We develop a theoretical model of long-run investment decisions on capacity in the context of a liberalized electricity market. The sector's idiosyncrasies such as the uncertainty surrounding future supply and demand, as well as technological constraints, are explicitly modelled. The model is sufficiently flexible to describe the situation in different systems. We derive the level of capacity that maximizes social welfare, and compare it to a decentralized outcome. We show that in the absence of any regulation, private investment decisions on capacity unambiguously lead to a socially sub-optimal outcome, and we illustrate these results using simulations.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
2998.
Find related papers by JEL classification: L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
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