The Use and Misuse of Average and Marginal Energy Prices: Implications for Climate Policy

Many governments and institutions use marginal price signals, such as fuel and carbon taxes, to meet emission reduction targets. However, the responses of firms and individuals to these price signals are often calculated using average prices commonly reported in economic data, rather than marginal prices. This paper first documents that the marginal price of electricity paid by U.S. manufacturing plants is 50% lower than the average price. To do so, we construct a novel dataset of both average and marginal electricity prices, and the wedge between these, using plant-level microdata from the U.S. Census and utility-level electricity rate schedules for over two hundred utilities. Second, we provide guidance on when average prices are an appropriate proxy for marginal prices in price elasticities by identifying economic and geographic characteristics that predict variation in this wedge. Overall, the magnitude of this wedge suggests that the standard use of average energy prices to calculate responses to carbon taxes may underestimate the energy price increases needed to meet emissions targets by 50%.