The Problem with Price Elasticity and Electricity Rate Design

Abstract

For both electric utilities and regulators that oversee them, it is the elephant in the room—the issue that can never be discussed or even acknowledged. I am referring to price elasticity of demand. When a utility goes in for a rate case and is allowed a certain increase in revenue requirements—and consequently an increase in electricity rates—to cover approved changes in cost of service, the utility's representatives rarely ask the regulatory commission to consider a further increase to compensate for usage reductions stemming from consumer reactions to the price increase. The increase already approved usually came about after a contentious hearing involving intervenors challenging the level of the increase, or even whether any increase at all should have been allowed, and it was usually a hard‐fought battle. I once asked a utility employee who had worked on rate cases if the subject of price elasticity ever surfaced during the hearings, and he replied that it was just generally assumed—by both the utility and the regulator—that price elasticity does not exist. The issues already under discussion and debate in the rate case were more than enough for the utility to contend with.