Consumers' bounded rationality: The case of competitive energy markets

The recent liberalization of the energy industry provides a challenge for understanding the decision-making processes of the agents involved in their markets. In this new environment, it is of particular interest to investigate consumers' decisions with respect to energy efficiency for a range of purposes that include the assessment of government policy and traders' strategy intents. The neo-classic methodologies reported in the literature generally make strong, and not evident, assumptions with respect to the decision-making processes of end-users, including: complete information, full rationality and lack of risk perception. In this paper, the concept of bounded rationality is incorporated, seeking alternative grounds to the traditional approaches. Against this background, we examine different sets of assumptions based on the concept of rationally bounded energy use and propose policies that may reduce some of the apparent market failures. However, both these claims, as well as the proposed system dynamics models that intend to account for bounded rationality, need to be clearly justified. Here, we do this by indicating, explicitly and implicitly, how bounded rationality operates and what policies and strategies might be appropriate to remove some of the consumers' barriers when confronting decisions. The system dynamics models presented in this paper incorporate consumers' behaviour and alternative policies to assess their likely impact on society. Examples related to the penetration of fuels and lighting appliances are provided, to illustrate the approach. Copyright (C) 2004 John Wiley Sons, Ltd.