Consumer Participation in Electricity Markets: Assessing Evidence on Rationality and Consumer Choice

Government targets on decarbonisation are transforming the way in which the electricity sector and electricity markets are organised. The sector is expected to become more decentralised, with new technologies expected to enable direct consumer participation in markets on a large scale, enabling demand-side response – the latter could serve to curb the need for new investments in capacity, as well as contribute to system ‘flexibility’. However, the current policy approach and incentives to enable consumer participation by lowering the transaction costs of this participation, are largely based on the assumption that consumers are rational economic actors, assessing costs and benefits and seeking to maximise their own welfare when making decisions around adopting new technologies. In economics, rational choice theory and consumer preference theory form the underlying rationale for this assumption. However, historical experience with electricity market liberalisation – the objective of which has been to enable competition and consumer choice in retail electricity provision – has shown that consumers demonstrate a high level of inertia, and have not tended to actively participate in retail electricity markets. Studies on policies to promote energy-efficient behaviour have defined this inertia as the ‘value-action gap’ or the ‘energy efficiency gap’.

In this paper we carry survey the literature for evidence on consumers’ response to incentives promoting changes in energy use. Evidence could point to one of two outcomes: first, that consumers do not respond to policy incentives, which calls for a complete rethink of the direction of policy on decarbonisation (i.e. decentralisation and greater consumer choice). Or second, that consumers make sub-optimal choices in response to policy incentives – supporting the theory that consumers face costs in acquiring information about the present as well as uncertainties about the future, making satisfactory rather than truly optimal choices around new technologies. The second outcome calls for transformational consumer education to accompany policy incentives.

By: Rahmat Poudineh , Anupama Sen