Pricing and Informality: Evidence from Energy Theft in Brazil

In certain settings, goods can be consumed outside of formal markets (e.g.: theft, counterfeit, or illegal sharing of subscriptions). When the share of informality is large, firms’ pricing decisions can be substantially affected, as the extensive margin - customers migrating to informal consumption - makes demand more elastic. We study this question in the context of electricity theft in Brazil, where stolen energy can represent more than 50% of the total formal market. We use detailed micro data from a major electric utility to estimate a structural model where consumers choose if they want to be formal or informal and then, how much to consume. For identification, we leverage a natural experiment where prices increased permanently to a set of consumers. We use the model to simulate counterfactual scenarios where: (i) theft is not possible, and (ii) the firm uses different pricing strategies. We find that the presence of informality increases the elasticity of demand from 0.24 to 0.39, and reduces monopoly optimal prices by 10.4%. Eliminating theft altogether would allow the firm to reduce prices by 17.7% while keeping profits constant. We also find that price discrimination is an effective tool to reduce informality rates.