The Italian electricity market has been deregulated around 2004-05, but there has not been yet a comprehensive empirical analysis of the demand side. A crucial issue is estimation of demand elasticity, which is relevant for research about consumer behavior, market structure, as well as for guidance to the adoption of policy measure, ranging from taxation to welfare. I pursue two objectives in this paper. The first one is to construct a model behavior of electricity demand in the Italian market. The second objective is to measure demand elasticity at hourly level, directly from consumer behavior. In the previous literature (e.g. following Wolak 2003, Bollino-Polinori, 2008), demand elasticity estimation has been done constructing a residual demand curve, using the supply or offer bid data, in order to measure unilateral market power through the Lerner index.
Methodology and data
This paper takes a novel approach, providing the first attempt in the literature to estimate demand elasticity using demand data. Notably, I use demand bids data in the day-ahead market in the Italian Power Exchange (IPEX), from January 2005 to September 2011, reporting type of market, bid quantity and price, status of accepted or rejected, awarded prices, accepted quantity, status of marginal plant, zone, plant and producer ID, trader ID. In this market, individual bidders on the demand side (i.e., “consumers”) send to market organizer a bid consisting of a pair of price and quantity for each hour of the following day; quantity is expression of the amount of KWh that consumer wants to purchase (and is kept liable to consume); price is expression of the unit value of KWh that consumer intends to pay for that quantity. Using duality approach, in this paper I assume that for both residential and industrial consumers it is possible to postulate existence of a cost function for using electricity as a good “e” and a composite numerary good “y”, from which it is straightforward to derive a hourly demand function for electricity, using Shephard’s Lemma, which expresses quantity demand for electricity as a function of own price, other goods price and the objective variable (output or utility).
Expected results
Empirical analysis of the demand side in the Italian Electricity Markets sheds light upon price formation mechanism and it is a crucial tool for market regulators to pursue competition policies. Econometric estimation allows to ascertain that elasticity varies significantly with time of the day (it is different during peak hours w.r.t. to off peak hours) and with customer size (it is different for large electricity consumers w.r.t. to small ones). Another interesting issue is how elasticity varies along the demand curve. Estimation results show that elasticity is generally higher and tends to increase in the portion below the actual equilibrium price. This means that more competition on the supply side can yield lower equilibrium prices and proportionately much higher quantities, because a lower offer curve, shifted to the right, would intersect a flatter portion of the demand curve.