Demand response in the retail electricity market

We develop a microeconomic model of the electricity consumer designed to provide insight and a template for simulations of consumer reaction to electricity price changes. We use game theory and illustrate its use in the context of a specific type of electricity Demand-Reduction Program that is popular in the current electricity industry. In this program, the retailer provides participating consumers (who pay fixed, regulated retail prices) with subsidies in return for voluntary reduction of consumption during periods of high wholesale market prices and/or low reserve rate of electricity supply. We find the optimal per-unit subsidies from both the consumer and retailer points of view and solve the game in which buyer and seller interact to determine program participation, the amount of the subsidy, and the amount of load reduction. We also show the empirical case study to support our theoretical model. The results confirm that the retailer’s profit-maximizing subsidy depends upon the wholesale price, and consequent fluctuations in the subsidy link retail and wholesale prices to induce greater demand-side price responsiveness in wholesale markets. Moreover, the responsiveness of electricity consumption to electricity price changes is greater when wholesale prices, consumer income, prior consumption, and supply elasticity are higher, and when retail prices are lower.