Energy Policy 39 (2011) 5519–5527

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Energy Policy
journal homepage: www.elsevier.com/locate/enpol

Income and price elasticities of electricity demand: Aggregate and

sector-wise analyses
Faisal Jamil n, Eatzaz Ahmad
School of Economics, Quaid-e-Azam University, Islamabad, Pakistan

a r t i c l e i n f o abstract

Article history: Cointegration and vector error correction modeling approaches are widely used in electricity demand
Received 24 March 2011 analysis. The study rigorously examines the determinants of electricity demand at aggregate and
Accepted 10 May 2011 sectoral levels in Pakistan. In the backdrop of severe electricity shortages, our empirical findings give
Available online 1 June 2011
support to the existence of a stable long-run relationship among the variables and indicate that
Keywords: electricity demand is elastic in the long run to both income and price at aggregate level. At sectoral
Electricity demand level, long-run income and price elasticity estimates follow this pattern except in agricultural sector,
VECM where electricity demand is found elastic to output but inelastic to electricity price. On the contrary, the
Price elasticity coefficients for income and price are rather small and mostly insignificant in the short run. We
employed temperature index, price of diesel oil and capital stock at aggregate and sectoral levels as
exogenous variables. These variables account for most of the variations in electricity demand in the
short run. It shows that mechanization of the economy significantly affect the electricity demand at
macro level. Moreover, elastic electricity demand with respect to electricity price in most of the sectors
implies that electricity price as a policy tool can be used for efficient use and conservation.
& 2011 Elsevier Ltd. All rights reserved.

1. Introduction
Electricity demand is a derived demand, resulting from the
desire for output or activity in question. Its consumption does not
yield utility by itself, but is used as an input in other processes
that give utility. For example, in hot summer days, the demand for
cooling the space and water rises. Since the cooling appliances
such as refrigerators and air-conditioners require electricity to
operate, its consumption rises during peak summer. The demand
for electricity like other goods essentially depends on income and
price among various other factors.
The major objective of electricity demand analysis is to obtain
estimates of income and price elasticity. The elasticity estimates
are equally important for policy makers, planners and managers
of electric utilities. Policy implications emanating from the
analysis depend upon the stability of electricity demand function.
A stable electricity demand function implies the existence of
theoretical relationship between the concerned variables. Main-
taining adequate electricity generating capacity to meet the real
time demand requires the electric utilities to have in-hand
demand estimates and reliable demand forecasts. The demand
elasticities may also help the regulators in decisions regarding the
effects of tax and subsidy on electricity.
n
Corresponding author. Tel.: þ92 3337416577; fax: þ92 51 9211391.
E-mail addresses: fsljml@hotmail.com (F. Jamil),
eatzaz@qau.edu.pk (E. Ahmad).
During the past few decades, demand for electricity has been
the focus of many empirical studies (see for example, the survey
article by Taylor (1975), and various other studies including
Bentzen and Engsted (1993), Beenstock et al. (1999), Fatai et al.
(2003) and Hotledahl and Joutz (2004)). Typically, these
studies relate electricity consumption to a variety of economic,
demographic and meteorological variables to get estimates of
short- and long-run elasticities. The advancement in time series
econometrics has resulted in methodological improvement in
electricity demand analysis.
The main objective of this paper is to empirically analyze the
electricity demand in Pakistan during the period 1961–2008
using annual aggregate and sector-wise data for residential,
commercial, manufacturing and agricultural sectors. These sec-
tors in total consume more than 80% of electricity sold in
Pakistan.1 The study employs the Johansen’s approach to coin-
tegration and vector error correction model (ECM) for estimating
elasticities. The results of this study show that variables are
cointegrated and that all models exhibit elasticity of electricity
demand with respect to real economic activity and price greater
than one in the long run with the exception of price elasticity of
electricity demand in agricultural sector model. Electricity
demand elasticity with respect to electricity price is much lower,
perhaps due to highly subsidized nature of electricity tariff rate
1
See WAPDA (2009).

0301-4215/$ - see front matter & 2011 Elsevier Ltd. All rights reserved.
doi:10.1016/j.enpol.2011.05.010
5520 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527
for agricultural sector prevailing in Pakistan. An important impli-
cation of high income elasticity is that when income level rises,
the demand for electricity is also expected to rise. Pakistan is
passing through a worse electricity crisis of the history and these
findings show that electricity supplying capacity needs to be
managed keeping in view the overall economic activity and
prudent use of price policy of electricity.
The paper is organized as follows. Section 2 presents brief
survey of literature on electricity demand. Methodology and data
are described in Section 3, while Section 4 presents the results
and discussion. Section 5 concludes the findings of the study.
2. Survey of literature
Considerable interest on the part of planners in particular and
academicians in general spawned a number of studies on elec-
tricity demand. The literature on electricity demand has improved
in terms of model specification, choice of variables as determi-
nants of demand and estimation techniques. A conventional
demand model comprises of income, own price and prices of
substitutes as explanatory variables. Several studies show that
electricity demand is income elastic and price inelastic, showing
that consumers consider it a normal good and a necessity (see, for
example, Fatai et al., 2003; Hotledahl and Joutz, 2004;
Hondroyiannis, 2004; Zachariadis and Pashourtidou, 2007;
Amarawickrama and Hunt, 2008).
There are many studies on energy demand for countries of
different geographical and economic backgrounds as shown in
Table 1. A substantial amount of effort in the literature has been
directed to sort out econometric modeling techniques that better
identify the relationship of electricity consumption with its
determinants. Earlier studies tend to estimate the demand func-
tion through single equation approach, ignoring possible simul-
taneity among the variables. Moreover, details of electric
appliances are explicitly used in earlier studies (see, for example,
Taylor, 1975). Later, partial adjustment modeling framework, in
which desired electricity consumption is used instead of capital
stock details became popular (for example, Kamerschen and
Porter, 2004; Rapanos and Polemis, 2006). Partial adjustment
model permits the estimation of both short- and long-run
elasticities.
Numerous studies investigate electricity demand specifically
in residential sector. Although the literature on electricity
demand analysis is not limited to residential sector only, yet it
comprises a good part of it.2 The electricity demand in residential
sector can be characterized as the use for daily services such as
lighting, refrigeration, washing, ironing, cooking and entertain-
ment and weather related services like using for the purpose of
heating and cooling the space and water. It motivates researchers
to incorporate the most relevant factors to electricity demand in
their analyses. Different studies use different sets of variables for
explaining the variation in electricity consumption. In general, the
variables used in electricity demand analysis can be arranged as
economic, demographic and weather and energy related
variables.
In an early energy demand study on Pakistan, Iqbal (1983)
estimates the income and price elasticities of residential electri-
city and natural gas demand. The results of the study show that in
case of electricity only income elasticity while, in case of natural
gas, both income and price elasticities are statistically significant.
2
See, for instance, Silk and Joutz (1997), Beenstock et al. (1999), Fatai et al.
(2003), Hotledahl and Joutz (2004), Hondroyiannis (2004), Halicioglu (2007) and
Zachariadis and Pashourtidou (2007). All these studies explicitly estimate elec-
tricity demand models in residential sector.
The availability of energy substitutes and possibility of realloca-
tion of resources from one form of energy to another is greater in
the long run than in the short run.
Some of the studies in recent past compare various methodol-
ogies of energy demand modeling and end up with different
results (see, for example, Beenstock et al., 1999; Clements and
Madlener, 1999; Fatai et al., 2003; Rao, 2007; Amarawickrama
and Hunt, 2008). Amarawickrama and Hunt (2008) employ six
techniques and compare the elasticities to explore the effect of
using different econometric estimation techniques. The findings
show some degree of variation in the preferred specification and
the resulting coefficients. The estimated long-run income and
price elasticities range from 1.0 to 2.0 and 0 to  0.6, respectively,
and the future demand forecasts up to the year 2025 obtained
through different techniques turn out to be fairly similar.
Methodological debates are a routine in research and it is
difficult to reach a definite conclusion because chances are rare
for empirical verifications consistently favoring one particular
approach. That is why there is no single preferred approach for
estimating econometric models especially from non-stationary
data (Beenstock et al., 1999). ECM has been widely used in
electricity demand analysis, especially because it provides a
dynamic relationship between electricity consumption and its
various determinants. In the recent past, autoregressive distrib-
uted lag (ARDL) models have attracted the researchers to the
study of energy demand. However, Clements and Madlener
(1999), Bentzen and Engsted (2001) and Fatai et al. (2003) suggest
that ARDL and Johansen approach give similar results both
qualitatively and quantitatively. Rao (2007) suggests that general
to specific (GTS) approach adequately summaries data and
captures the data generating process. He examines the alternative
techniques to estimate time series models including GTS, Vector
Autoregressive (VAR) and ECM, and concludes that ECM specifica-
tion has advantage over the alternative approaches. Fatai et al.
(2003), however, finds that new ARDL approach has better
forecasting performance than all other approaches considered.
One characteristic of ARDL approach is that it does not need pre-
testing for the order of integration of the variables, though
variables of different order of integration are unlikely to be
cointegrated.
The above review of literature on energy demand suggests that
the major determinants of electricity in almost all countries are
output or real GDP, price of electricity and temperature. More-
over, a few studies have employed the price of energy substitute
such as oil, gas and LPG. The substitution possibilities of these
fuels are considerably low especially, in residential sector, hence
the cross price elasticity is found insignificant in most of the
studies. In residential sector models, real mortgage interest rate
(Silk and Joutz, 1997) and urbanization (Hotledahl and Joutz,
2004) are found to be significant. The use of only aggregate or
residential data in most of earlier studies is an obvious limitation.
We capture sectoral aspects of electricity demand in our sectoral
demand models, which provide an interesting extension to the
existing literature. This study covers four sectors and examines
the factors relevant to each particular sector.
3. Econometric methodology and data
Electricity is demanded for end-use services it provides. The
factors that affect the economic activity and consumption pat-
terns will affect the electricity demand. For example, the policies
of public utilities of providing subsidized electricity to some
under-privileged sectors and rural electrification programs might
have increased access as well as induced additional electricity
consumption (Berndt and Samaniego, 1984). Electricity demand
 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527 5521

Table 1
List of studies reviewed.

Study Country Data period Methodology Short run Long run

Income Price Income Price

elasticity elasticity elasticity elasticity

Iqbal (1983) Pakistan 1960–1981 Ordinary least square (OLS) 0.85  0.06 2.94  0.22
Bentzen and Engsted Denmark 1948–1990 Cointegration and error correction model 0.67  0.14 1.21  0.47
(1993)
Silk and Joutz (1997) United 1949–1993 Cointegration and error correction model 0.38  0.63 0.52  0.48
States
Beenstock et al. (1999) Israel 1965–1995 Johansen maximum likelihood – – 0.99  0.43
(Quarterly)
Bentzen and Engsted Denmark 1960–1996 Autoregressive distributed lag model – – 1.29  1.03
(2001) Ordinary least square (OLS) – – 1.21  0.79
Johansen maximum likelihood – – 1.11  0.93
Non-linear least square – – 1.14  0.87
Dynamic OLS – – 1.12  0.88
Fatai et al. (2003) New 1960–1999 Engle–Granger 0.46  0.24 1.24  0.55
Zealand Autoregressive distributed lag model 0.24  0.18 0.81  0.59
Full modified least square 0.46  0.19 1.14  0.44
Lin (2003) China 1952–2001 Cointegration and error correction model 0.86  0.04 – –
1978–2001 0.78  0.02 – –
Hotledahl and Joutz (2004) Taiwan 1955–1996 Cointegration and error correction model 0.22  0.15 1.57  0.15
Hondroyiannis (2004) Greece 1986–1999 Cointegration and error correction model – – 1.56  0.41
(Monthly)
De Vita et al. (2006) Namibia 1980–2002 Bounds testing approach to cointegration within – – 1.27  0.34
(Quarterly) ARDL MODEL – – 0.59  0.30
– – 1.08  0.86
– – 2.08  0.11
Rapanos and Polemis Greece 1965–1999 0.79  0.31 1.54  0.60
(2006)
Halicioglu (2007) Turkey 1968–2005 Bounds testing approach to cointegration within 0.44  0.33 0.70  0.52
ARDL model
Zachariadis and Cyprus 1960–2004 Cointegration and error correction model  0.02  0.10 1.17  0.43
Pashourtidou (2007)
Altinay (2007) Turkey 1980–2005 Bounds testing approach to cointegration within 0.64  0.10 0.61  0.18
ARDL model
Amarawickrama and Hunt Sri Lanka 1970–2003 Engle–Granger (static) – – 1.76  0.02
(2008) Johansen method – – 1.74  0.04
Dergiades and Tsoulfidis United 1965–2006 Bounds testing approach to cointegration within 0.27  1.06 0.1  0.38
(2008) States ARDL model
Ziramba (2008) South 1978–2005 Bounds testing approach to cointegration within 0.30  0.02 0.31  0.04
Africa ARDL model

can be expressed in general, as a function of economic activity,
electricity price, price of substitute goods and stock of energy
using capital and temperature. Therefore, we employ the follow-
ing specification for parameterizing electricity demand in each of
aggregate and sectoral level models:
LnðEt Þ ¼ b1 þ b2 lnðYt Þ þ b3 lnðPt Þ þ b4 lnðPdt Þ þ b5 lnðKt Þ þ b6 lnðTt Þ þ ui
ð1Þ
where Et, Yt, Pt and Pdt represent, respectively, the electricity
consumption in Gigawatt hours (GWh), aggregate and sectoral
real GDP (private consumption expenditures in case of residential
sector), real price of electricity and real price of diesel taken as a
substitute good. The stock of capital is represented by Kt and
weighted monthly temperature in Pakistan is represented by Tt.
The empirical models use a double logarithmic specification.
The first step in the analysis involves the testing for unit root
of the series. In the second step, the model is tested for the
existence of cointegration in a multivariate framework. We
applied the Johansen approach (Johansen, 1988; Johansen and
Juselius, 1990) for identifying the existence of cointegrating
vectors. The Johansen procedure estimates the parameters of
cointegrating vectors using maximum likelihood procedure.
Finally, the error correction model (ECM) is estimated to obtain
the short-run elasticities. We applied the error correction model-
ing approach since it has certain advantages. First, ECM takes into
account the possible endogeneity and simultaneity of variables by
inclusion of error correction terms to be contemporaneously
related across equations. Second, it allows modeling the short-
run adjustments, wherein the long-run estimates are also
included in short-run equations. Third, it enables to identify the
variable(s) that adjust towards equilibrium in the system
(Bentzen and Engsted, 1993).
The error correction model contains an error-correcting vector
obtained from long-run relationship and conveys the deviation in
dependent variable, that is, electricity consumption from its long-
run mean. The error-correction term measures the proportion by
which the long-run disturbance in the dependent variable is
corrected in each short-run period. The size and the statistical
significance of error-correction term measure the tendency of
dependent variable to return to its long-run equilibrium. Thus, its
coefficient measures the speed of adjustment in current electri-
city consumption to its previous equilibrium value. Significance of
parameter estimates of error-correction term in a particular
equation of error correction model implies that the dependent
variable has the tendency to restore long-run equilibrium and
take the burden of a shock to the system. We estimate the
following error correction model of electricity demand. The
coefficients of differenced variables represent the short-run
movements in the variables, while the error correction term
brings the long-run equilibrium in the model (Bentzen and
Engsted, 1993; Silk and Joutz, 1997; Fatai et al., 2003; Lin, 2003;
5522 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527

Hotledahl and Joutz, 2004; Zachariadis and Pashourtidou, 2007): Table 2

Results of unit root test.
X
l X
m X
n
D Et ¼ a þ Wj DEtj þ bj DYtj þ gj DPtj þ m1 DKt1 þ m2 DPdt1 Sector/ ADF Philips-Perron Order of
j¼1 j¼0 j¼0
variable integration
Levels First Levels First
þ m3 Tt þ j½Et1 aYt1 bPt1 c þ et ð2Þ
difference Difference
where the lag orders l, m and n are chosen to make error term
Aggregate
white noise. The coefficient of error correction term is repre- Et  2.15  5.43n  3.18  5.43n I(1)
sented by j. The same representation is applied in the aggregate Yt  1.99  5.08n  1.54  4.92n I(1)
and four sectoral demand models using data of Et, Yt, Pt and Kt Pt  0.09  3.08n  0.33  3.09n I(1)
specifically at aggregate and sectors’ levels. Kt  0.89  3.87n  2.29  3.87n I(1)
The data for aggregate and sectoral electricity consumption Residential
and electricity price proxied by average revenue per kilowatt hour Et  0.37  3.23n  0.03  4.91n I(1)
are taken from WAPDA (2009). Real economic activity proxied by Yt  2.14  5.50n  2.09  5.21n I(1)
Pt  1.61  4.12n  0.21  4.15n I(1)
real GDP and sectoral output/GDP (at base prices of 1999–2000) Kt  2.22  3.89n  2.24  3.66n I(1)
and real price of diesel oil are obtained from Pakistan Economic
Commercial
Survey (various issues). In residential sector model, we use
Et  2.13  5.44n  2.11  6.01n I(1)
private consumption expenditure as the scale variable. The capital Yt  2.18  5.69n  2.14  6.16n I(1)
stock variable is constructed from the series of gross fixed capital Pt  1.21  3.04n  1.64  3.98n I(1)
formation at aggregate and sector levels, published in Pakistan Kt  1.50  3.46n  1.69  3.45n I(1)
Economic Survey (various issues). For temperature variable, we Manufacturing
obtained the data for monthly mean temperature from the nine Et  2.72  5.81n  2.67  5.81n I(1)
major weather stations across the country from Pakistan Meteor- Yt  2.29  6.11n  2.42  6.05n I(1)
Pt  1.86  5.67n  1.96  5.60n I(1)
ology Department.3 The temperature variable is constructed by
Kt  1.44  6.16n  2.21  6.10n I(1)
taking the sum of degrees above 24 1C and below 12 1C from
average monthly temperature at each weather station. The index Agricultural
Et  2.43  5.14n  2.41  4.95n I(1)
is constructed by taking weighted averages based on population Yt  2.26  5.89n  2.17  5.73n I(1)
at each weather station. The heating degrees (HD) that require Pt  0.40  5.69n  0.38  5.75n I(1)
heating the space and water are calculated as follows: Kt  3.13n  4.02n I(0)
P9 hP12 i
Other explanatory
i¼1 j ¼ 1 Hj ð121Ti,j,avg Þ variables
HD ¼ ð3Þ
9 Pdt  0.28  6.19n  0.31  6.18n I(1)
Tt  4.55n  4.57n I(0)
where Hj is a dummy variable equal to 1 if average monthly
temperature at a weather station is below 12 1C, and zero Notes: The ADF regressions include an intercept. The critical values are from
otherwise. The average monthly temperature for the ith weather MacKinnon (1996).
station in jth month is represented by Ti,avg. Similarly, the cooling n
Significance at 5% level.
degrees (CD) that require cooling the space and water are
calculated as follows:
P9 hP12 i Philip–Perron tests. Both the unit root tests suggest that all the
i¼1 j ¼ 1 Cj ðTi,j,avg 241Þ variables are integrated of order one at 5% level of significance
CD ¼ ð4Þ except capital stock in agricultural sector and temperature.
9
Despite the concerns regarding climate change, the stationarity
where Cj is a dummy variable equal to 1, if average monthly
of temperature is consistent with most of the previous related
temperature is above 24 1C. The temperature variable (Tt), defined
studies. Next, we examine the cointegrating relationship among
as a sum of degrees showing extreme temperatures in a year, is
the electricity consumption, economic activity and electricity
obtained by adding the two measures in Eqs. (3) and (4):
price variables by employing Johansen approach separately for
Tt ¼ HD þ CD ð5Þ aggregate electricity demand model and sectoral models. The
Predominantly, the measure of accumulated number of results of trace statistic and maximum eigenvalue tests presented
degrees depicts intensity of electricity requirement of consumers at Table 3 suggest the presence of one cointegrating vector in each
for the heating and cooling purposes. model, indicating the existence of a stable long-run relationship
among electricity consumption, price and economic activity.
Table 3 also presents the estimated cointegrating equations that
4. Empirical results give the long-run elasticity estimates of electricity demand. It shows
that the income elasticity is positive with coefficients exceeding one
Our econometric analysis of electricity demand begins with in all cases, indicating that real economic activity is the most
unit root tests and identification of cointegrating relationships important determinant of electricity demand in the long run. The
among the variables in aggregate and four sectors’ models. Next, coefficient of electricity price is also greater than one in aggregate
we estimate ECMs to obtain short-run elasticities after applying and sectoral models with the exception of agricultural sector model.
various diagnostic checks to reach the final models. Table 2 The lower electricity demand elasticity with respect to electricity
presents the result of Augmented Dickey–Fuller (ADF) and price in agricultural sector highlights the role of excessive subsidy in
electricity tariff rate to this sector making electricity much cheaper
than all other alternative fuels. The highest income and price
3
Pakistan Meteorology Department collects and maintains data for tempera- elasticities are in residential and commercial sectors, respectively.
ture, rainfall, radiation, etc. at several weather stations throughout the country.
We obtain data for nine weather stations covering all four provinces and federal
In commercial sector, electricity demand is relatively more elastic to
capital, namely Islamabad, Lahore, Faisalabad, Multan, Peshawar, Quetta, Sialkot, price fluctuations than to output. Our findings are almost in unison
Hyderabad and Karachi. with most of the previous studies that show income elasticity
 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527 5523

Table 3
Johansen’s tests for cointegration analysis (intercept and trend in CE).

Sector Rank r Trace statistics Maximum eigenvalue Cointegrating vectors

Et Yt Pt Constant

Aggregate
0 44.79n 27.28n 1  1.56 1.27  0.30
[35.19] [22.97] (  4.18) (2.18)
rr1 17.31 11.70
[20.26] [12.89]
rr2 5.60 5.60
[9.16] [9.16]

Residential
0 73.56n 60.20n 1  1.97 1.22 13.12
[29.79] [21.13] (  16.30) (6.03)
rr1 13.36 11.05
[15.49] [14.26]
rr2 2.30 2.30
[3.84] [3.84]

Commercial
0 35.37n 22.62nn 1  1.47 1.68  0.83
[35.19] [22.30] (  3.52) (3.39)
rr1 12.75 6.63
[20.26] [15.89]
rr2 6.11 6.11
[9.16] [9.16]

Manufacturing
0 33.34n 21.72n 1  1.61 1.22 4.34
[29.79] [21.13] (  18.02) (6.27)
rr1 11.62 11.55
[15.49] [14.26]
rr2 0.70 0.70
[3.84] [3.84]

Agricultural
0 42.22n 30.49n 1  1.25 0.51 7.61
[35.19] [22.29] (  5.51) (4.72)
rr1 11.72 7.79
[20.26] [15.89]
rr2 3.93 3.93
[9.16] [9.16]

Note: Critical values given in [ ] are from MacKinnon et al. (1999). The figures in ( ) represent t-statistics.
n
Significance at 5% level.
nn
Significance at 10% level.

Table 4
Short run elasticities-error correction model results.

Equation ECTt  1 DEt  1 DYt  1 DPt  1 Constant DK t  1 DPdt  1 Tt a F-stat. R2

Total  0.08  0.27n 0.32  0.07  0.79 1.08nn 0.07 0.06 3.45 0.48
Electricity consumption ( 1.25) ( 2.31) (0.84) (1.18) (  0.79) (1.81) (1.22) (1.43)

Residential  0.11n  0. 39n 0.49 0.07 0.27 0.32n 0.14nn 0.35 4.95 0.47
Electricity consumption ( 5.62) ( 2.93) (1.27) (0.73) (0.86) (2.34) (1.80) (1.23)

Commercial  0.08  0.20 0.05  0.31  1.78 1.03 0.26 0.71n 2.83 0.39
Electricity consumption ( 1.27) ( 1.38) (1.18) ( 1.10) (  1.58) (1.26) (0.86) (2.51)

Manufacturing  0.20nn 0.07 0.64n  0.06 0.23 0.67nn 0.11 0.06 3.25 0.40
Electricity consumption ( 1.82) (0.48) (2.02) ( 1.46) (1.45) (1.78) (1.16) (1.17)

Agricultural  0.47n 0.19 0.24  0.19  1.55n 0.50nn 0.15 0.14n 8.67 0.61
Electricity consumption ( 3.90) (1.37) (1.32) ( 1.24) (  2.67) (1.81) (1.31) (2.77)

Notes: The figures in ( ) represent t-statistics.

a
Coefficient of Tt at levels. We use the series at levels since the variable is found stationary in both ADF and Philip–Perron tests.
n
Levels of significance at 5%.
nn
Levels of significance at 10%.

greater than price elasticity in the long run (see, for example, The cointegrating vectors represent the long term relationship
Amarawickrama and Hunt, 2008). Moreover, the elasticity estimates among the variables. To examine the model for electricity
are generally found higher in developing countries than the same for demand more thoroughly, short-run error correction models are
developed countries (see, for instance, Table 1). employed. The results of final error correction model are given in
5524 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527

Table 5
Diagnostic statistics of the error correction models.

Model/ Equation ECTt  1 LM(1) LM(2) ARCH- ARCH- HET Chow Reset Norm Durbin–
sector LM(1) LM(2) forecast Watson

Total DEt  0.08 [  1.25] 0.30 (0.59) 1.07 (0.36) 0.38 (0.54) 0.36 (0.70) 1.47 (0.18) 0.66 (0.77) 0.09 (0.77) 2.07 (0.35) 1.83
D Yt  0.02[  0.92] 0.50 (048) 1.18 (0.37) 0.08 (0.92) 0.07 (0.93) 0.70 (0.73) 1.15 (0.36) 0.08 (0.82) 0.20 (0.90) 1.90
DPt  0.27n[  4.38] 0.75 (0.39) 0.38 (0.69) 0.60 (0.44) 0.73 (0.49) 0.88 (0.52) 1.29 (0.28) 1.92 (0.18) 2.48 (0.23) 2.09

Residential DEt  0.11n[  5.62] 0.15 (0.70) 0.66 (0.52) 1.86 (0.18) 1.15 (0.32) 0.92 (0.55) 1.05 (0.43) 3.94 (0.06) 10.12n (0.01) 1.92
D Yt 0.04[1.96] 0.37 (0.54) 1.79 (0.18) 0.35 (0.56) 1.15 (0.32) 0.68 (0.70) 1.39 (0.23) 0.17 (0.67) 1.03 (0.59) 1.87
DPt  0.03[  0.79] 1.38 (0.25) 2.19 (0.13) 0.24 (0.62) 1.06 (0.36) 1.11 (0.38) 5.55n (0.03) 0.12 (0.89) 1.66 (0.43) 1.78

Commercial DEt  0.08[  1.27] 0. 15 (0.80) 0.04 (0.86) 0.02 (0.87) 0.04 (0.93) 1.31 (0.25) 0.51 (0.89) 0.10 (0.74) 2.49 (0.29) 1.96
D Yt 0.10n[2.70] 0.70 (0.40) 2.76 (0.14) 0.04 (0.83) 0.26 (0.77) 1.10 (0.39) 7.45n (0.01) 0.59 (0.21) 15.78n (0.01) 2.08
DPt  0.03[  0.80] 0. 71 (0.39) 0.34 (0.70) 0.43 (0.83) 0.79 (0.46) 0.73 (0.10) 0.23 (0.97) 0.05 (0.94) 3.01 (0.13) 1.90

Manufacturing DEt  0.20[  1.82] 2.21 (0.14) 1.71 (0.19) 3.68 (0.06) 1.91 (0.16) 1.82 (0.09) 1.14 (0.37) 0.31 (0.57) 1.04 (0.59) 2.04
D Yt 0.11[1.35] 0.14 (0.70) 0.69 (0.53) 1.71n (0.04) 1.03 (0.06) 1.90 (0.07) 6.94n (0.00) 0.69 (0.73) 9.87n (0.03) 1.83
DPt  0.38n[  2.84] 0.29 (0.59) 1.16 (0.32) 0.03 (0.86) 0.19 (0.82) 0.94 (0.51) 0.72 (0.51) 2.12 (0.15) 1.19 (0.55) 2.01

Agriculture DEt  0.47n[  3.90] 0.07 (0.88) 0.48 (0.62) 0.02 (0.97) 1.46 (0.23) 0.32 (0.98) 0.83 (0.62) 0.47 (0.49) 3.17 (0.20) 2.01
D Yt 0.03[0.11] 0.64 (0.43) 1.41 (0.25) 0.05 (0.83) 0.23 (0.79) 0.61 (0.83) 0.48 (0.91) 1.71 (0.21) 6.12 (0.07) 2.09
DPt  0.21[  1.84] 0.33 (0.56) 1.21 (0.31) 2.29 (0.14) 1.31 (0.28) 1.15 (0.35) 0.52 (0.88) 1.92 (0.17) 1.24 (0.53) 2.05

Notes: The figures in [ ] are t-values, whereas ( ) are probability values for rejecting the hypotheses of the above mentioned diagnostic tests.
LM denotes the Breusch–Godfrey LM test for serial correlation for testing the null of no serial correlation at first and second lags, ARCH is an LM test for autoregressive
conditional heteroskedasticity in residuals and HET is the statistic for White Test, testing the null of no heteroscedasticity. Reset is Ramsey’s RESET stability test statistic
and Norm is Jarque–Bera statistic for testing the null of Gaussian errors. Chow Forecast test uses the year 1996 for breakpoint because reforms were introduced in
electricity sector of Pakistan in that year. The last column gives the DW statistic in the respective equation.
n
Statistical significance at 5%.

Table 4, while Table 5 provides the coefficient and t-values of
error correction terms in each equation of models. We employed
aggregate and sector-wise capital stock, price of diesel and
temperature index as exogenous variables in each model in our
general to specific approach. Since the major focus of this study is
to examine the dynamics of electricity demand in relation with
economic activity, price and capital stock, we report in Table 4 the
short-run coefficients from equations of electricity consumption
of error correction models corresponding to Eq. (2).
The error correction term expresses deviations in electricity
consumption from its mean in long run, and its coefficients in each
equation of the model are reported in Table 5. The error correction
takes place in electricity consumption equation in residential and
agricultural sector models. In the aggregate and manufacturing
sector models electricity price corrects the error to take the models
to long-run equilibrium. Finally, in commercial sector, real economic
activity bears the brunt of correcting error from long-run equili-
brium. Our original specification of models begins with four lags of
all the endogenous variables and we proceed by systematically
omitting the most insignificant lags and variables in ECM through
lag exclusion Wald test, ensuring that there is no serial correlation
among the residuals. All the final models include only one lag, which
is reasonable in case of annual data.
In the aggregate model, the coefficients on the differenced
income and price variables are 0.32 and  0.07, respectively. Both
coefficients are smaller than their long-run counterparts but are
statistically insignificant. The coefficient of error correction term
is significant in the equation of electricity price, suggesting that in
case of disequilibrium, electricity price adjust towards the long-
run equilibrium with about 27% of the adjustment taking place in
the first year. Growth in electricity consumption in the previous
year has a statistically significant negative effect on current
consumption. The coefficient of capital stock is 1.08 and turns
to be significant at 10%. The price of diesel is insignificant and has
relatively low positive effect on aggregate electricity consumption
that essentially shows less substitutability of electricity with
diesel. The temperature variable is also found statistically insig-
nificant with very low coefficient.
We now come to error correction models of the four sectors,
namely residential, commercial, manufacturing and agricultural.
In residential sector, the error correction takes place in equation
of electricity consumption as coefficient of error correction term
is significant in equation of electricity consumption. The adjust-
ment coefficient is quite low indicating slow adjustment in case
the system moves away from the long-run equilibrium and that
electricity consumption takes lead in adjusting towards the
equilibrium. Growth in electricity consumption at lag-1 has a
statistically significant negative effect and explains 39% reduction
in total electricity consumption in the next year. The coefficient of
capital stock equals to 0.32 and appears significant at 5%. Both
economic activity and electricity price variables are insignificant
and low in the short run. The price of diesel has a positive but
very low effect on electricity consumption and is significant at
10%. The temperature is found rather insignificant in residential
sector.
In commercial sector model, the error correction takes place in
equation of economic activity. The adjustment coefficient is vary
low showing that economic activity adjusts to restore the long-
run equilibrium in the system such as one tenth of the error
corrects in first year of the shock. The short-run price elasticity is
higher than short-run income elasticity although both are insig-
nificant at 5%. The capital stock has an elastic coefficient but is not
significant even at 10%. The temperature is found significantly
affecting electricity consumption in the sector with sufficiently
high coefficient value, 0.71, indicating that a 1% increase in
temperature index results in 0.7% increase in electricity consump-
tion in the commercial sector.
In manufacturing sector model, error correction takes place in
electricity price such that it reduces by 38% in the first year to
bring the system towards the long-run equilibrium. The short-run
output elasticity of electricity demand appears significant in the
manufacturing sector model of electricity demand and its coeffi-
cient equals 0.64. The capital stock is found significant at 10%
level with a coefficient value 0.67. Other exogenous variables
such as price of diesel and temperature are found insignificant at
5% level of significance.
 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527 5525

20 1.6
CUSUM 5% Significance CUSUM of Squares 5% Significance
15
1.2
10

5 0.8
0
0.4
-5

-10
0.0
-15

-20 -0.4
1975 1980 1985 1990 1995 2000 2005 1975 1980 1985 1990 1995 2000 2005

20 1.6
CUSUM 5% Significance CUSUM of Squares 5% Significance

1.2
10

0.8
0
0.4

-10
0.0

-20 -0.4
1970 1975 1980 1985 1990 1995 2000 2005 1970 1975 1980 1985 1990 1995 2000 2005

20 1.6
CUSUM 5% Significance CUSUM of Squares 5% Significance

1.2
10

0.8
0
0.4

-10
0.0

-20 -0.4
1970 1975 1980 1985 1990 1995 2000 2005 1975 1980 1985 1990 1995 2000 2005

20 1.6
CUSUM 5% Significance CUSUM of Squares 5% Significance

1.2
10

0.8
0
0.4

-10
0.0

-20 -0.4
1970 1975 1980 1985 1990 1995 2000 2005 1970 1975 1980 1985 1990 1995 2000 2005

20 1.6
CUSUM 5% Significance CUSUM of Squares 5% Significance

1.2
10

0.8
0
0.4

-10
0.0

-20 -0.4
1970 1975 1980 1985 1990 1995 2000 2005 1970 1975 1980 1985 1990 1995 2000 2005

Fig. 1. Graphical representation of CUSUM and CUSUMSQ tests. (a) Aggregate Electricity Demand, (b) Residential Electricity Demand, (c) Commerrcial Electricity Demand,
(d) Manufacturing Electricity Demand and (e) Agricultural Electricity Demand.

Finally, in agriculture sector the error correction takes place in demand curve, electricity consumption adjusts quickly towards
electricity consumption with an adjustment coefficient of  0.47, long-run equilibrium. The quick adjustment may be due to the
indicating that if the system drifts away from the long-run availability of substitutes of electricity in the agricultural sector.
5526 F. Jamil, E. Ahmad / Energy Policy 39 (2011) 5519–5527
Electricity is mainly used for irrigation purposes in agricultural
sector and diesel oil is technically a close substitute for electricity.
Moreover, the availability of canal water is also important for
agricultural electricity demand since Indus basin irrigation sys-
tem of Pakistan is the largest contiguous irrigation system in the
world (Chaudhry and Young, 1989). In the short run, elasticity of
electricity demand with respect to output and price is lower than
their long-run counterparts but the coefficients are insignificant.
The capital stock is significant at 10% level with a coefficient value
0.50. The temperature variable is found significant in agriculture
sector model, though coefficient value is low, 0.14.
In a nutshell, most of the coefficient estimates are consistent
with theory and provide interesting dynamics. The analysis con-
cludes that the long-run elasticities are consistently higher than
their short-run counterparts. The low and/or mostly insignificant
estimates of short-run error correction model indicate the lesser
influence of short-run conditions in determining the equilibrium of
electricity consumption. The results of the analysis indicating price
elastic demand of electricity are interesting from the policy point of
view. It shows that electricity price can be used as a policy tool to
achieve efficient use and energy conservation. The capital stock
appears at 10% in all error correction models except the commercial
sector model. Only the commercial and agricultural sector models
significantly capture the impact of temperature on electricity
demand. In other ECMs, it is rather insignificant.
These models perform well from a statistical point of view,
indicating that they are well specified. We applied a battery of
diagnostic tests to each of the model in order to check the
robustness of the models. The results are presented in Table 5,
which indicate no significant departure from standard regression
assumptions like serial correlation, homoskedasticity or normality.
We obtain the Jarque–Bera statistic to test the null hypothesis of
whether the standardized residuals are normally distributed. The
results show that we cannot reject in most of the equations the
null of normality. The null hypothesis underlying the White test
assumes that the errors are both homoskadastic and independent
of the regressors, and that the linear specification of the model is
correct, whereas failure of these conditions implies heteroskedastic
residuals. We applied White heteroskedasticity test with ‘‘no cross
terms’’ option along with the ARCH-LM test for heteroskedasticity.
The test statistics suggest that there is no sign of residual serial
correlation or autoregressive conditional heteroskedasticity in
most of the equations.
Several stability tests including Chow’s forecast test and
recursive tests such as Cumulative Sum (CUSUM) and Cumulative
Sum of squares (CUSUMSQ) tests are applied to check the stability
of the parameter. Chow test estimates two models to test the
sample parameter stability, where one uses the full set of data,
and the other uses a long sub-period. A significant Chow test
statistic indicating wide difference between the two models
makes suspicious the stability of the estimated relation over the
sample period. Reset test of specification error with one fitted
term is applied to each equation. The CUSUM and CUSUMSQ of
parameter stability tests indicate that the estimated parameters
of the models are stable over the sample period notwithstanding
the short-run disturbances. Fig. 1 supports the structural stability
of estimated regression for the overall period used in the
empirical analysis of our error correction models because the
plots of the CUSUM and CUSUMSQ statistics are confined within
the 5% critical bounds of parameter stability.
5. Conclusion
In this study, long term structural relationship between
electricity consumption and a number of its determinants is
examined at aggregate level, as well as at four major electricity
consuming sectors in Pakistan. The analysis is carried out in a
multivariate cointegration framework. The study leads to a
number of conclusions and policy implications. Our results are
partially consistent with the results of previous studies that show
higher income elasticity estimates for developing countries.
Johansen’s approach provides the evidence of one cointegrating
relationship in all the five models. The long-run income elasticity
estimates indicate that electricity demand is responsive to real
economic activity at aggregate and sectoral levels. The elasticity
of electricity demand with respect to price is also higher than one
in all cases except agricultural sector. The long-run electricity
demand is price inelastic in agricultural sector due to highly
subsidized nature of agricultural tariff rate for this particular
sector in Pakistan.
The estimation of consistent and stable income and price
elasticity estimates is essential for policy makers and planners
for the assessment of future demand and investment require-
ments for electricity supply network expansion. Thus, the results
of the study have important practical applications. The estimates
of the analysis indicate rising electricity requirements as the
country achieves higher GDP growth rates. The capital stock has
significant short-run positive effect on electricity consumption in
aggregate and sectoral models except the commercial sector
model indicating the rising electricity demand with the mechan-
ization of the economy. Below are given the inferences drawn
from our empirical analysis. First, a stable long-run electricity
demand function exists over the estimated period in Pakistan.
Second, the deviation from long-run equilibrium is corrected in at
least one of the three equations of the cointegrating vector. Third,
the long-run income elasticity of electricity demands is significant
and greater than one in all cases, suggesting responsiveness of
electricity demand to economic growth. Fourth, the price elasti-
city of electricity demand is less than unity only in agricultural
sector. All other models exhibit elastic electricity demand with
respect to its price. The price elastic electricity demand delineates
the importance of electricity variable as a policy tool. It is also
alarming, since if the regulatory body raises the electricity price
due to rising electricity generation cost, it would hurt real
economic activity in the country. Pakistan relies heavily on
thermal power stations (about 65% of the total), mainly using
the imported furnace oil. Thus the oil shock of any magnitude
directly strikes the electricity sector in the country besides the
fact that Pakistan is already among the countries with the lowest
per capita electricity consumption (Muneer and Asif, 2007). It
emphasizes the need for diversification in modes of electricity
generation, especially focusing on the renewable and indigenous
resources based thermal generation. Fifth, the temperature
appears significant only in agricultural and commercial sectors.
Sixth, the capital stock has a significant positive impact on
electricity consumption, although its coefficient is less than one
in residential, manufacturing and agricultural sectors. Finally, the
price of diesel as a substitute of electricity does not appear
significant in most of the cases, indicating low technical or
financial substitutability of electricity with diesel oil. Besides
various other determinants, electricity consumption in develop-
ing countries relies heavily on generation capacity and sustain-
able supply. The investment in improving generation capacity,
efficiency and electricity transmission and distribution network is
imperative to meet the growing energy needs of the masses,
which is imminent as is evident from high income elasticity.
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