The Evolution of Price and Income Elasticity of Energy Demand in Iran: A Kalman filter Approach

The high energy intensity and air pollution in Iran have led to the consideration of energy demand management and the factors affecting it since the last decade. In this context, how prices affect energy consumption is of great importance. On the other hand, the price elasticity of energy demand changes over time due to the fluctuation of energy prices, the development of the energy market and economic conditions. Therefore, the main purpose of this paper is to estimate the time-varying price elasticity of energy demand in Iran during 1991-2018. For this purpose, energy demand elasticities were estimated using real non-oil GDP, energy price index and real total energy consumption of Iran and Kalman filter method. The results show that the price elasticity of energy demand has changed between -0.010 and -0.043 and its average value is -0.027. The income elasticity of energy demand has changed between 0.902 and 0.13, and its average value is 0.46. Several important points can be derived from these results First, energy demand is less elastic to income and price. Second, these elasticities are not constant over time, and ignoring this instability leads to biased estimates. Third, energy prices play an insignificant role in energy consumption in Iran relative to economic growth. Therefore, to improve energy intensity, in addition to energy price reform, special attention should be paid to requirements that increase consumer price sensitivity.JEL Clasification: Q41, Q48, C22.