Haas Newsroom

Heat or Eat? UC Berkeley Haas School of Business Professor Catherine Wolfram Finds Some Households Cut Spending When Energy Costs Rise

April 26, 2006

Media Contacts:
Ute S. Frey
UC Berkeley Haas School of Business

Ronna Kelly
UC Berkeley Haas School of Business

The rise in home energy bills this winter meant that some households were likely eating out less and cutting back on other spending, according to research by UC Berkeley Haas School of Business Associate Professor Catherine Wolfram.

In a working paper co-authored with Julie Berry Cullen of UC San Diego and Leora Friedberg of the University of Virginia, Wolfram found that households without savings cut back their spending by roughly 40 cents for each dollar that they didn’t expect on their energy bills.

In their paper, “Consumption and Changes in Home Energy Costs: How Prevalent Is the ‘Heat or Eat’ Decision?”, the trio distinguished between anticipated changes in energy spending – for instance because it is winter in the Northeast – from those that are unanticipated – for instance because it is an unusually cold winter. Using data from the Consumer Expenditure Survey from 1990 to 2002, they also divided a sample of 53,241 households between those with and without substantial financial assets.

“The people who had savings didn’t change their consumption,” says Wolfram, a member of the Haas Economic Analysis and Policy Group. “But the people without savings had to take it out of somewhere when energy bills unexpectedly spiked.”

Households without savings didn’t reduce spending on food, Wolfram notes. Instead, they cut spending on other nondurable goods – including entertainment, eating out, and personal care items – when higher energy bills were unanticipated.

The findings are particularly relevant to the experience of consumers this past winter, when households were hit by an unexpected increase in energy bills. For instance, in the San Francisco Bay Area, utility PG&E forewarned consumers of a 20% increase in natural gas rates in the fall. But then Hurricanes Katrina and Rita struck, prompting the utility to warn of an even bigger 40% jump in winter gas bills.

“Households spend enough on home energy that variation in fuel prices and weather can require a significant adjustment elsewhere in the budget,” Wolfram and her co-authors conclude. “This is especially true for poor and elderly households.”

They note that poor and elderly households spend a greater proportion of their budget on energy. The median household below the poverty line spends 7.2% of its budget on energy, while poor households with elderly members spend more on energy at every income level. By comparison, the median of all households spends about 5% of their budget on energy.

They point out several reasons why low-income households spend a greater portion of their budget on energy: Low-income dwellings are less well-insulated, and low-income consumers are less likely to use gas and more likely to use an inefficient heating source such as electricity, bulk fuels, or wood.

The bulk of Wolfram’s research has centered on the electricity industry, taking her to countries such as Norway and the United Kingdom that have been ahead of the US on deregulation. She also has investigated pharmaceutical pricing in response to the threat of government intervention.