  Residential Demand Response has emerged as a viable tool to alleviate supply
and demand imbalances of electricity, particularly during times when the
electric grid is strained due a shortage of supply. Demand Response providers
bid reduction capacity into the wholesale electricity market by asking their
customers under contract to temporarily reduce their consumption in exchange
for a monetary incentive. To contribute to the analysis of consumer behavior in
response to such incentives, this paper formulates Demand Response as a
Mechanism Design problem, where a Demand Response Provider elicits private
information of its rational, profit-maximizing customers who derive positive
expected utility by participating in reduction events. By designing an
incentive compatible and individually rational mechanism to collect users'
price elasticities of demand, the Demand Response provider can target the most
susceptible users to incentives. We measure reductions by comparing the
materialized consumption to the projected consumption, which we model as the
"10-in-10"-baseline, the regulatory standard set by the California Independent
System Operator. Due to the suboptimal performance of this baseline, we show,
using consumption data of residential customers in California, that Demand
Response Providers receive payments for "virtual reductions", which exist due
to the inaccuracies of the baseline rather than actual reductions. Improving
the accuracy of the baseline diminishes the contribution of these virtual
reductions.
