Heterogeneous (Mis-) Perceptions of Energy Costs: Implications for Measurement and Policy Design

Quantifying heterogeneity in consumers’ misperceptions of product costs is crucial for policy design. We illustrate this point in the context of energy-using durables, where a long-standing policy debate continues on whether taxes or standards are superior for regulating externalities. We derive formulae to quantify welfare effects for each instrument, accounting for misperceptions. Standards have a notable advantage over taxes. They reduce the variance of the misperceived attribute in the choice set, which reduces allocative inefficiencies. In the U.S. appliance market, standards dominate taxes across scenarios, and correctly characterizing misperception heterogeneity is less important for setting optimal standards than for taxes.