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Dan Ariely asks: Why do we buy a Toyota Prius but won't invest in making our homes more energy efficient, when the financial payback and CO2 saving from house improvements would be greater?

He suggests three factors:

The first is that we remember the price of gas at the pump, and seeing the gas price every time we fuel-up makes it more psychologically painful to drive a less efficient car. The second is that when we drive a Prius it acts as a constant reminder of how little we spend on gas compared to all the cars driving around us–providing us with positive comparison. The third is that we project a positive social image when other people see us driving a socially conscious car. Homes don’t have any of these features.

In a thoughtful response, Felix Salmon suggests another reason, derived from recent experience from the mortgage market:

When people took out 3/1 mortgages, they didn't worry about the resets often because they had no intention of staying in their house for the full three years. And in that kind of context, home improvements which only pay back over the long term are much less attractive: it's the people you sell to who will get most of the benefit with none of the cost.

My suspicion is that Dan's third explanation is the correct one: it's all about the psychology. If you look at the market share data, you'll find that the Prius has an astonishing 50% share of the hybrid market.

The reason for that is that the Prius is only available as a hybrid, whereas most other hybrids come also in non-hybrid options. The Prius is therefore instantly recognizable as a hybrid. That results in strong sales among people who want to be seen owning a hybrid, and want to be consciously reminded themselves that they are driving a hybrid. In other words, the psychology of owning a hybrid (and being seen to own a hybrid) is having a huge impact on which hybrids are selling, irrespective of price.

If you apply that to the question of home improvements, it would explain why people won't invest in insulation when that would save more CO2. Nobody can see how much roof insulation you have, and you can even forget it yourself (except when the bill arrives).

What are the implications for alternative energy stocks? The message from the Prius is actually great news. As far as I know, every form of alternative energy is more expensive than conventional energy (particularly if you remove the government subsidies). If the decision to use alternative energy was purely economic, nobody would do it until the relative price falls.

But concerns about the environment and future energy prices are enough to incentivize people to adopt green technology even if it's not economical now. The key, however, is that these technologies must be packaged for the end user so it's obvious to everyone that this is a green product, not just a "hybrid under the hood". People will pay more to be green, as long as it's obvious to them and their neighbors that they're green.

So next time you hear someone complaining about solar panels being too obtrusive, think again.

Source: Lessons from the Toyota Prius for Alt Energy Stocks