Rational, Lazy or Confused? Evidence of misperception in consumer responsiveness to nonlinear prices

Abstract

This paper examines how consumers respond to nonlinear prices. Using arich dataset that exploits a natural experiment on electricity consumers inBritish Columbia, I find evidence of households misunderstanding nonlinearprices—specifically that marginal price applies to all consumption, not simplyincremental. While small in number, these households have a large effectin aggregate, masking an otherwise predominant response to average price.Previously largely unexplored in the literature, misperception has importanteconomic and policy implications beyond electricity markets. I estimate thewelfare loss of these misperceiving households to be the equivalent of 10% ofannual electricity expenditure.