Ito, Koichiro “Do Consumers Respond to Marginal or Average Price: Evidence from Nonlinear Electricity Pricing” (Revised October 2012) (Revised version published in American Economic Review, 104(2): 537-63, 2014), WP-210: Full Paper
Nonlinear pricing and taxation complicate economic decisions by creating multiple marginal prices for the same good. This paper provides a framework to uncover consumers’ perceived price of nonlinear price schedules. I exploit price variation at spatial discontinuities in electric service areas, where households in the same city experience substantially different nonlinear pricing. Using household-level panel data from administrative records, I find strong evidence that consumers respond to average price rather than marginal or expected marginal price. This sub-optimizing behavior makes nonlinear pricing unsuccessful in achieving its policy goal of energy conservation and critically changes the welfare implications of nonlinear pricing.