The impact of price on residential demand for electricity and natural gas

Abstract

Climate change will affect the demand of many resources that households consume, including electricity and natural gas. Although price is considered an effective tool for controlling demand for many resources that households consume, including electricity and natural gas, there is disagreement about the exact magnitude of the price elasticity. Part of the problem is that demand is confounded by block pricing and the interrelated consumption of electricity and natural gas, which prevent easy estimation of price impacts. Block pricing suggests that the purchaser controls the marginal price of a commodity by the quantity purchased, turning price into an endogenous variable. Interrelated consumption indicates that demand for one resource is affected by the price of another. These complications have made difficult the estimation of the price elasticity of demand for resources and consequently the household-level impact of climate change, which will affect resource supplies. This paper evaluates statistical tools for estimating the joint demand for natural gas and electricity when both resources face a block price setting and develops estimates of own and cross price elasticity. We use data from the Federal Residential Energy Consumption Survey, along with utility price data, to estimate the household demand for electricity and natural gas in California as separate commodities. We then use a joint estimation procedure to evaluate the household demand for natural gas and electricity. Finally, we evaluate the degree to which block pricing and interrelated demand affect the price elasticity of demand for the two resources. The paper ends by noting the continuing uncertainty surrounding the use of price to manage household demand for electricity and natural gas.