Free Slides from Ed Dolan’s
Econ Blog http://dolanecon.blogspot.com/ A Natural Experiment in Demand Elasticity: Metered vs. Unmetered Electricity Post prepared August 17, 2010 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.

NYC Electric Rates as a
Natural Experiment <ul><li>Economists can’t always conduct controlled experiments, but sometimes experiments occur naturally </li></ul><ul><li>New York City electric rates provide an example </li></ul><ul><ul><li>About 1.75 million apartments have electric meters.* </li></ul></ul><ul><ul><li>The average price per kilowatt hour is about 21 cents, among the highest in the country </li></ul></ul><ul><ul><li>About 250,000 apartments have unlimited electric power included in the rent, with no meters* </li></ul></ul><ul><li>What can we learn from this case? </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Stuyvesant Town Apartments, New York City Photo by David Shankbone http://commons.wikimedia.org/wiki/File:Stuyvesant_Town_in_New_York_City.jpg Some of the information in these slides is based on Sam Dolnick, “Air-Conditioners that Run When Nobody’s Home,” New York Times Aug. 16, 2010, p. A13 st=csehttp://www.nytimes.com/2010/08/16/nyregion/16chill.html?_r=1&scp=3&sq=sam%20dolnick&

Three Hypotheses about Demand Elasticity
<ul><li>Three hypotheses to consider: </li></ul><ul><li>Demand for electricity is perfectly inelastic </li></ul><ul><li>Elasticity of demand for electricity is constant at all P and Q </li></ul><ul><li>Electricity demand curve is a straight line with varying elasticity </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Picture source: http://commons.wikimedia.org/wiki/File:ElectricMeter.jpg

Perfectly Inelastic Demand? <ul><li>Hypothesis 1:
Demand for electricity is perfectly inelastic </li></ul><ul><li>Quantity does not vary when price changes </li></ul><ul><li>Value of elasticity = 0 </li></ul><ul><li>Demand curve is a vertical line </li></ul><ul><li>A price increase would not be an effective incentive for conservation </li></ul><ul><li>This hypothesis is rarely favored by economists but it is implicit in many popular discussions of economic policy </li></ul><ul><li>Have you ever heard someone say something like this? </li></ul><ul><li>“ Increasing the price of electricity wouldn’t do any good for promoting conservation. Rich people can afford to use as much as they want no matter what it costs. And poor people would still need electricity for daily needs. Raising the price would just make them even poorer.” </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Constant Elasticity of Demand? <ul><li>Hypothesis
2: Electricity demand has constant elasticity for all P and Q </li></ul><ul><li>Because of their convenient mathematical form, constant elasticity demand curves are often used in statistical studies </li></ul><ul><li>Such a curve does not touch the axes </li></ul><ul><ul><li>Implies that there is no limit to demand when the good is free (P=0) </li></ul></ul><ul><ul><li>Implies at least some of the good will be bought no matter how high the price </li></ul></ul><ul><li>The equation for a constant-elasticity demand curve is Q=Ap e , where Q is quantity, p is price, e is elasticity, and A is a constant </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Linear Demand? <ul><li>Hypothesis 3: The
demand curve for electricity is a straight line </li></ul><ul><li>Elasticity of a linear demand curve decreases as one moves down the curve </li></ul><ul><li>A linear demand curve intersects both axes </li></ul><ul><ul><li>Above some maximum price, quantity demanded is zero </li></ul></ul><ul><ul><li>There is a finite quantity demanded even at a price of zero </li></ul></ul><ul><li>Textbooks often show linear demand curves, maybe just because they are easier draw </li></ul><ul><li>Example of a linear demand curve </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Observations from the NYC Experiment
<ul><li>People use more electricity when unlimited use is included in the rent and there is no meter </li></ul><ul><li>Some individuals use electricity very wastefully when it is not metered </li></ul><ul><li>Still, there is a limit to wasteful use. Total electric use in unmetered apartments is only about 30 percent greater than use in metered apartments </li></ul><ul><li>“ My A.C. is pretty much running 24/7.” 28-year-old TV producer with no meter, who likes to keep a cool apartment for his cat </li></ul><ul><li>A young couple recently left their A.C. on for four days in July when they left town for a funeral. They wanted to come home to a cool apartment. </li></ul><ul><li>“ Using [the A.C.] when you’re not home is downright irresponsible and disrespectful to the rest of us.” Dan Hendrick, NY League of Conservation Voters </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Quotes from article by Sam Dolnick, “Air-Conditioners that Run When Nobody’s Home,” New York Times Aug. 16, 2010, p. A13 st=csehttp://www.nytimes.com/2010/08/16/nyregion/16chill.html?_r=1&scp=3&sq=sam%20dolnick&

Conclusions from the NYC Experiment
<ul><li>People use more electricity when it is “free,” in the sense that unlimited electricity is included in the rent, with no meter </li></ul><ul><li>Some people use electricity very wastefully when it is not metered </li></ul><ul><li>However, total electric use in non-metered apartments is only about 30 percent greater than use in unmetered apartments </li></ul><ul><li>On balance, the hypothesis of a linear demand curve fits the observations better than zero or constant elasticity </li></ul><ul><li>Metering electricity does provide an effective incentive for conservation </li></ul><ul><li>Although some people do use electricity wastefully when it is “free,” demand is by no means unlimited. The demand curve does intersect the horizontal axis. </li></ul>Post P100817 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/