Empirical analysis of the spot market implications of price-elastic demand

Regardless of the form of restructuring, deregulated electricity industries share one common feature: the absence of any
significant, rapid demand-side response to the wholesale (or, spot market) price. For a variety of reasons, electricity
industries continue to charge most consumers an average cost based on regulated retail tariff from the era of vertical integration, even as the retailers themselves are forced to purchase electricity at volatile wholesale prices set in open markets. This results in considerable price risk for retailers, who are sometimes forbidden by regulators from signing hedging contracts. More importantly, because end-users do not perceive real-time (or even hourly or daily) fluctuations in the wholesale price of electricity, they have no incentive to adjust their consumption in response to price signals. Consequently, demand for electricity is highly inelastic, and electricity generation resources can be stretched to the point where system
stability is threatened. This, then, facilitates many other problems associated with electricity markets, such as market power and price volatility. Indeed, economic theory suggests that even modestly price-responsive demand can remove the stress on generation resources and decrease spot prices. To test this theory, we use actual generator bid data from the New York
control area to construct supply stacks, and intersect them with demand curves of various slopes to approximate different
levels of demand elasticity. We then estimate the potential impact of real-time pricing on the equilibrium spot price and
quantity. These results indicate the immediate benefits that could be derived from a more price-elastic demand. Such
analysis can provide policymakers with a measure of how effective price-elastic demand can potentially reduce prices and
maintain consumption within the capability of generation resources.