2017 Last revised: 27 Mar 2023

Date Written: August 2017

Abstract

Investments in energy efficiency entail uncertainty, and when faced with uncertainty consumers have been shown to behave according to prospect theory: preferences are reference-dependent and exhibit loss aversion, and probabilities are subjectively weighted. Using data from a choice experiment eliciting prospect theory parameters, I provide evidence that loss-averse people are less likely to invest in energy efficiency. Then, I consider policy design under prospect theory when there are also externalities from energy use. A higher degree of loss aversion implies a higher subsidy to energy efficiency. Numerical simulations suggest that the impact of prospect theory on policy may be substantial.

Suggested Citation

Heutel, Garth, Prospect Theory and Energy Efficiency (August 2017). NBER Working Paper No. w23692, Available at SSRN: https://ssrn.com/abstract=3023092

Garth Heutel (Contact Author)

Georgia State University ( email )

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