Do you know how much electricity you used last month? How much would you save if you turned the lights off every time you left the room? Or if you bought a more efficient freezer, or insulated your attic? Do you know your marginal price of electricity?
If you don’t know the answers to all of these questions, you are not alone. A growing body of research suggests that understanding and responding to prices is particularly challenging when it comes to household utilities such as energy and water. This will come as no surprise to many consumers--your monthly bill reflects the energy-use choices you made more than a month ago, and the total tells you very little about how much you used, or the price you paid per kilowatt-hour. As a result, when the price of electricity goes up, it may take consumers longer to notice than if the price and their own patterns of use were more transparent. Perhaps unsurprisingly then, household electricity-use is relatively inelastic to price, meaning when the price goes up, electricity-use does not fall by much. For example, a recent study in the United States shows that for a 10% increase in electricity price, use falls by less than 1% in the short run, and around 3% in the long run. For comparison, consider that a 10% increase in the price of coffee (which, for me, is just as essential as electricity) is estimated to lower consumption by about 5%, even in the short run.
These research findings suggests that economists’ favorite approach to addressing climate change – markets! – may not have much of an impact on the amount of electricity residential customers use. Of course, that isn’t problematic if customers really value electricity and make a rational choice to pay more to keep consuming, even when prices go up. But if other features of their bills make them less responsive, then consumers and the planet pay more than they want to for these additional carbon emissions.
In a recent paper, Grant Smith and I study prepaid electricity metering--a technology that is gaining prominence in the developing world as an alternative to monthly billing for electricity customers. A prepaid electricity meter acts a lot like a prepaid cell phone. Customers load credit onto their meter and consume until the balance hits zero and the lights go out. This model fundamentally changes the way consumers interact with their electricity, and it transforms electricity from a service billed monthly to a standard consumer good, paid for in advance. Most electric utilities in developing countries are rolling out prepaid meters to improve revenue recovery (i.e., to avoid unpaid bills and cheating meter readers) and lower the costs of serving poor customers.
We show that prepaid metering also has a big impact on how much electricity people consume. In Cape Town, South Africa, we find that households reduce their electricity use by 14% immediately after they are put on a prepaid meter, and then stay at this lower level over time. It would take a massive price hike to achieve those kinds of reductions in electricity use. In addition, we show that households start to respond more to electricity prices once they have a prepaid meter, maybe because they have better information about how much they are using (they watch as their meter ticks down to zero), and about their price (they pay upfront, making the price much more salient).
While further research is needed (and currently underway) to understand the costs and benefits of this approach for the consumer, the energy savings are unambiguous. Additionally our findings on prepaid electricity metering offer an important lesson for the design of new environmental markets: market performance depends not only on what is being priced, but also on how that price is transmitted to producers and consumers.