Applying Psychology to Economic Policy Design: Using Incentive Preserving Rebates to Increase Acceptance of Critical Peak Electricity Pricing

This project extends the idea that policy makers should address problems by improving economic incentives. This project adds that presenting incentives in a way that reflects how people make decisions can sometimes improve consumers’ responses to the incentives and policy outcomes. This paper uses behavioral economics to propose ways to increase electricity policy effectiveness. The cost of generating power fluctuates enormously from hour to hour but most customers pay time-invariant prices for power. The mismatch between the fluctuating cost and the fixed price wastes billions of dollars. Critical Peak Pricing (CPP) reduces this waste by setting offpeak, peak, and “critical” prices that better reflect the cost of power during time periods. Customers in CPP pilot programs used less power during high-priced periods than did customers on traditional, time-invariant rates. CPP customers reported high satisfaction levels and often saved 10% or more. Yet, roughly 99% of customers reject opportunities to switch to CPP. The psychology literature documents a set of decision making heuristics that people use to choose among options with uncertain payoffs. This paper describes the evidence that one or more of these heuristics explains customer reluctance to opt-in to CPP. It then suggests Incentive Preserving Rebates that change the presentation of CPP to address these heuristics. Incentive Preserving Rebates reframe scarcity “events” as opportunities to get rebates rather than as periods of extremely high prices. Incentive Preserving Rebates change the presentation, but change neither marginal incentives nor each customer’s total annual payments. The paper then explores the implications of Incentive Preserving Rebates for customers who participated in a California pilot program.