Price Elastic Demand in Deregulated Electricity Markets

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The degree to which any deregulated market functions efficiently often depends on the ability of market agents to respond quickly to fluctuating conditions. Many restructured electricity markets, however, experience high prices caused by supply shortages and little demand side response. We examine the implications for market operations when a risk adverse retailer's end use consumers are allowed to perceive real time variations in the electricity spot price. Using a market equilibrium model we find that price elasticity both increases the retailer's revenue risk exposure and decreases the spot price. Since the latter induces the retailer to reduce forward electricity purchases while the former has the opposite effect, the overall impact of price responsive demand on the electricity forward price is ambiguous. Indeed, each retailer's response depends on the relative magnitudes of its risk exposure and end user price elasticity. Nevertheless, price elasticity decreases cumulative electricity consumption. By extending the analysis to allow for early settlement of demand, we find that forward stage end user price responsiveness decreases the electricity forward price relative to the case with price elastic demand only in real time. Moreover, we find that only if forward stage end user demand is price elastic will the equilibrium electricity forward price be reduced.

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