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It might well be that if they were properly informed, consumers and firms, on their own and without the incentives of a tax, would reduce their use of fossil fuels. Why might this be the case? Consider the option of replacing incandescent light bulbs with LED bulbs, which are far more energy efficient. [...] While LED bulbs are more expensive than incandescent bulbs, the savings in electricity usage are so large that the LED bulbs will usually pay for themselves in a year or two and thus save money. So, with almost no effort and little or no cost, consumers (and firms) can reduce energy consumption (and thus reduce CO2 emissions by electric power plants). They just need to be properly informed in order to be incentivized to change their light bulbs. Likewise, energy consumption can be reduced if consumers are better informed about the cost savings of better insulation, “smart” thermostats, and so on. This is where behavioral economics comes into play in the design of public policy. If the policy objective is to reduce energy use, we need to understand how people’s behavior affects the decisions they make regarding energy. If consumers were fully rational and utility-maximizing, they would make the effort on their own to learn about the cost savings from LED light bulbs and then act accordingly by switching to LED bulbs. But that’s asking too much of consumers. Instead, one element of public policy would be to educate consumers about LED bulbs, perhaps through paid advertisements or even classes on “home economics and finance” in schools and colleges. The behavioral approach to public policy is illustrated in Figure 19.6 [...]. In this figure, an industry emits a pollutant, so there is a marginal external cost of industry output, given by the curve MEC. The marginal social cost of industry output, MSC, is the sum of the marginal private cost (MC) and the marginal external cost. Industry output is therefore too large: Q1 instead of the socially optimal output Q2. One solution to this problem would be to impose a tax, t, which would equate the marginal social and private costs. But suppose that with a bit of education, consumers and firms would realize that they can save money by reducing their emissions of the pollutant. That would lower the marginal external cost curve (from MEC to MEC’ in the figure) and likewise lower the marginal social cost curve (to MSC’). Output might still be too large (in the figure, Q3 instead of Q2), but a much smaller tax (t* instead of t) would be needed to correct the problem. In the case of CO2 emissions and climate change, there are other ways that consumers and firms might be induced to reduce their energy consumption. One example would be moral persuasion. If consumers were convinced that they have a moral obligation to conserve energy (even if doing so was inconvenient or costly), they might indeed reduce their energy consumption.
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Other policy options might alter (and hopefully improve) the environment in which individuals make choices. For example, one option might be to change the default option available to consumers. In the light bulb example, local ordinances might require stores to make incandescent bulbs available only upon request. Another option might be for stores to be encouraged or even required to feature LED bulbs prominently but to make incandescent bulbs less visible. Finally, stores might be required to simplify consumer choices by displaying signage that clearly describes the advantages of LED bulbs over incandescent bulbs. All of these policy options change the environment in which consumers make choices. Giving consumers a “nudge” in the direction of choices that they would likely make if fully informed can help them to maximize utility.