Accommodating Bounded Rationality in Pricing Demand Response

Demand response is considered an effective mechanism to deal with the intermittency and stochasticity of renewable sources in power systems. These mechanisms assume that participants behave as rational decision-makers. However, behavioural economists commonly agree that decision-makers are rather bounded rational and deviate from the optimal response. The purpose of this paper is to generalize the existing mechanisms to account for bounded rationality. This is done in the framework of the coupon incentive-based demand response program, by formulating a Stackelberg game between the load serving entity and the consumers. The game is recast as a bilevel optimization problem that can account or not for bounded rationality to study its effects on social welfare and revenue streams. Our analysis of a case study shows that bounded rational consumers lead to undesirable loss of revenue for the load serving entity that can be reduced by accounting for bounded rationality in pricing demand response.