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On optimal scarcity prices

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  • Zöttl, Gregor

Abstract

This article contributes to the debate of missing money (compare Joskow(2007a)). This debate has seriously questioned the desirability of limiting scarcity prices in markets with fluctuating demand by emphasizing their potentially negative impact on firms' investment decisions in the long run. A prominent example are recently liberalized electricity markets, where competition authorities have imposed price caps3 or adopted other measures to mitigate high scarcity prices. The impact of reduced scarcity prices in the long run still is only incompletely explored. We thus analyze investment of firms in base load and peak load technologies in a market with fluctuating demand under imperfect competition. We show that an appropriately chosen limitation of scarcity prices is not only beneficial in the short run but also in the long run. It leads to a strict increase of investment in peak load technologies, leaving investment in base load technologies unchanged. Furthermore, we characterize the optimal limit on scarcity prices.

Suggested Citation

  • Zöttl, Gregor, 2011. "On optimal scarcity prices," International Journal of Industrial Organization, Elsevier, vol. 29(5), pages 589-605, September.
  • Handle: RePEc:eee:indorg:v:29:y:2011:i:5:p:589-605
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    References listed on IDEAS

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    1. Robert Earle & Karl Schmedders & Tymon Tatur, 2007. "On Price Caps Under Uncertainty," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 93-111.
    2. Paul Joskow & Jean Tirole, 2007. "Reliability and competitive electricity markets," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 60-84, March.
    3. Reynolds, Stanley S. & Wilson, Bart J., 2000. "Bertrand-Edgeworth Competition, Demand Uncertainty, and Asymmetric Outcomes," Journal of Economic Theory, Elsevier, vol. 92(1), pages 122-141, May.
    4. 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.
    5. Jean J. Gabszewicz & Sougata Poddar, 1997. "Demand fluctuations and capacity utilization under duopoly," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 10(1), pages 131-146.
    6. Grimm Veronika & Zöttl Gregor, 2010. "Price Regulation under Demand Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-34, June.
    7. Bolle, Friedel, 1992. "Supply function equilibria and the danger of tacit collusion : The case of spot markets for electricity," Energy Economics, Elsevier, vol. 14(2), pages 94-102, April.
    8. von der Fehr, Nils-Henrik Morch & Harbord, David, 1993. "Spot Market Competition in the UK Electricity Industry," Economic Journal, Royal Economic Society, vol. 103(418), pages 531-546, May.
    9. de Frutos, María-Ángeles & Fabra, Natalia, 2011. "Endogenous capacities and price competition: The role of demand uncertainty," International Journal of Industrial Organization, Elsevier, vol. 29(4), pages 399-411, July.
    10. Crew, Michael A & Fernando, Chitru S & Kleindorfer, Paul R, 1995. "The Theory of Peak-Load Pricing: A Survey," Journal of Regulatory Economics, Springer, vol. 8(3), pages 215-248, November.
    11. Green, Richard J & Newbery, David M, 1992. "Competition in the British Electricity Spot Market," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 929-953, October.
    12. Boom, Anette, 2009. "Vertically integrated firms' investments in electricity generating capacities," International Journal of Industrial Organization, Elsevier, vol. 27(4), pages 544-551, July.
    13. Severin Borenstein & James B. Bushnell & Frank A. Wolak, 2002. "Measuring Market Inefficiencies in California's Restructured Wholesale Electricity Market," American Economic Review, American Economic Association, vol. 92(5), pages 1376-1405, December.
    14. Klemperer, Paul D & Meyer, Margaret A, 1989. "Supply Function Equilibria in Oligopoly under Uncertainty," Econometrica, Econometric Society, vol. 57(6), pages 1243-1277, November.
    15. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
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    Cited by:

    1. Thomas-Olivier Léautier, 2016. "The Visible Hand: Ensuring Optimal Investment in Electric Power Generation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    2. Fabra, Natalia, 2018. "A Primer on Capacity Mechanisms," CEPR Discussion Papers 13088, C.E.P.R. Discussion Papers.

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