This is why paternalism exists

The gulf between theoretical, efficient markets and real markets never ceases to surprise me. This paper from 2005 evaluates the saving consumers were able to make on their power bill by switching plans:

…we find that the subsets of consumers who claimed to be switching exclusively for price reasons appropriated only between 26-39% of the maximum gains available through their choice of new supplier. While such behaviour can be explained by the existence of high search costs, the observation that 27-38% of the consumers actually reduced their surplus as a result of switching cannot.

Yes, among people who switched to save money they only saved a third of what was available to them. A third of the people who switched actually increased their bill.  The authors rule out a number of explanations to conclude that these people just got it wrong because figuring out optimal tariffs is quite tricky. And these are the people who are actively switching and evaluating tariffs, so this is what market success looks like!Outcomes like this make us instinctively want to provide some sort of expert assistance or intervention to help these people. Unfortunately, regulating to ‘fix’ problems like this one is exceptionally difficult because every household has different needs. What it might point to is the need for thoughtful default options because, when engaged consumers are this poor at selecting the best option, what hope is there for those who are not actively comparing tariffs?

2 replies
  1. PaulL
    PaulL says:

    Or, arguably, it could show a market opening for a company that:

    a) creates a set of simple to understand plans, and
    b) helps their customers to select the best plan, and
    c) surveys their customers success so their ads can say “97% of people switching to us save money, only 30% of people switching to our competition save money and in fact 30% of people lose money”

    At which point the market has self corrected this abysmal situation.

    Of course, this would never happen in the real world. Sigh.

    • jamesz
      jamesz says:

      It is interesting in an energy market that has a lot of retail competition. I think it reinforces the idea that the outcomes of a competitive market may occur in the limits but are rarely likely to be observed.

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