Price and income elasticities of electricity in China: Estimation and policy implications

Abstract

AbstractChina has been reforming the energy sector, especially the electricity industry. One of the important aims is to reform the cross‐subsidies (the industrial sector has been subsidizing the residential sector for decades), which requires policy‐makers have a good understanding of price and income elasticities of electricity. However, few studies have estimated China's price and income elasticities of electricity, partly due to limited micro data. This study estimates price and income elasticities of electricity in China using AIDS (almost ideal demand system) demand model, which is consistent with consumer theory and more flexible than other regression models. The AIDS demand model is estimated using provincial‐level data from 2006 to 2016 and the estimation results show that the uncompensated price elasticity is −0.062, and the estimated income elasticity of residents is 0.889. To better understand the welfare implications of cross‐subsidies, which requires an estimate of the price elasticity of demand in the industrial sector. Based on the estimated price elasticity of electricity, we simulate the consumer surplus under different pricing mechanisms. Ramsey pricing, as expected, generated the larger consumer surplus than actual pricing mechanism, which would provide guidance for the price reform of China's power industry.