The Supply Function Equilibrium and Its Policy Implications for Wholesale Electricity Auctions

The supply function equilibrium provides a game-theoretic model of strategic bidding in oligopolistic wholesale electricity auctions. This paper presents an intuitive account of current understanding and shows how welfare losses depend on the number of firms in the market and their asymmetry. Previous results and general recommendations for divisible-good/multi-unit auctions provides guidance on the design of the auction format; setting the reservation price; the rationing rule; and restrictions on the offer curves in wholesale electricity auctions.Wholesale Electricity Markets; Supply Function Equilibria; Competition Policy

Cournot Versus Supply Functions: What does the Data Tell us?

The liberalization of the electricity sector increases the need for realistic and robust models of the oligopolistic interaction of electricity firms. This paper compares the two most popular models: Cournot and the Supply Function Equilibrium (SFE), and tests which model describes the observed market data best. Using identical demand and supply specifications, both models are calibrated to the German electricity market by varying the contract cover of firms. Our results show that each model explains an identical fraction of the observed price variation. We therefore suggest using Cournot models for short term analysis, as more market details, such as network constraints, can be accommodated. As the SFE model is less sensitive to the choice of the calibration parameters, it might be more appropriate for long term analysis, such as the study of a merger.supply function equilibrium;Cournot competition;electricity markets

Cournot versus supply functions: what does the data tell us?

The liberalization of the electricity sector increases the need for realistic and robust models of the oligopolistic interaction of electricity firms. This paper compares the two most popular models: Cournot and the Supply Function Equilibrium (SFE), and tests which model describes the observed market data best. Using identical demand and supply specifications, both models are calibrated to the German electricity market by varying the contract cover of firms. Our results show that each model explains an identical fraction of the observed price variation. We therefore suggest using Cournot models for short term analysis, as more market details, such as network constraints, can be accommodated. As the SFE model is less sensitive to the choice of the calibration parameters, it might be more appropriate for long term analysis, such as the study of a merger.supply function equilibrium, Cournot competition, electricity markets

Cournot versus Supply Functions: What Does the Data tell us?

The liberalization of the electricity sector increases the need for realistic and robust models of the oligopolistic interaction of electricity firms. This paper compares the two most popular models: Cournot and the Supply Function Equilibrium (SFE), and tests which model describes the observed market data best. Using identical demand and supply specifications, both models are calibrated to the German electricity market by varying the contract cover of firms. Our results show that each model explains an identical fraction of the observed price variation. We therefore suggest using Cournot models for short term analysis, as more market details, such as network constraints, can be accommodated. As the SFE model is less sensitive to the choice of the calibration parameters, it might be more appropriate for long term analysis, such as the study of a merger.supply function equilibrium;Cournot competition;electricity markets

Equilibrium Predictions in Wholesale Electricity Markets

We review supply function equilibrium models and their predictions on market outcomes in the wholesale electricity auctions. We discuss how observable market characteristics such as capacity constraints, number of power suppliers, load distribution and auction format affect the behavior of suppliers and performance of the market. We specifically focus on the possible market power exerted by pivotal suppliers and the comparison between discriminatory and uniform-price auctions. We also describe capacity investment behavior of electricity producers in the restructured industry.Electricity markets; Supply function equilibrium; Markov perfect equilibrium; electricity auctions; pivotal suppliers; capacity investment.

Game-theoretical, Strategic forward Contracting in the Electricity Market

Forward sales is a credible commitment to aggressive spot market bidding, and it mitigates producers’ market power in electricity markets. Still it can be profitable for a producer to make such a commitment if it results in a soft response from competitors in the spot market (strategies are substitutes). The optimal contracting level of a risk-neutral producer is determined by the extent to which strategies are substitutes and the slope of the residual demand in the forward market. Conditions under which strategies are substitutes are identified for a two-stage game with supply function competition and capacity constrained producers.Supply Function Equilibrium; Forward Market; Strategic Contracting; Arbitrage; Strategic Substitutes; Oligopoly; Electricity Market

Predicting market power in wholesale electricity markets

The traditional measure of market power is the HHI, which gives implausible results given the low elasticity of demand in electricity spot markets, unless it is adapted to take account of contracting. In its place the Residual Supply Index has been proposed as a more suitable index to measure potential market power in electricity markets, notably in California and more recently in the EU Sector Inquiry. The paper investigates its value in identifying the ability of firms to raise prices in an electricity market with contracts and capacity constraints and find that it is most useful for the case of a single dominant supplier, or with a natural extension, for the case of a symmetric oligoply. Estimates from the Sector Inquiry seem to fit this case better than might be expected, but suggests an alternative defintion of the RSI defined over flexible output that should give a more reliable relationship

Trade Policy Under Asymmetric Information

We consider optimal trade policy for a large country with private information. We show that the optimal tariff leads to a signaling equilibrium with higher tariffs and lower welfare than under complete information, whereas the optimal import quota replicates the complete information equilibrium and thus is superior to the tariff. We also show that, with the tariff, the country may be better off being uninformed. Finally, we show that if the importing nation cannot commit to its tariff, the use of futures contracts together with the dynamically consistent tariff leads to the same equilibrium as under complete information with commitment.

Competition, risk neutrality and loan commitments

Credit;monetary economics

Receiprocity and Downward Wage Rigidity

The employment relationship is to a large extent characterized by incomplete contracts, in which workers have a considerable degree of discretion over the choice of their work effort. This discretion at work kicks in the potential importance of “gift exchange” or reciprocity between workers and employers in their employment relationship. Built on the seminal work of Akerlof (1980), this paper adopts a social norm approach to model reciprocity in labor markets and theoretically derives two versions of downward wage rigidity. The first version explains why employers may adopt a high wage policy far above the competitive level. This version is not a novel finding in the existing literature and is mainly served as a benchmark for later comparison in the current paper. Our main contribution lies in the second version in which not nly may employers adopt a high wage policy far above the competitive level, but one can also account for the asymmetric behavior of wages and explain why employers are hesitant about wage cuts in the presence of negative shocks. We argue that this second and stronger version of downward wage rigidity has moved the efficiency wage theory a step forward.Reciprocity, Downward Wage Rigidity, Social Norm, Efficiency Wage