The demand for electricity is more elastic in the long run than in the short run because

Abstract

In this paper we employ a dataset of three dimensions—state, sector, and year—to estimate the short- and long-run price elasticities of state-level electricity demand in the United States. Our sample covers the period 2003–2015. We contribute to the literature by employing instrumental variable estimation approaches, using the between estimator, and pursuing panel specifications that enable us to control for multiple dimensions of fixed effects. We conclude that state-level electricity demand is very price inelastic in the short run, with a same-year elasticity of −0.1. The long-run elasticity is near −1, larger than often believed. Among the sectors, it is industry that has the largest long-run price elasticity of demand. This appears to in part be due to electricity-intensive industrial activities clustering in low-price states.

Journal Information

The Energy Journal is the official quarterly journal of the International Association for Energy Economics. It was founded in 1980 to promote the advancement and dissemination of knowledge concerning energy, economics and related topics. The editors strive to publish a blend of theoretical, empirical and policy related papers in energy economics. Each quarterly issue (250 pages) contains original refereed articles, short notes, and book reviews on energy related topics.  Some of the topics covered in this publication include:  Energy & environmental issues, Petroleum matters (upstream & downstream), electricity markets, energy & developing countries, natural gas topics, gasoline demand analysis, OPEC and oil markets, renewable energy, energy policy issues, coal topics, distributed generation, econometric modeling, alternative transportation fuels, energy efficiency, regulatory economics, energy taxation, market power issues, interfuel substitution, nuclear power issues, transportation, emissions trading (SO2, CO2) and carbon emissions reduction, etc.  Impact Factor: 1.857.

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The International Association for Energy Economics (IAEE), founded in 1977, is a worldwide non-profit professional organization with members in over 100 nations.  The organization provides an interdisciplinary forum for the exchange of ideas, experience and issues among professionals interested in energy economics. IAEE publishes three periodicals. The Energy Journal is a quarterly, academic publication; Economics of Energy & Environmental Policy is a semi annual publication; the IAEE Energy Forum (newsletter) delivers the latest information on the association, and contains articles that appeal to a general audience interested in the energy field. The association holds an International Energy Conference each year. Past meetings have taken place in cities such as Rome, Quebec, New Delhi, Budapest, Washington D.C. and Copenhagen. These conferences attract delegates and speakers from around the world, and from some of the most influential government, corporate and academic circles. Membership in IAEE is open to anyone who has an interest in the field of energy economics. 

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Now that you have a general idea of what elasticity is, let’s consider some of the factors that can help us predict whether demand for a product is likely to be elastic or inelastic. The following are important considerations:

• Substitutes: Price elasticity of demand is fundamentally about substitutes. If it’s easy to find a substitute product when the price of a product increases, the demand will be more elastic. If there are few or no alternatives, demand will be less elastic.
• Necessities vs. luxuries: A necessity is something you absolutely must have, almost regardless of the price. A luxury is something that would be nice to have, but it’s not absolutely necessary. Consider the elasticity of demand for cookies. A buyer may enjoy a cookie, but it doesn’t fulfill a critical need the way a snow shovel after a blizzard or a life-saving drug does. In general, the greater the necessity of the product, the less elastic, or more inelastic, the demand will be, because substitutes are limited. The more luxurious the product is, the more elastic demand will be.
• Share of the consumer’s budget: If a product takes up a large share of a consumer’s budget, even a small percentage increase in price may make it prohibitively expensive to many buyers. Take rental housing that’s located close to downtown. Such housing might cost half of one’s budget. A small percentage increase in rent could cause renters to relocate to cheaper housing in the suburbs, rather than reduce their spending on food, utilities, and other necessities. Therefore the larger the share of an item in one’s budget, the more price elastic demand is likely to be. By contrast, suppose the local grocery store increased the price of toothpicks by 50 percent. Since toothpicks represent such a small part of a consumer’s budget, even a significant increase in price is likely to have only a small effect on demand. Thus, the smaller the share of an item in one’s budget, the more price inelastic demand is likely to be.
• Short run versus long run: Price elasticity of demand is usually lower in the short run, before consumers have much time to react, than in the long run, when they have greater opportunity to find substitute goods. Thus, demand is more price elastic in the long run than in the short run.
• Competitive dynamics: Goods that can only be produced by one supplier generally have inelastic demand, while products that exist in a competitive marketplace have elastic demand. This is because a competitive marketplace offers more options for the buyer.

With these considerations in mind, take a moment to see if you can figure out which of the following products have elastic demand and which have inelastic demand. It may be helpful to remember that when the buyer is insensitive to price, demand is inelastic.

• Gasoline
• College textbooks
• Coffee
• Airline tickets
• Concert tickets
• Soft drinks
• Medical procedures

Self Check: Explaining Elasticity

Answer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not count toward your grade in the class, and you can retake it an unlimited number of times.

You’ll have more success on the Self Check if you’ve completed the two Readings in this section.

Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.

Why is demand likely to be more elastic in the long run than in the short run?

Would the Price elasticity of demand for electricity be more elastic over a shorter or longer?

Why is the supply curve more elastic in the long run than in the short run multiple choice question?

Is the demand for electricity elastic or inelastic in the short run in the long run?