Energy Conservation, Price Increases and Payback Periods

ABSTRACT - This research examines consumers' responses to price increases in gasoline and electricity as well as their willingness to accept various payback periods for investments in insulation and solar energy equipment. The results indicate that consumers will conserve energy in response to significant price increases in energy although they are not willing to wait extended periods of time to recover investments in energy saving equipment.

Citation:

William H. Cunningham and Brondel Joseph (1978) ,"Energy Conservation, Price Increases and Payback Periods", in NA - Advances in Consumer Research Volume 05, eds. Kent Hunt, Ann Abor, MI : Association for Consumer Research, Pages: 201-205.

Advances in Consumer Research Volume 5, 1978      Pages 201-205

ENERGY CONSERVATION, PRICE INCREASES AND PAYBACK PERIODS

William H. Cunningham, The University of Texas at Austin

Brondel Joseph, The University of Illinois at Chicago Circle

[Adopted from Energy Use and Conservation Incentive, with permission of Praeger Publishers, New York, 1977.]

ABSTRACT -

This research examines consumers' responses to price increases in gasoline and electricity as well as their willingness to accept various payback periods for investments in insulation and solar energy equipment. The results indicate that consumers will conserve energy in response to significant price increases in energy although they are not willing to wait extended periods of time to recover investments in energy saving equipment.

INTRODUCTION

Examination of consumer response to various incentives designed to encourage energy conservation is just beginning. Preliminary findings in the area are not encouraging. The response given first and foremost by consumers is that the most acceptable energy policies are those which require the least inconvenience, the least personal cost, and the least change in lifestyle (Cunningham and Lopreato, 1977, Doering et al., 1974; Gottlieb and Matre, 1976; Grier, 1976). Bartell (1974) reports greatest public acceptance for behavioral regulation such as the 55 m.p.h., speed limit, a required reduction of 10 percent in electricity use, and reserved freeway lanes for buses and car pools. In addition, several studies are available which deal with the impact of price adjustments on various income sectors of society (Berman and Graubard, 1973; Berman, Hammer, and Tihansky, 1972). The major suggestions emerging from these analyses are, not surprisingly, that high-income groups display a greater ability than low-income groups to reduce electrical consumption, both direct and indirect energy expenditures are regressive in nature, and the ability of low-income groups to reduce their consumption of energy is relatively low.

In summary, not very much is known about consumer reactions to conservation incentives. The objectives of this research are first to examine consumers' reactions to price increases in gasoline and electricity and second to analyze the payback periods that consumers are willing to accept to invest in insulation and solar energy. The data is broken down by income groups because federal legislation has been proposed with energy incentive provisions which impact on family's taxable income. Also most incentive systems are in some way based on price and therefore it seems reasonable to focus the present research on consumers' ability to respond to the price mechanism.

METHODOLOGY

The data for the study were collected through a mail questionnaire sent to residents in five communities: Austin and E1 Paso, Texas; Flagstaff and Prescott, Arizona; and Albuquerque, New Mexico. These cities were selected to represent various types of communities in the Southwest. The subjects were selected from the consumer billing records of the local natural gas company. Every tenth residential consumer on the firm's mailing list was chosen for the sample. Twelve percent of the residential customers serviced by the electric utility in Flagstaff and Prescott are all-electric home customers; three percent of the customers of the utility servicing Albuquerque are all-electric customers, as are nine percent in Austin, and one percent in E1 Paso (Federal Power Commission, 1975). While it cannot be assumed that all of the remaining residents supplement their electrical energy with natural gas, it is highly likely in this region of the country that the vast majority use some natural gas and are therefore part of the population sampled.

Ten thousand questionnaires were mailed with an accompanying letter explaining that consumers were being asked to participate in a study sponsored by The University of Texas at Austin and that responses would be reported only in aggregate form. A response rate of nearly 25 percent yielded 2,403 codable returns for analysis.

The subjects were broken down into the following six groups based on their total annual family income: (1) <$5,000; (2) $5,000-9,999; (3) $10,000-14,999; (4) $15,000-19,999; (5) $20,000-24,999; (6) >$25,000. They were asked to state what their reactions in terms of fuel use would be to nine price increases varying from five percent to more than 150 percent in gasoline, and electricity. The response categories which were presented included: (1) "no reduction," (2) "slight reduction," (3) "moderate reduction," (4) substantial reduction," (5) "maximum possible reduction," and (6) "would no longer use." The data are presented such that a score of 1 equals no reduction, a score of 2 equals a slight reduction, and so forth.

The subjects were also questioned on what would be the maximum amount of time that was acceptable to them to recover various levels of investments in insulation and solar energy equipment through savings in their energy bills. The response categories included: "less than one year," "1-2 years," "3-4 years," "5-6 years," "7-8 years" and "more than 8 years." F-tests were used to determine if significant differences existed between the respondent groups, with respect to their reactions to each price increase and payback periods.

RESULTS

Price Increases in Gasoline

Figure 1 compares the mean responses of the total sample along with the mean responses of each of the six income groups to price increases in gasoline ranging from 5 percent to 150 percent. It is apparent that even a 5 percent increase in the price of gasoline elicits some energy-conserving reactions on the part of all income groups. A 10 percent increase generates a mean response from all consumers of 1.95, just below the "slight reduction in the use of gasoline" category. A 30 percent increase in the price of gasoline elicits a mean response score of 3.01, which is virtually equivalent to "moderate reduction in the use of gasoline." A 50 percent increase elicits an average response of 3.58, which is midway between moderate and substantial reduction. It is important to note that while there is wide variation by income group, the average score for the total sample on a 100 percent price increase is 4.0, which is equivalent to "substantial reduction in the use of gasoline."

FIGURE 1

CONSUMERS' RESPONSES TO PERCENTAGE PRICE INCREASES IN GASOLINE

The patterns reflected in Figure 1 are interesting, particularly since they are basically consistent with the data on electricity. In the first place, a 50 percent price increase marks a threshold level in terms of consumer response. Price increases up to 50 percent elicit markedly rising levels of reported conservation. After the 50 percent mark, however, the response levels off, and little further conservation is reported. It is not possible to determine whether this pattern is due to consumers' refusals to cut back on gasoline use past "substantial" reduction, or whether consumers simply find it difficult to believe that price increases up to 150 percent over present levels would occur. Average gasoline prices in the southwest had already risen 30 percent from October 1974 to October 1975 when the survey was taken. Consumers may have viewed the hypothetical increases above 50 percent as unrealistic.

A second pattern involves the low price responsiveness of the lowest and the highest income groups, or conversely, the high responsiveness of the middle-income consumers. This finding is consistent with earlier work (Grier, 1976). The assumption is widespread that low-income groups cannot do much about their energy use and that high-income groups will not. The present findings tend to bear out that assumption.

These consumers whose total family income is below $5,000 per year are by far the least price responsive. Their conservation efforts tend to level off after the 30 percent price increase in gasoline. The gap between the responses of this group and those of the other groups is substantial. The difference between the mean response score of the lowest income group and the mean score of the sample at the 100 percent hypothetical price increase, for instance, is .91 (4.0-3.09). It is difficult to say why the pattern of response is not linear. That is, why is it that low-income people do not indicate "maximum" reduction in use at 30 percent price increases instead of responding with only "moderate'' reduction? Any explanation here is post hoc, but it may reflect the attitude that "there is nothing more we can do." Low-income people use much less fuel than other groups of consumers, so that a moderate reduction in that use does not signify the same thing as a moderate reduction among more affluent consumers.

Consumers with yearly family incomes above $25,000 are the least price responsive at the lower levels of increase (5-30%). At the 30 percent level they become more responsive than the low-income group, but it is not until the 100 percent increase that they draw close to the middle-income groups. At all hypothetical price levels, the consumers in the $15,000-19,999 category show the most reported behavioral change. The differences in response by income group are statistically significant (see Table 1) as well as substantively clear from the graphs. It is apparent that price increases are much more effective incentives for some groups of people than for others, and that the high energy users are not those most affected.

TABLE 1

RESULTS OF ANALYSIS OF VARIANCE FOR GASOLINE AND ELECTRICITY PRICE INCREASES

Increases in Electricity

The responses of consumers to price increases in electricity are quite similar to their responses for price increases in gasoline. Figure 2 indicates that the mean response for the total sample for percentage price increases in electricity is practically linear for 5 percent to 50 percent. Consumers are willing to make only the most modest conservation adjustment to a 5 percent price increase. However, they appear increasingly price responsive up to a 50 percent price increase, which elicits a mean response for the entire sample of 3.4, substantially in excess of "modest reduction in the use of electricity." Increases above 50 percent elicit additional conservation, although the behavior curves begin to level off. For the 100 percent to 150 percent price increases, the sample's mean response barely changes.

Analysis of variance significantly differentiates the income groups based on responses to the various price increases (see Table 1). The lowest income group (<$5,000) is the most responsive to a 5 percent increase in the price of electricity, with a mean score of 1.72. This pattern quickly shifts, however, with additional price increases in the range from 30 percent to 150 percent.

FIGURE 2

CONSUMERS' RESPONSES TO PERCENTAGE PRICE INCREASES IN ELECTRICITY

With two exceptions (the 5 percent and 75 percent price increases), the most responsive subjects to price increase were in the $15,000 to $19,999 income group. For both 100 percent and 150 percent price increases, the consumers in this group indicated, as a whole, that they would make more than a "substantial reduction in the use of electricity."

The patterns of response to price increases in electricity are similar to those for gasoline. The highest and lowest income groups are the most responsive. Degree of reduction in use is virtually the same for the two fuels.

Payback Periods for Insulation

The subjects were presented with five investment capital alternatives for insulation: $100, $200, $300, $400, and $500. As Figure 3 indicates, the mean responses for the entire sample show a linear pattern. For an investment of $100 the sample as a whole indicated that investment should be recovered in approximately one year. Each $100 of additional investment means that investors will wait approximately eight additional months for recovery. As a result, for an investment of $500 the sample, as a whole, responds that investment recovery must be made tn approximately four years.

It is interesting to note from Figure 3 that the six income groups are dichotomized in their responses. On one hand there are those consumers in the two lowest income segments (<$5,000 and $5,000-$9,000), who clearly must be able to recover even small amounts of investments in insulation very quickly. As an example, the lowest income segment feels it can wait no longer than approximately six months to recover expenditure of $100 on home insulation. For an investment of $500 this group would be willing to wait only a little longer than one and one-half years to recover the investment.

FIGURE 3

MAXIMUM ACCEPTABLE TIME TO RECOVER INVESTMENTS IN INSULATION

On the other hand, the four wealthiest segments of the population are rather similar in their behavior towards the insulation. They are willing to accept longer periods of time to recover investments from savings in insulation. As an example, the fourth highest income segment ($15,000-$19,000) is consistently willing to wait longer than any other income group to recover the cost of insulation. For an investment of $100 they feel they need to recover this investment in just under one and one-half years, while an investment of $500 finds them willing to wait more than four and one-half years to recover their expenditures on insulation. Table 2 indicates that the six income groups are significantly different in terms of their responses.

TABLE 2

RESULTS OF ANALYSIS OF VARIANCE FOR CAPITAL INVESTMENTS IN INSULATION AND SOLAR ENERGY

Payback Periods for Solar Energy

The subjects were asked what would be the maximum amount of time that they would be willing to wait to recover capital investment through savings in energy bills from solar energy equipment. The required investments were: $500, $1,000, $10,000, and $15,000.

As Figure 4 indicates, the mean responses to the solar energy investments are curvilinear. For a $500 investment the subjects are willing to wait slightly more than one and one-half years. In the same manner, for a $1,000 investment the average acceptable time period is more than two and one-half years. However, as the investment increases in size the consumers are not willing to wait for proportional time period increases to recover their investment. For example, a $10,000 investment finds the average subject willing to wait only slightly more than four and one-half years. For a $15,000 investment the average subject is willing to wait only a little longer than five years.

FIGURE 4

MAXIMUM ACCEPTABLE TIME TO RECOVER INVESTMENTS IN SOLAR ENERGY

Once again, the lowest two income segments tend to react in the same manner while the highest four income segments also tend to respond to the questions similarly. Although this pattern of responses also occurred in the examination of the insulation data, it is much more pronounced with the solar energy data.

The responses for the two lowest income groups change substantially from $500 to $1,000 to $3,000 investments. As an example, the second highest income group felt it should recover its $500 investment in solar energy in slightly under one and one-half years while for an investment of $3,000 they are willing to wait more than two and one-half years. However, for investments from $3,000 to $15,000, the lowest two income segments do not vary greatly. The second lowest group is willing to wait only three and one-half years to recover a $15,000 investment in solar energy.

In contrast with the pattern of the two lowest income segments, the upper-income segments were more willing to accept substantially longer time periods to recover their investments in solar energy equipment. As Figure 4 indicates, there are few differences among the response patterns for the three highest income groups. The third highest income segment's behavior is very similar to the top three, although it is distinguishable in all cases. The highest three income groups are willing to wait more than four and one-half years to recover a $3,000 investment in solar energy equipment. For an investment of $15,000, each of the three highest income segments are willing to wait more than five and one-half years. Table 2 indicates that there were significant differences among the income groups' responses to the solar heating and cooling investment questions.

IMPLICATIONS

There are several important implications from the present study. First, conservation of gasoline and electricity can be achieved with price increases. While this finding is not surprising, it is important to know the price levels which are most encouraging of conservation. In each case an increase of 50 percent appears to be the point below which substantially less conservation occurs and above which little additional conservation occurs. It is, however, interesting to note that President Carter's proposed five cent per gallon gasoline tax, which would be imposed in January of each year when the nation's consumption of gasoline exceeds the previous year's target, seems to result in little more than a redistribution of income. The data is quite clear that a five cent price increase per gallon of gasoline will not have a material effect on gasoline consumption.

Second, it is possible to identify different conservation patterns on the part of the six income groups to changes in the price of the gasoline and electricity. Although each income group displayed a curvilinear reaction to the price increases, the $10,000-$14,999, $15,000-$19,999, and $20,000-$24,999 income groups were generally the most willing to conserve energy. As an example, at price increases from 75 percent to 150 percent these groups scored above the average for the entire sample on conservation efforts for both fuels. In contrast, the lowest income segment (<$5,000) was normally the least willing to conserve; the next least willing to conserve was the wealthiest segment of society. Although it is not possible to know exactly why this pattern takes place, it is reasonable to speculate that the low-income consumers are already conserving energy and are just not in a position to conserve more energy, while the upper-income people are simply not as concerned about the cost of energy as is the sample as a whole.

Third, as was the case for responses to price increases, clear patterns emerge in responses concerning recovery time for costs of energy-saving investments. In this case, however, the two lowest income groups are distinctly split off from the other groups. Low-income consumers do not seem likely to make investments that require long payback periods. The middle and upper-income groups are more willing to wait longer periods of time to recover their investment. However, even for large investments (on solar energy equipment, for example), consumers generally expect a recovery time of less than six years. This seems to indicate that long-term life cycle energy savings from home improvements will not be effective inducements and that more direct approaches must be made to lower initial investments.

CONCLUSIONS

The present study has shown that consumers seem to be willing to conserve energy in response to price increases. This may appear to be in conflict with the recent study done by Willenborg and Pitts (1977) which found that the price mechanism was not very effective in reducing consumption of gasoline when prices are increased gradually over time. However, the present study was done after the price increases that Willenborg and Pitts were studying had taken place. In addition, the present study does not imply that the mandated price increases must take place gradually. This research does seem to indicate that the price mechanism will work quite effectively up to a 50% price increase. After this point, if further conservation efforts are required, additional steps such as allocation of fuels will have to be employed.

The study also found that consumers are not willing to wait very long to recover their investments in energy saving equipment. Since the retrofitting of homes will probably not result in payback schedules which are acceptable to most consumers the federal government should consider the use of its tax depreciation, direct tax write off, and income credit powers to stimulate the adoption of energy saving equipment.

REFERENCES

Ted Bartell, "The Effects of the Energy Crisis on Attitudes and Lifestyles of Los Angeles Residents," Proceedings (American Sociological Association, Summer Conference, 1974), pp. 88-93.

M. B. Berman and Morlie H. Graubard, "A Model of Residential Electricity Consumption," Rand Paper Series, (P-5063) (July 1973).

M. B. Berman, M. J. Hammer and D. P. Tihansky, The Impact of Electricity Price Increases on Income Groups: Western United States and California (Santa Monica: Rand Corporation (R-1050-NSF/CSA), 1972).

William H. Cunningham and Sally Lopreato, Consumers Energy Attitudes and Behavior, (New York: Praeger Publishers, 1977).

Otto Deering, Jerry Fezi, Dave Gauker, Mike Michand and Steve Pell, Indiana's Views on the Energy Crisis (Lafayette: Purdue University Agricultural Economics Department, Cooperative Extension Service, 1974).

Federal Power Commission, All Electric Homes in the United States (Washington: United States Printing Office, 1975).

David Gottlieb and Mari Matre, Sociological Dimensions of the Energy Crisis--A Follow-up Study (Houston: The University of Houston, The Energy Institute, 1976).

Eunice Grier, "Changing Patterns of Energy Consumption and Costs in U.S. Households," (Allied Social Science Associations Meeting, September 1976).

John F. Willenborg and Robert E. Pitts, "Gasoline Prices: Their Effect on Consumer Behavior and Attitudes,'' Journal of Marketing, 41 (January, 1977), pp. 24-31.

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