Rational Choices and Welfare Changes in Philippine Family Energy Demand: Evidence from Family Income and Expenditure Surveys

Abstract

Examining rationality of expenditures and analyzing welfare changes are interrelated because welfare change analysis is predicated on “rational” (i.e., expenditure-minimizing) responses to price and income changes. This study examined Philippine family demands for (1) electricity, (2) gas and liquid fuels, (3) solid fuels, (4) food, and (5) “others”—based on the Family Income and Expenditure Survey in 2009, 2012, and 2015—and found them rational. Specifically, own-price elasticities are negative (i.e., downward-sloping demand curves). Cross-price elasticities between (1), (2), and (3) are positive (i.e., substitutes, because of similar end-uses). Cross-price elasticities of (1), (2), and (3) with (4) or (5) are mostly negative (i.e., generally complements, because (1), (2), and (3) are used with (4) or (5)). Finally, income elasticities are positive, except for (3), implying that it is consumed less as income rises which is reasonable because (3) comprises “fuelwood and charcoal” that are consumed less by higher income households. The above elasticities yield a Hicks-Slutsky substitution matrix that is symmetric and negative semi-definite—the necessary and sufficient conditions for expenditure minimization—a finding probably unprecedented in a Philippine demand study. Therefore, the above results validate computing compensating variation (CV) and equivalent variation (EV) which are changes in compensated incomes (i.e., minimum expenditures) that maintain welfare after a change in prices. During 2009-2015, the aggregate price index (i.e., CPI) increased 3.08 percent annually to which price increases of energy, with a weight of 7.4 percent, contributed 0.23 percentage points, about equal to the mid-point CV and EV estimates from 0.18 to 0.30 percent of 2009 total expenditures. This CV or EV measures welfare losses from energy price increases assuming no change in total expenditures. However, total expenditures increased annually by over 3.0 percent which was more than enough compensation for welfare losses. But improved household energy end-use efficiency by “waste” reduction—in the 2011 Household Energy Consumption Survey—fully compensated the small welfare losses of 0.18 to 0.30 percent even without increasing total expenditures or investing in efficiency improvements. Waste exists because expenditure-minimizing “buyers” could be unwittingly wasteful as “users.”