page_title: Demand response
section_title: Electricity pricing
hierarchical_section_title: Demand response / Electricity pricing
caption_attribution_description: Equilibrium price under demand inelastaic and elastic demand
context_page_description: Demand response is a change in the power consumption of an electric utility customer to better match the demand for power with the supply. Until recently electric energy could not be easily stored, so utilities have traditionally matched demand and supply by throttling the production rate of their power plants, taking generating units on or off line, or importing power from other utilities. There are limits to what can be achieved on the supply side, because some generating units can take a long time to come up to full power, some units may be very expensive to operate, and demand can at times be greater than the capacity of all the available power plants put together. Demand response seeks to adjust the demand for power instead of adjusting the supply.
  Utilities may signal demand requests to their customers in a variety of ways, including simple off-peak metering, in which power is cheaper at certain times of the day, and smart metering, in which explicit requests or changes in price can be communicated to customers.
context_section_description: In most electric power systems, some or all consumers pay a fixed price per unit of electricity independent of the cost of production at the time of consumption. The consumer price may be established by the government or a regulator, and typically represents an average cost per unit of production over a given timeframe (for example, a year). Consumption therefore is not sensitive to the cost of production in the short term (e.g. on an hourly basis). In economic terms, consumers' usage of electricity is inelastic in short time frames since the consumers do not face the actual price of production; if consumers were to face the short run costs of production they would be more inclined to change their use of electricity in reaction to those price signals.  A pure economist might extrapolate the concept to hypothesize that consumers served under these fixed-rate tariffs are endowed with theoretical "call options" on electricity, though in reality, like any other business, the customer is simply buying what is on offer at the agreed price.  A customer in a department store buying a $10 item at 9.00 am might notice 10 sales staff on the floor but only one occupied serving him or her, while at 3.00 pm the customer could buy the same $10 article and notice all 10 sales staff occupied.  In a similar manner, the department store cost of sales at 9.00 am might therefore be 5-10 times that of its cost of sales at 3.00 pm, but it would be far-fetched to claim that the customer, by not paying significantly more for the article at 9.00 am than at 3.00 pm, had a 'call option' on the $10 article.
  In virtually all power systems electricity is produced by generators that are dispatched in merit order, i.e., generators with the lowest marginal cost (lowest variable cost of production) are used first, followed by the next cheapest, etc., until the instantaneous electricity demand is satisfied. In most power systems the wholesale price of electricity will be equal to the marginal cost of the highest cost generator that is injecting energy, which will vary with the level of demand. Thus the variation in pricing can be significant: for example, in Ontario between August and September 2006, wholesale prices (in Canadian Dollars) paid to producers ranged from a peak of $318 per MW·h to a minimum of - (negative) $3.10 per MW·h.  It is not unusual for the price to vary by a factor of two to five due to the daily demand cycle.  A negative price indicates that producers were being charged to provide electricity to the grid (and consumers paying real-time pricing may have actually received a rebate for consuming electricity during this period).  This generally occurs at night when demand falls to a level where all generators are operating at their minimum output levels and some of them must be shut down.  The negative price is the inducement to bring about these shutdowns in a least-cost manner.
  Two Carnegie Mellon studies in 2006 looked at the importance of demand response for the electricity industry in general terms and with specific application of real-time pricing for consumers for the PJM Interconnection Regional Transmission authority, serving 65 million customers in the US with 180 gigawatts of generating capacity. The latter study found that even small shifts in peak demand would have a large effect on savings to consumers and avoided costs for additional peak capacity: a 1% shift in peak demand would result in savings of 3.9%, billions of dollars at the system level. An approximately 10% reduction in peak demand (achievable depending on the elasticity of demand) would result in systems savings of between $8 to $28 billion.
  In a discussion paper, Ahmad Faruqui, a principal with the Brattle Group, estimates that a 5 percent reduction in US peak electricity demand could produce approximately $35 billion in cost savings over a 20-year period, exclusive of the cost of the metering and communications needed to implement the dynamic pricing needed to achieve these reductions.  While the net benefits would be significantly less than the claimed $35 b
caption: Explanation of demand response effects on a quantity (Q) - price (P) graph. Under inelastic demand (D1) extremely high price (P1) may result on a strained electricity market.
  If demand response measures are employed the demand becomes more elastic (D2). A much lower price will result in the market (P2).
  
  It is estimated[14] that a 5% lowering of demand would result in a 50% price reduction during the peak hours of the California electricity crisis in 2000/2001. The market also becomes more resilient to intentional withdrawal of offers from the supply side.
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