Asymmetry of information and demand response incentives in energy markets

Abstract

The price set in electricity markets is given by the intersection of supply and demand during a given time period. The demand-side has traditionally been a price taker while the supply-side actively adjusts the output of the market clearing unit to fluctuations in consumption. Currently, there is a transition toward active demand participation that can adequately respond to market conditions. However, private knowledge of demand adjustments, such as the impact of modifying behavior or the availability to do so, creates asymmetry of information between the active supply side and the passive demand. This paper proposes a revelation mechanism that will prompt the demand-side to choose the best option for themselves among a menu of incentives. Rational behavior of consumers implies that demand will only shift when the benefit of doing so is higher than the costs of modifying consumption patterns. Given differences among demand participants and the objectives of the market operator, an analysis of the rationale of each market agent shows the feasible options for demand incentives. This study enables the design of appropriate market mechanisms aimed to discover customer categories and determine the adequate incentives for each case.