Price elasticity of electricity demand in China– A new instrument variable based on marketization policy

Abstract

Estimating the price elasticity of the demand for electricity is important in research on the economics of electricity. However, the conventional approach of using average electricity prices as explanatory variables introduces endogenous challenges, such as measurement errors and reverse causality. In this study, we provide a novel analysis of China's coal and electricity marketization process, investigating the impact of coal marketization on electricity prices. To overcome the endogeneity issue, we employ an instrumental variable (IV) method that leverages exogenous variations in average electricity prices induced by the coal marketization policy. The results indicate that the ordinary least squares (OLS) method underestimates the price elasticity of the demand for electricity by ignoring the fluctuations in coal prices. These results carry significant policy implications for countries considering energy marketization reforms as a solution to their energy challenges. Moreover, our research offers an innovative approach to address endogeneity, contributing to the methodological advancement of the field.