Improving Energy Demand Analysis (1984) / Chapter Skim
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2 The Effects of Price on Demand
2 The Effects of Price on Demand
Pages 27-42
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From page 27... ...
average price versus marginal price; (2) real price versus nominal price; (3)
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From page 28... ...
~ — DO CONSUMERS REACT TO AVERAGE OR MARGINAL PRICES? Although elementary economic analysis may lead one to believe that consumers respond to marginal prices, there is some behavioral evidence that householders, at least, do not seem to notice them.
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From page 29... ...
When marginal and average prices are different, the question arises as to which is more important in determining consumer behavior. The answer that can be derived from demand theory is both; theory also predicts that consumer demand will also be affected by the structure of lover the last decade many utilities have instituted "life-line" rates and other forms of inverted block pricing schedules.
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From page 30... ...
While the per-dollar effect of changed cost in lower consumption blocks is, in most 2 Indeed, Blattenburger (1977) has shown that, in theory, some changes in consumption can be induced by changing rate schedules, even though average and marginal prices remain unchanged.
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From page 31... ...
Rate schedules are currently undergoing major restructuring: declining block-rate schedules are rapidly being replaced by life-line rates, n inverted or increas1ng D10CK rates, and even tlme-ot-day seasonally adjusted flat rates. The divergence of average from marginal prices that may arise from these new structures may be much greater that that observed in the past for declining block rates, and responses to average prices may gain correspondingly in analytical importance.
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From page 32... ...
If consumers base their expenditures on real prices, proportionally equal increases or decreases in all nominal prices and incomes should leave the demand for all goods unaltered. Relationships that exhibit this property are termed "homogeneous of degree zero.
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From page 33... ...
While some possible aggregations of activities might tend to smooth out the production surface, it remains true that home production is complex and its outputs may not be representable by a smooth function of peak and off-peak electricity demand. Thus, it would be fortuitous if a single-valued continuous demand specification would yield results consistent with homogeneity (or any condition implied by demand theory except negativ
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From page 34... ...
Two other sources of evidence in economics may be pertinent to the question of responses to nominal price: macroeconomics and the study of equilibrium in single markets. In the macroeconomic literature, the issue of real versus nominal prices is generally cast in terms of differential perception of price and income changes.
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From page 35... ...
However, economists seem to agree that while the speed of reaction may well depend more on nominal prices, the overall reaction is constrained by real prices. The importance of the issue of consumer reaction to real versus nominal prices depends on the level and stability of the overall rate of price change.
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From page 36... ...
Thus, if consumers do base their decisions on expected prices and if they base their expectations on deviations of actual from expected prices, then both the level and the rate of change of prices should affect consumer reaction. The adaptive expectations model has been used numerous times in energy demand studies (see, e.g., Dahl, 1979; Hopthakker, Verleger, and Sheehan, 1974; Kwast, 1980; Taylor, 1978)
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From page 37... ...
Before concluding that the evidence supports the idea that consumers react to both price levels and price changes, we should note that Archibald and Gillingham's findings are subject to alternative interpretations. Their sample period ended in the first quarter of 1974, exactly the period in which the effects of the 1973 oil implies serial correlation of the errors and the partial adjustment mechanism does not.
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From page 38... ...
If the price-change variable is picking up the effects of the embargo, the implication might be not that consumers respond to price changes as well as levels, but that they are unwilling to reduce consumption when the price level is due to a (perhaps temporary) supply disruption.
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From page 39... ...
Experiments with alternative electricity rates, such as the time-of-use pricing experiments, could be used as tests if properly designed rate schedules were included among the experimental conditions. It might also be possible to illuminate the issue through analyses of panel data on electricity consumption because electricity rates often change in different proportions in different utility service areas.
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From page 40... ...
Similarly, the dynamics of consumer response are also likely to be affected differentially if real energy price changes are the result of changes in nominal energy prices or of changes in the nominal prices of other goods. We should note that all the hypotheses discussed in this chapter can easily be represented in terms usable in formal demand models.
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From page 41... ...
There may be enough independent variation in these data to determine the relative effects of real and nominal prices on energy demand. Furthermore, with data on the individual commodity prices upon which the indices are constructed, repeated measures of consumption over the same units of time -- such as is available in a crude form from the Panel Study of Income Dynamics and may in the future be available from the Residential Energy Consumption Survey (RECS)
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From page 42... ...
Furthermore, once a sample is created, it is valuable to maintain it by contacting sampled households on a regular basis. In short, to develop an adequate understanding of how price changes affect consumer behavior, it is important to conduct RECS and similar studies even during rather "dull" periods in which energy supplies are plentiful and prices stable.
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