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Misunderstanding Nonlinear Prices: Evidence from a Natural Experiment on Residential Electricity Demand

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  • Blake Shaffer

Abstract

This paper examines how consumers respond to nonlinear prices. Exploiting a natural experiment with electricity consumers in British Columbia, I find evidence that some households severely misunderstand nonlinear prices—incorrectly perceiving that the marginal price applies to all consumption, not simply the last unit. While small in number, the exaggerated responses by these households have a large effect in aggregate, masking an otherwise predominant response to average price. Largely unexplored in the literature, this type of misunderstanding has important economic, policy, and methodological implications beyond electricity markets. I estimate the welfare loss for these households to be the equivalent of 10 percent of annual electricity expenditure.

Suggested Citation

  • Blake Shaffer, 2020. "Misunderstanding Nonlinear Prices: Evidence from a Natural Experiment on Residential Electricity Demand," American Economic Journal: Economic Policy, American Economic Association, vol. 12(3), pages 433-461, August.
    • Handle: RePEc:aea:aejpol:v:12:y:2020:i:3:p:433-61
    DOI: 10.1257/pol.20180061
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    More about this item

    JEL classification:

    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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