1. University of Greenwich Business school MSc in Financial Management and Investment Analysis

2. Economics 1112 Economics for Finance and Investment Analysis

3. October 2008 Doc. 11 - Demand for energy ; some guidelines for coursework question one Dr M. Pourhosseini

4. Consumer and producer demand We can study demand for energy by considering the requirements of consumers and producers We can study demand for energy by considering the requirements of consumers and producers We define a two stage budgeting process We define a two stage budgeting process In stage one the consumers divide their budget between the demand for energy and other goods. In stage two they divide they energy budget between different fuels In stage one the consumers divide their budget between the demand for energy and other goods. In stage two they divide they energy budget between different fuels

5. CONSUMER Stage 1: The consumer must decide how to allocate total expenditure) between broad categories of consumption Energy (E) and other Goods (X) subject to the budget constraints: Stage 1: The consumer must decide how to allocate total expenditure) between broad categories of consumption Energy (E) and other Goods (X) subject to the budget constraints:

6. Consumer split expenditure between Gas and Electricity

7. PRODUCER Stage 1:A cost minimising firm will try to minimise the cost (C) of achieving its output target Q. It uses inputs capital (K ) and Energy (E) in combinations determined by their relative prices and target output : Stage 1:A cost minimising firm will try to minimise the cost (C) of achieving its output target Q. It uses inputs capital (K ) and Energy (E) in combinations determined by their relative prices and target output :

8. Producer split expenditure between Gas and Electricity

9. Derivation of elasticities We need a functional form to estimate price and income elasticities. We need a functional form to estimate price and income elasticities. A common model is a log-log (or linear in logs model A common model is a log-log (or linear in logs model We write a functional form and then estimate the elasticities We write a functional form and then estimate the elasticities

10. Log-Log( or Linear in logs model Log-Log( or Linear in logs model The first item is the nominal price of aggregate energy The first item is the nominal price of aggregate energy is the nominal price of other goods is the nominal price of other goods is nominal income is nominal income

11. Functional form and derivation of Elasticities : Log-Log Model We use this functional form We use this functional form Then we estimate Then we estimate 1. The own –price elasticity of energy demand 2. Income elasticity of energy demand 3. The cross-price elasticity of energy demand

12. The own –price elasticity of energy demand

13. Income elasticity of energy demand

14. The cross-price elasticity of energy demand

15. Imposing restrictions The present form allows for money illusion : The present form allows for money illusion : It is possible for It is possible for In other words : In other words :

16. Substitution restriction into the equation In other words In other words

17. Rearranging log log form

18. Partial Adjustment Model These elasticities can be used to estimate a Partial Adjustment Model (PAM) These elasticities can be used to estimate a Partial Adjustment Model (PAM) THE LOG-LOG MODEL MAY BE REDEFINED IN A TIME-SERIES CONTEXT THE LOG-LOG MODEL MAY BE REDEFINED IN A TIME-SERIES CONTEXT

19. Short term vs Long term elasticities PAM PAM Where Where