Watt’s better? Pay-as-bid vs. Uniform pricing in electricity market

Rising electricity prices of recent years have reopened the debate on replacing uniform with pay-as-bid pricing in electricity markets. This paper contributes to this ongoing political debate by comparing peak prices, consumer surplus, and welfare under pay-as-bid and uniform pricing in a game-theoretic model of suppliers’ strategic bidding behaviour. For this comparison, it derives supply function equilibria for both pricing rules in a model that matches four stylised facts of electricity markets: Suppliers have (1) oligopolistic market power, (2) increasing marginal costs, (3) face a downward-sloping demand, and (4) have uncertainty over time-varying demand but common knowledge of production costs. In the model, peak prices are lower under pay-as-bid pricing. Both pay-as-bid and uniform pricing maximise welfare with zero profits for producers when marginal costs are flat, or there is an infinite number of producers. Restricting attention to the case where marginal costs and demand are linear with a uniformly distributed intercept of demand, pay-as-bid pricing results in a higher expected consumer surplus. The welfare comparison is ambiguous even in this linear model. Pay-as-bid pricing results in higher expected welfare if and only if demand variation is sufficiently low. The findings of this paper suggest that regulators should seriously consider pay-as-bid pricing to raise consumer surplus and curb price peaks.