value of energy expected to be used or saved. A family decision to exchange a large “gas guzzler” automobile for a new fuel-efficient subcompact car can be regarded as an investment decision: for a capital investment of, say, $7,500 less trade-in, the family will be able to reduce its energy costs by a predictable annual amount. This sort of analysis underlies the practice of analyzing expenditures on energy-efficient technologies in terms of payback period or return on investment.
There are many ways an energy user might calculate the expected outcome from an energy investment. Economists generally argue that the best, most accurate index is the internal rate of return. This index is the interest rate that would make the present value of the stream of benefits expected from the investment equal to the initial cost of the investment. It is considered best because it takes into account the fact that a dollar now would grow if invested, and because rate of return allows easy comparisons with the value of alternative investments. An internal rate of return, however, is difficult to calculate, since it is the sum of a mathematical series. It requires careful mathematics and uncommon patience—for a small computer. In fact, many economic analyses of energy-efficiency investments have used more simplified indices, such as the present-value, time-discounted cost-benefit ratio or the payback period. If the most accurate index of the value of an investment is difficult even for economists to use, it is not surprising that few ordinary energy users do these calculations.
Individuals tend to quantify most household energy sources in dollars, rather than in energy units (Kempton and Montgomery, 1982). This difference in estimation procedures makes energy users behave very differently than an expert’s analysis would predict. Figure 3 shows two sets of calculations of a simple index of investment—the payback period from an investment that costs the equivalent of one year’s fuel cost and that cuts energy use by 30 percent. A payback period is the time it takes to recover the cost of investment through energy savings. The “expert model” shows that the initial cost of the investment is paid back faster if fuel prices increase, because more costly fuel is being saved. The “folk model,” by contrast, calculates savings in dollars compared to preinvestment expenditures. In this model, fuel price increases can quickly make a 30 percent fuel savings disappear because fuel bills return to their preinvestment levels. While this folk model may be demonstrably “irrational” in economic terms, it does follow logically from the method most commonly used by individuals to judge the effects of attempts to save energy. People who try to make rational calculations based on their own assumptions about energy would be led to make fewer energy-saving investments than an expert analyst would recommend. Not only would they interpret their investments as less effective than would an expert; they would also communicate this judgment to their friends. It is of little use to decry the unsophisticated