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Capacity Mechanisms and Effects on Market Structure

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  • Elberg, Christina
  • Kranz, Sebastian

Abstract

Liberalized electricity markets are characterized by a fluctuating price-inelastic demand, non-storable electricity and often show substantial market shares held by one or few incumbent firms. These characteristics have led to a controversial discussion concerning the need for and the design of capacity mechanisms, which combine some form of capacity payments with price caps in the spot market. The purpose of this study is to understand the effects of different capacity mechanisms on the market structure. We consider a model with a dominant firm and a competitive fringe and investigate the impact of price caps and capacity payments on investment incentives and market shares of both parties. While lower price caps reduce the potential for the exercise of market power in static models, we find that in the dynamic model with endogenous investments lower price caps increase market concentration and the frequency of capacity withholding, as well as, the dominant firm's profits. --

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Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order with number 79811.

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Date of creation: 2013
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Handle: RePEc:zbw:vfsc13:79811

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  1. Salop, Steven C & Scheffman, David T, 1983. "Raising Rivals' Costs," American Economic Review, American Economic Association, vol. 73(2), pages 267-71, May.
  2. Natalia Fabra & Nils-Henrik von der Fehr & David Harbord, 2002. "Designing Electricity Auctions," Microeconomics 0211017, EconWPA, revised 31 Aug 2003.
  3. Catherine D. Wolfram, 1999. "Measuring Duopoly Power in the British Electricity Spot Market," American Economic Review, American Economic Association, vol. 89(4), pages 805-826, September.
  4. Cramton, Peter & Stoft, Steven, 2008. "Forward reliability markets: Less risk, less market power, more efficiency," Utilities Policy, Elsevier, vol. 16(3), pages 194-201, September.
  5. Joskow, Paul L., 2008. "Capacity payments in imperfect electricity markets: Need and design," Utilities Policy, Elsevier, vol. 16(3), pages 159-170, September.
  6. Cramton, Peter & Stoft, Steven, 2005. "A Capacity Market that Makes Sense," The Electricity Journal, Elsevier, vol. 18(7), pages 43-54.
  7. Milgrom,Paul, 2004. "Putting Auction Theory to Work," Cambridge Books, Cambridge University Press, number 9780521551847, April.
  8. Finon, Dominique & Pignon, Virginie, 2008. "Electricity and long-term capacity adequacy: The quest for regulatory mechanism compatible with electricity market," Utilities Policy, Elsevier, vol. 16(3), pages 143-158, September.
  9. repec:rje:randje:v:37:y:2006:1:p:23-46 is not listed on IDEAS
  10. Natalia Fabra & Nils‐Henrik M von der Fehr & María‐Ángeles de Frutos, 2011. "Market Design and Investment Incentives," Economic Journal, Royal Economic Society, vol. 121(557), pages 1340-1360, December.
  11. Grimm, Veronika & Zöttl, Gregor, 2010. "Investment Incentives and Electricity Spot Market Design," Discussion Papers in Economics 11705, University of Munich, Department of Economics.
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