Economics Of Regulation And Restructuring Of Energy Industries Economics Essay
If future demand for electricity is to be matched by equal supply, so it is indispensable that theoretical accounts are built for gauging accurately, what the future demand for electricity is likely to be. In order to carry through this, it is necessary that the factors impacting electricity demand are clearly indentified and quantified. It is even more important in the instance of energy industries because, future energy demand requires investing disbursement today ( due to their immense capital investing demand and long lead clip ) .[ 1 ]In other words, if a state should undervalue its future electricity demand, so it would most likely non do equal capital investing in the present clip which would so ensue in a deficit of electricity supply ( when compared to demand ) in the hereafter.
One of the most influential factors impacting the demand for electricity is the monetary value of electricity.[ 2 ]The monetary value of electricity has since been incorporated into the bulk of electricity demand theoretical accounts.[ 3 ]This paper tries to analyze the effects of the monetary value of electricity in the UK on its ain electricity demand. The focal point here is to find the monetary value snap of demand for the period 1980-2008 ( one-year clip series informations ) by the usage of a loglinear arrested development theoretical account.
The research paper will take the undermentioned format. Chapter one is the debut, chapter two will be the literature reappraisal, chapter three will concentrate on the modeling attack and informations analysis and chapter four will be the decision and findings.
Harmonizing to economic theory there is an reverse relationship between the monetary value of energy and the measure of energy demanded. As energy monetary values rise the measure of energy demanded falls and frailty versa. Given that all other factors are held changeless[ 4 ]. Economic theory farther postulates that the demand for energy is non every bit antiphonal to the alterations in energy monetary values as compared to other trade goods that are more antiphonal to their single monetary values[ 5 ]. Economists define monetary value snap as consumer ‘s sensitiveness to monetary value alterations or the grade of reactivity of alterations in measure demanded to alterations in monetary values and is given by the expression below as:
Price Elasticity = % a?† in Quantity Demanded[ 6 ]
% a?† in Price
Where ; % a?†= Percentage Change
Since monetary value snap is the ratio of two per centums, we hence do non show it in any unit. Price snaps are normally negative this is due to the opposite relationship between demand and monetary value. Demand snaps are chiefly of two types which are ; elastic and inelastic. If the values of snap of demand autumn within the absolute values of 0 to 1 so demand is said to be inelastic and this can be interpreted therefore as a alteration in monetary value consequences in a less than proportionate alteration in measure demanded. On the other manus if the values of snap of demand peers to the absolute value of one or above one, so demand is said to be elastic. In the instance where snap of demand is equal to the absolute value of 1, it is interpreted as ; a alteration in monetary value leads to a proportionate alteration in measure demanded. If the snap of demand is greater than the absolute value of 1 so it is taken therefore as: a alteration in monetary value consequences in a more than a proportionate alteration in measure demanded. For illustration in the inelastic scope, if monetary value additions by 10 per centum on a trade good with a monetary value snap of -0.3 so the demand for the good falls by merely 3 per centum. However, in the instance of the elastic scope, a trade good with an snap of -2.0 would confront a autumn in demand of 20 per centum, if monetary value was to increase by 10 per centum. This relationship can be farther illustrated in the figure below.
Beginning: RAND TR292-1.1
Figure 1: Relationship of supply and demand with two demand curves
Figure 1 shows a supply curve ( S1 ) and two demand curves which have different snaps of demand ( D’1 and D1 ) . D’1 is more elastic than D1 ( i.e. less steeper ) . At equilibrium, the supply curve S1, with both demand curves D’1 and D1, have a common equilibrium monetary value and measure at P1 and Q1.Now, allow us now assume that the supply curve displacements to the left due to state an addition in the cost of production ( i.e. the monetary value of coal used to bring forth electricity ) . Then, the new equilibrium point will depend on the nature of the demand curve that is used as shown in figure 2. If the demand curve is comparatively elastic at ( D’1 ) , so monetary values will lift and demand will fall by a much larger sum when compared to the more inelastic demand curve ( D1 ) . Note here that with the inelastic demand curve, the monetary value and measure demanded ( P2 and Q2 ) are much larger than in the instance of a more elastic demand curve at ( P’2 and Q’2 ) . In world this can be explained by the fact that, if the demand for a trade good is inelastic so, any addition in costs ( for illustration coevals costs as mentioned above ) can easy be passed on to the consumers without much decrease in supply, therefore the larger monetary value. On the other manus if the demand for the trade good were to be elastic so merely a much smaller part of the cost addition would be passed on to the consumer.
Beginning: RAND TR292-1.2
Figure 2: Shows the effects of a displacement in the Supply Curve
We can besides see the effects of a displacement in the demand curve on monetary value and measure. If we assume that demand curves were to switch outward to the right ( i.e. additions ) from ( D1 to D2 ) and ( D’1 to D’2 ) while supply is held changeless so with a more elastic demand curve the equilibrium monetary value and measure ( P’2 and Q’2 ) would be much lower than if demand were to be inelastic ( i.e. P2 and Q2 ) .
Beginning: RAND TR292-1.3
Figure 3: Effectss of a displacement in the Demand Curve
From the three above illustrations it is rather clear that the resulting impact of alterations in supply or demand on equilibrium monetary value and measure will change in conformity to the nature of merchandise snap.
Monetary value snaps can be used to demo how consumer demand responds to alterations in monetary value every bit good as the easiness at which persons can exchange over to a replacement, when trade good monetary values travel up. A consumer who has a fixed income has three options of reacting to monetary value alterations in the short term ; ( a the consumer can exchange over to a replacement ; b ) they can buy less of the trade good without any extra purchase of a replacement ; or ( c he or she can still purchase the same measure of good while cut downing his or her ingestion of other trade goods that make up their entire outgo.
In the instance of electricity the grade at which it can be substituted is really limited. Electricity can be used chiefly for warming, buoy uping or a broad scope of electric contraptions such as ( computing machines, telecasting sets, pressmans, chainss etc. ) . In the instance of warming, a consumer may replace the usage of electricity for natural gas ( and in the instance of less developed states may even replace it for it for kerosine or firewood ) . However, the consumer besides has the option of exchanging over to an contraption that uses a more energy conserving beginning. For end utilizations such as power supply for telecasting sets, electricity has no replacements. The consumer besides has the option of buying a more efficient telecasting set and keeping the same degree of service while utilizing less electricity. Replacing contraptions such as telecasting sets may affect the alteration of a comparatively expensive contraption and as such would take some clip to make so. Since, this will affect a first initial capital spending which in bend depends on the income of the consumer, frequence of pay payment and payment of measures agendas etc. The clip period required by consumers to replace a comparatively expensive contraption in response to higher energy monetary values is normally referred to as the long-term accommodation clip period.
On this the footing of this analysis, it is expected that the monetary value snap of demand is normally inelastic in the short tally and more elastic in the long tally. This is because in the short tally the consumers options of reacting to higher electricity monetary values are limited i.e. he is restricted to reactions such as, cut downing his or her degree of contraption use ( for illustration running the warmer for lesser hours of the twenty-four hours ) or cut downing his outgo on other trade goods to keep the same degree of electricity ingestion. In the long tally nevertheless, his options of reacting to high energy monetary values are increased compared to the options he had in the short tally. In the long tally the consumer can to the full react to monetary value alterations by the purchase of contraptions that are more efficient and/or the purchase of contraptions that use a cheaper energy beginning. That is why in the long tally snaps tend toward a more elastic scope than in the short tally.
2.2 Earlier Literature on Price Elasticity of Electricity Demand
Earlier literature on electricity demand has revealed that the monetary value snap of demand for electricity is comparatively inelastic in the short tally and be given to be comparatively more elastic in the long tally. The old plants written on monetary value snap of demand are far excessively much to be to the full discussed in this research. Therefore we shall concentrate on merely the sum-up of a few.
Taylor ( 1975 ) wrote one of the first literatures on electricity demand studies. After transporting out reappraisals on assorted bing surveies of commercial, industrial and residential electricity demand, he reported the followers: ( a in the instance of residential demand for electricity, short term monetary value snap ranged from -0.13 to -0.90 while long tally monetary value snaps ranged from near 0 to -2.0. In the instance of commercial demand, monetary value snaps were valued at -0.17 for the short tally and -1.36 for the long tally[ 7 ].
Boone kamp ( 2007 ) utilizing the underside up theoretical account on an one-year information series for the period 1990-2000 reported that the family long term monetary value snap ranged from -0.09 to – 0.13[ 8 ].
Pouris ( 1987 ) conducted an analysis for the snap of demand for electricity for South Africa utilizing informations for the period ( 1950-1983 ) and determined that the long term monetary value snap of electricity demand for the period was -0.90.[ 9 ]
Bjoner and Jensen ( 2002 ) utilizing a loglinear fixed effects theoretical account on panel informations for the period of ( 1983-1996 ) discovered that short term monetary value snap to be -0.479.[ 10 ]
Filippini and Pachuari ( 2002 ) utilizing a loglinear theoretical account on a monthly family panel informations series discovered that the family short term monetary value snap for electricity ranged from -0.16 to – 0.39.[ 11 ]
Zimmerman and Bohi ( 1984 ) carried out a elaborate reappraisal of bing surveies of energy demand. They reported that general consensus figures for residential monetary value snap of electricity were -0.2 in the short tally and -0.7 in the long tally. The scope of estimations in commercial electricity was excessively volatile to supply any consensus on values.[ 12 ]
Al Faris ( 2002 ) used an mistake rectification theoretical account to gauge short term monetary value snap for UAE, Kuwait, Oman, Qatar and Bahrain to run from-0.04 to- 0.18.[ 13 ]
The analysis carried out was based on an one-year clip series informations for the period 1970-1997.
Garcia Cerruti ( 2000 ) calculated the monetary value snap for residential demand for electricity in California to hold an estimated average value of -0.17.[ 14 ]
In drumhead, earlier literature show that monetary value snap of electricity demand are usually inelastic in the short tally and tends to be more elastic in the long tally. However, on the whole monetary value snap of electricity demand are normally inelastic ( i.e. the absolute value of the co-efficient of monetary value snap is normally below 1 ) .
Modeling APPROACH AND DATA ANALYSIS
Harmonizing to Lin ( 2003 )[ 15 ]he identified that there were three major factors impacting the demand for electricity in any state which were, electricity monetary values ( duty ) , GDP ( Gross Domestic Product ) and population. He went farther to state that there were other factors as good lending to the monetary value of electricity which varied with different states. Such factors includes nature of conditions ( i.e. people tend to utilize more electricity for heating intents during cold seasons than in hot seasons ) and alterations in the construction of the economic system.
Pouris ( 1987 )[ 16 ]identified the two major factors impacting the demand for electricity as monetary value and GDP.
Using the common independent variables identified by both Lin and Pouris, we have the undermentioned theoretical account ;
Log EDt = I± + b1LogPEt + b2 LogYt +Aµ — — — — — — — Equation
EDt = Total electricity demand in period in a given twelvemonth ( Gwh )
PEt = Average monetary value of electricity in changeless footings for a given twelvemonth ( ?/Kwh )
Yt = GDP of state for period T in changeless Billion Pounds
I± = Constant
b1 =Price snap of electricity demand
b2 =Income snap of electricity demand
Aµ= Disturbance term ( represents all other factors impacting the demand for electricity )
We use the log functional signifier because it enables us easy find the
monetary value snap for electricity demand which is the arrested development coefficient of monetary value. The monetary value snap of demand for electricity is besides assumed to be changeless.[ 17 ]
The informations used for the period is in changeless footings and aggregated at the national degree. We express our informations in changeless footings because we would wish to take out the effects of rising prices. The information used is aggregated at a national degree because it tends to supply a more stable relationship between independent and dependent variables. Pouris ( 1987 )[ 18 ]cited Ehrenberg ‘s ( 1975 )[ 19 ]work in which he ( Ehrenberg ) argued that the progresss in physical scientific disciplines are to a great extent due to the fact that simple relationships ( Torahs ) are accomplishable because they normally account for the corporate behavior of million entities. Pouris ( 1987 ) so argued further that, the success of happening Torahs in societal scientific disciplines would be in likely countries where behavior of big persons or objects can be aggregated.
We so execute a arrested development analysis utilizing existent electricity monetary value and existent GDP as independent variables for electricity demand. We have the undermentioned consequence ;
& lt ; 0.0001
Assurance Interval 95 %
Arrested development Table
& lt ; 0.0001
Log ( Real GDP ( ? ) )
& lt ; 0.0001
Log ( Real Electricity Prices ?/Kwh ) – 0.145353929 0.04605721 -3.1559 0.0040 – 0.240025887 -0.050681971
From the above tabular array we can see that the monetary value snap of demand for electricity ( for the UK ) is about -0.15 which agrees with economic theory that ;
( a snaps of demand are reciprocally related to monetary value as shown by the negative coefficient of monetary value snap and ( b monetary value snap of demand for electricity tends to be inelastic i.e. holding an absolute value below one.
Besides we do non reject the consequence due to the high R2 = 0.9688 ( co-efficient of finding ) and the fact that the consequence is statistically important i.e. the absolute T values for existent GDP and existent electricity monetary values are above 2. While their ( existent GDP and existent electricity monetary values ) P values are below 5 % .
The tabular array below shows the informations ( for U.K. ) used in transporting out the arrested development analysis.
Table 1: Shows the Real GDP, Real Electricity Prices and Demand for Electricity ( U.K ) during the period 1980-2008.
The demand for electricity informations and mean electricity monetary values were sourced from the Economic and Social Data Services ( ESDS ) web site. While the Real GDP and Consumer monetary values were obtained from the International Monetary Fund ( IMF ) web site
The monetary value snap of electricity demand for the period ( 2008-2020 ) is about -0.15, which is consistent with economic theory that the co-efficient of monetary value snaps tend to hold negative values and that the monetary value snaps for electricity tend to be inelastic. If we assume that the monetary value snap for all organisation and persons in the U.K. lies near to this value ( -0.15 ) and is changeless through out clip, so such information could hold assorted deductions for the economic system.
First, an inelastic demand for electricity, would intend that there would be small or no authorities intercession required on the supply side ( bing manufacturers and providers ) to guarantee that manufacturers and providers of electricity are able to breakeven ( retrieve costs from generated gross ) . This is because an inelastic demand for electricity ( with regard to monetary value ) would intend that whenever there is an addition in demand and manufacturers have to increase their supply in order to fit the lifting demand, the costs associated with increasing supply can easy be passed on to the consumer. As such, the authorities could be able to concentrate on other activities such as the proviso and care of public roads, infirmary, and schools.
Second, it would enable the authorities easy achieve renewable energy marks set in the power bring forthing sector, due to the fact that the possible additions in costs originating from puting renewable energy marks can easy be transferred to the consumer ( due to inelastic nature of electricity demand ) . The authorities should nevertheless guarantee that the marks are set in a just chief mode such that the impact of the marks are felt by all power generators in a similar manner and that no undue advantage is given to any one individual manufacturer due to the execution of such marks. Furthermore the authorities should guarantee that the marks are set in such a manner that it does non increase duties excessively much so that consumers can non easy afford their measures. Which in bend would so cut down demand drastically ( since the consumers in the short tally have the option of turning of their contraptions ) and therefore, adversely affect supply as manufacturers may non be able to retrieve all their fixed cost. If this consequence ( lifting monetary values drastically impacting demand ) is ineluctable so the authorities should follow policies that could help in bettering the disposable income of its citizens.