Response of residential electricity demand to price: The effect of measurement error

In this paper we present an empirical analysis of the residential demand for electricity using annual aggregate data at the state level for 48 US states from 1995 to 2007. Earlier literature has examined residential energy consumption at the state level using annual or monthly data, focusing on the variation in price elasticities of demand across states or regions, but has failed to recognize or address two major issues. The first is that, when fitting dynamic panel models, the lagged consumption term in the right-hand side of the demand equation is endogenous. This has resulted in potentially inconsistent estimates of the long-run price elasticity of demand. The second is that energy price is likely mismeasured. To address these issues, we estimate a dynamic partial adjustment model using the Kiviet corrected Least Square Dummy Variables (LSDV) (1995) and the Blundell-Bond (1998) estimators. We find that the long-term elasticities produced by the Blundell-Bond system GMM methods are largest, and that from the bias-corrected LSDV are greater than that from the conventional LSDV. From an energy policy point of view, the results obtained using the Blundell-Bond estimator where we instrument for price imply that a carbon tax or other price-based policy may be effective in discouraging residential electricity consumption and hence curbing greenhouse gas emissions in an electricity system mainly based on coal and gas power plants.