Basicwomen's Blog

{October 27, 2010}   What NYC Air Conditioners Tell Us About Marginal Incentives

Not enough is being said about marginal incentives in discussions on greenhouse gases. In economics, a marginal incentive is what motivates you or me to consume one more of something. So if you’re at a buffet where you pay a flat rate for ‘all-u-can-eat,’ then you have a strong marginal incentive to get another plate of food (your physical capacity to eat and health consciousness not withstanding) because you essentially only pay for your first plate—the second and third and fourth plates are basically free. But if for dessert you then go to a frozen yogurt place where you have to pay for each topping and ounce of froyo, you have much weaker marginal incentives because you’ll have to pay more per every item you add on.

This distinction is crucially important if we ever want to reduce carbon emissions.

About a week ago, the Times published a story on how people with utilities included in their rent are using an absurd amount of power this summer. Since they don’t have to pay for power, they will let their air conditioners run endlessly:

“Forget round-the-clock doormen or views of Central Park. This sweltering summer, the most coveted New York real estate amenity is two little words that in other times can go unnoticed: ‘utilities included.’ Mr. Perlo and his neighbors live in a building where not just heat and hot water, but electricity, is part of their monthly rent — a more-common-than-you’d-think arrangement caused by old-fashioned wiring in which a building has a single “master meter” tracking power use rather than individual meters tied to each tenant. They can blast their air-conditioners all summer long without paying a dollar extra.”

The story goes on about people—professedly eco-conscious people—who leave their air conditioners on while they’re away so they can come home to a chilly apartment, or so that their cats can enjoy the cool.

That should sound completely irrational, but from an economist’s point-of-view, it isn’t. Since these tenants pay the same whether they keep their air conditioners on or off, they might as well be lavish. They’re incentivized to be wasteful, and their only crime is wanting the most bang for their buck.

But in such situations, the environmental impact is often forgotten. I chalk it up to a tragedy-of-the-commons type mentality—each person figures that their contribution to environmental harm is small, but once everybody thinks along those lines you have an aggregate impact that’s quite large.

According to the article, roughly 250,000 apartments in the city include utilities in their rent, including Stuy Town. Each one expends on average 30 percent more electricity than a pay-for-power counterpart. What’s more is that residential buildings account for 39 percent of the city’s carbon emissions, and 40 percent of the energy those buildings use comes from heating and cooling alone.

A few hundred thousand New York City apartments may not single-handedly cause catastrophic global warming to tumble forth. But it’s an exemplary part of a larger pattern of how people can be wasteful without the right marginal incentives. We can see this pattern everywhere, from college dorms and dining halls to apartments with free hot water to failed recycling initiatives.

From a purely environmental stance, misguided marginal incentives are depressingly ubiquitous. From a consumer’s perspective though, such “misguided” incentives are usually quite valuable. Who could resist the lure of unlimited utilities?

Still, marginal incentives have to, and will be, a major aspect of reducing emissions. And at the end of the day, people will respond to incentives, whether or not they’re as desirable as other set-ups. Changing our lifestyle to reduce our carbon footprints may never be easy, but if somehow the steps we have to take offer the strongest marginal incentives, then we will collectively do it.

How could society provide these incentives?

We would have to reward people not only for being green but also for being greener. The more steps they take, the more benefits they should be given. This is possible because marginal incentives can be increasing or decreasing.

So, for example, we could have a progressive power system where high power usage means higher prices per kilowatt (to appease customers, this would have to pair with a per-joule price reduction on the lower end of the scale). If this could reduce the overall demand for power, it would bring down carbon dioxide emissions from power plants. At the same time, people and corporations could be given marginal tax incentives to increase their support of alternative energy (for instance the more alternative energy they use the more they’ll get back per kilowatt).

Since driving is the second largest contributor to greenhouse gases, car buyers can get a tax break for the first hybrid they purchase and an even larger one for their second. The same could be done for used cars. Similar thinking could also be applied to cattle farms, the third biggest contributor to global warming.

Such new, green marginal incentives can, in addition to being increasing or decreasing, be targeted as broadly or narrowly as we want. They can focus on a specific good or an entire industry. If the government (the only body who would have this kind of power) does it right, we can have a network of complimentary marginal incentives to encourage people to make more environmentally-sound decisions.

In the end, when you think about marginal incentives you’re thinking about scale. And since we need to cut down a substantial quantity of our emissions, people need economic incentives to continue being green, rather than to commit a single green act.

Of course, political realities will make redefining marginal incentives a much more complicated process than it may appear here. It can be done, but how exactly to accomplish it should probably be the subject of another article.

Or book.

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