Estimating demand response in an extreme block pricing environment: Evidence from Korea's electricity pricing system, 2005–2014

Abstract

Standard consumer theory predicts that under block pricing, quantities consumed should bunch below block thresholds where marginal prices rise. However, researchers have previously found little or no evidence of bunching. In this study, I examine whether consumers respond to the marginal prices by using a different form of block pricing, one that includes both marginal price and fixed charge increases at the threshold, called increasing fixed-charge block pricing. Under this pricing schedule, the price increase at the threshold is more salient compared to the standard block pricing due to the increase in fixed charge. As a result, consumers are predicted to bunch below the thresholds and generate a zero density hole above the thresholds. I empirically test this by using the case in South Korea and find evidence that consumers tended to respond to price increase at the thresholds in 2005 and 2006. The considerable consumer bunching is observed around the thresholds. However, this evidence suddenly disappears after 2007 and never returned. While the reasons for this disappearance are not fully understood, the absence of consumer bunching suggests that consumers tend to respond to alternative pricing schedules rather than marginal price even with salient marginal price increases at the threshold.