On The Optimal Design of Demand Response Policies

We characterize the optimal regulatory policy to promote demand response in the electricity sector. Demand response arises when consumers reduce their purchases of electricity in times of peak demand, when the utility's marginal cost of supplying electricity is relatively high. The optimal policy differs systematically from the policy in the U.S. Federal Energy Regulatory Commission's (FERC's) Order 745. Under plausible conditions, implementation of the FERC's policy can reduce welfare substantially below the level secured by the optimal demand response policy.