Misunderstanding Nonlinear Prices: Evidence from a Natural Experiment on Residential Electricity Demand
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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.Citation
Shaffer, Blake. 2020. "Misunderstanding Nonlinear Prices: Evidence from a Natural Experiment on Residential Electricity Demand." American Economic Journal: Economic Policy, 12 (3): 433-61. DOI: 10.1257/pol.20180061Additional Materials
JEL Classification
- D12 Consumer Economics: Empirical Analysis
- L11 Production, Pricing, and Market Structure; Size Distribution of Firms
- L94 Electric Utilities
- Q41 Energy: Demand and Supply; Prices
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