Friday, January 29, 2010

Introduce real time electricity pricing?

Prices are a wonderful mechanism to allocate scarse resources, especially as it is a really cheap mechanism compared to command and control. But there are times where the price mechanism is not good enough. Take for example congestion pricing. In principle, charging higher tolls when many people are on the road, or raising public transportation prices during peak times, should entice those who have other options to travel at other times or in other ways, thus reduceing the need to accomodate peek demad with oversized infrastructure. But this is only going to work if consumers are sufficiently price elastic and congestion pricing is not too expensive to implement.

The same reasoning would apply to residential electricity supply. Hunt Allcott studies this and comes to the conclusions that consumers are not sufficently price elastic to justify the additional metering costs. While households react to higher prices in peak periods, they do not adapt during more inexpensive off-peak periods. Thus, their welfare decreased. But seeing how large parts of the world have differentiated pricing for electricity and have remarkably adapted to this, for example with heating systems that accumulate heat in off-peak periods, one has to wonder whether there are multiple equilibria. Uniform pricing with no incentive to start an industry that takes advantage of off-peak periods, and congestion pricing where such an industry is in place. Maybe with some initial costs, a switch to congestion pricing could be worth it in the long run.

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