Measuring Demand Responses to Wholesale Electricity Prices Using Market Power Indices
47 Pages Posted: 31 Mar 2016
Date Written: March 30, 2016
We investigate wholesale demand response to hourly price movements in the Ontario wholesale electricity market using detailed generator and market level data. We calculate hourly market power measures such as the Lerner Index and the Residual Supplier Index, which are utilized in a Cournot competition model to structurally estimate price elasticity of demand during peak hours of days, seasons and years. We find that price elasticities are small and statistically significant, and they exhibit large variations over the times of days/seasons and show differences over the years. For instance, while the elasticity estimates fall into the range [-0.021, -0.133] in 2007, they are in the interval of [-0.013, -0.053] in 2008. We also extend the study period to include 2006 (during which extreme weather conditions occurred) and 2009 (when the economic crisis hit and natural gas prices plummeted) to measure the demand responses to irregular price movements and find that price elasticities during the economic crisis were higher than a year earlier. Comparing high demand winter hours to high demand summer hours indicates that consumers’ price responsiveness is lower in summer than in winter during 2006-2009. Moreover, we employ these indices along with the estimated price elasticities to project the likely impact of interconnection capacity expansions on market prices. Our calibrations show that even a small amount of transmission investment (and hence trade activity) can result in substantial market price reductions. In addition, we discuss how our approach could be used to estimate price elasticities for other goods such as crude oil and gasoline.
Keywords: Price elasticity of demand; wholesale electricity market; Cournot competition; GMM estimation
JEL Classification: D22; D24; L13; L94; Q41
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