Minimal adjustment costs, factor demands, and seasonal time-of-use electricity rates

In time-of-use (TOU) pricing schemes, utilities charge rates that depend on the time of day and the season of the year at which electricity is used. Estimates of the effects of TOU rates on business customers in the US and Israel have differed widely; however, the actual response by business customers in the aggregate is very small. Most firms do not appear to respond at all, but those that do respond make substantial adjustments to newly introduced TOU rates. In this paper we show that adjustment costs associated with changing the level of employment can explain the observed pattern of behavior in the US and Israel. We develop a model that predicts whether a firm will respond to the introduction of TOU rates, and show that the 'average' firm in the US and Israel is unlikely to respond to the current TOU rate schedules. Moreover, the more often the price structure changes during the year, the less likely are firms employing only one labor shift to respond. We apply our model to TOU rates in the US and Israel and show that it predicts the actual response to these rates quite well.