Modelling the effectiveness of climate policies: How important is loss aversion by consumers?

Abstract

Reliable decarbonisation policies can only be developed with a thorough understanding of how consumers choose between energy technologies. Current energy models assume optimal consumer decisions which may result in expectations of the effectiveness of climate policies that are far too optimistic. Prospect Theory, on the other hand, aims to model real-life choices, based on empirical observations that losses have a relatively larger influence on decisions than gains, relative to a reference point. Here, we show for the first time how loss aversion can be included into a global energy model with high spatial resolution, using heating technology uptake as a case study. We simulate the future heating technology diffusion for 59 world regions covering the globe, with and without the consideration of loss aversion. We find that ignoring the implications of loss aversion overestimates the market uptake of renewables, in individual countries as well as on the global level. As a consequence, loss aversion results in higher projected CO2 emissions by households, and the need for much stronger policy instruments for achieving decarbonisation targets. In the case of residential heating, a carbon tax of 200 €/tCO2 is projected to reduce overall emission levels to a similar extent than a carbon tax of 100 €/tCO2 without the consideration of loss aversion. Even for similar degrees of decarbonisation, accounting for loss aversion implies substantial changes in the underlying technology composition: technology choices become subject to a ‘conservative shift’ towards low-carbon technologies which are relatively less efficient, but already more established in local markets.