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Consumer Behavior and Risk Aversion

Auto manufacturers have known and surveys confirm that consumers require short payback periods (2-4 years) for investments in fuel economy. Using societal discount rates, engineering-economic generally find substantial potential to increase fuel economy, cost-effectively. This phenomenon, often referred to as the ?energy paradox?, has been observed in nearly all consumers? choices of energy-using durable goods. Loss aversion, perhaps the most well established theory of behavioral economics, provides a compelling explanation. Engineering economic analyses generally overlook the fact that consumers? investments in fuel economy are not sure things but rather risky bets. Future energy prices, real world on-road fuel economy, and many other factors are uncertain. Loss aversion describes a fundamental human tendency to exaggerate the potential for loss relative to gain when faced with a risky bet. It provides a sufficient explanation for consumers? apparently short payback requirements and the market?s tendency to undervalue future energy savings relative to their expected value. Implications for the market for high-efficiency vehicles are explored.

David L. Greene, Oak Ridge National Laboratory

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