An economic welfare analysis of demand response in the PJM electricity market

We analyze the economic properties of the economic demand-response (DR) program in the PJM electricity market in the United States using DR market data. PJM's program provided subsidies to customers who reduced load in response to price signals. The program incorporated a "trigger point", at a locational marginal price of $75/MWh, at or beyond which payments for load reduction included a subsidy payment. Particularly during peak hours, such a program saves money for the system, but the subsidies involved introduce distortions into the market. We simulate demand-side bidding into the PJM market, and compare the social welfare gains with the subsidies paid to price-responsive load using load and price data for year 2006. The largest economic effect is wealth transfers from generators to non price-responsive loads. Based on the incentive payment structure that was in effect through the end of 2007, we estimate that the social welfare gains exceed the distortions introduced by the subsidies. Lowering the trigger point increases the transfer from generators to consumers, but may result in the subsidy outweighing the social welfare gains due to load curtailment. We estimate that the socially optimal range for the incentive trigger point would be $66-77/MWh.