IDEAS home Printed from https://ideas.repec.org/p/cam/camdae/1016.html
   My bibliography  Save this paper

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

Author

Listed:
  • Holmberg, P.
  • Newbery, D.

Abstract

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.

Suggested Citation

  • Holmberg, P. & Newbery, D., 2010. "The Supply Function Equilibrium and its Policy Implications for Wholesale Electricity Auctions," Cambridge Working Papers in Economics 1016, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:1016
    as

    Download full text from publisher

    File URL: http://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe1016.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Edward J. Anderson & Pär Holmberg & Andrew B. Philpott, 2013. "Mixed strategies in discriminatory divisible-good auctions," RAND Journal of Economics, RAND Corporation, pages 1-32.
    2. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, January.
    3. Allaz Blaise & Vila Jean-Luc, 1993. "Cournot Competition, Forward Markets and Efficiency," Journal of Economic Theory, Elsevier, vol. 59(1), pages 1-16, February.
    4. Nils-Henrik M. von der Fehr, Eirik S. Amundsen and Lars Bergman, 2005. "The Nordic Market: Signs of Stress?," The Energy Journal, International Association for Energy Economics, vol. 0(Special I), pages 71-98.
    5. Green, Richard J & Joanne Evans, 2003. "Why did British electricity prices fall after 1998?," Royal Economic Society Annual Conference 2003 92, Royal Economic Society.
    6. Rassenti, Stephen J & Smith, Vernon L & Wilson, Bart J, 2003. "Discriminatory Price Auctions in Electricity Markets: Low Volatility at the Expense of High Price Levels," Journal of Regulatory Economics, Springer, vol. 23(2), pages 109-123, March.
    7. David M. Newbery, 2005. "Electricity liberalization in Britain: The quest for a satisfactory wholesale market design," The Energy Journal, International Association for Energy Economics, vol. 0(Special I), pages 43-70.
    8. Robert Wilson, 1979. "Auctions of Shares," The Quarterly Journal of Economics, Oxford University Press, vol. 93(4), pages 675-689.
    9. James B. Bushnell & Erin T. Mansur & Celeste Saravia, 2008. "Vertical Arrangements, Market Structure, and Competition: An Analysis of Restructured US Electricity Markets," American Economic Review, American Economic Association, pages 237-266.
    10. Pär Holmberg, 2009. "Supply function equilibria of pay-as-bid auctions," Journal of Regulatory Economics, Springer, vol. 36(2), pages 154-177, October.
    11. Alfred E. Kahn & Peter Cramton & Robert H. Porter & Richard D. Tabors, 2001. "Uniform Pricing or Pay-as-Bid Pricing: A Dilemma for California and Beyond," Papers of Peter Cramton 01ej, University of Maryland, Department of Economics - Peter Cramton, revised 27 Jan 2001.
    12. Willems, Bert & Rumiantseva, I. & Weigt, H., 2007. "Cournot versus Supply Functions : What Does the Data tell us?," Discussion Paper 2007-023, Tilburg University, Tilburg Law and Economic Center.
    13. Robert H. Patrick & Frank A. Wolak, 2001. "Estimating the Customer-Level Demand for Electricity Under Real-Time Market Prices," NBER Working Papers 8213, National Bureau of Economic Research, Inc.
    14. Lawrence M. Ausubel & Peter Cramton & Marek Pycia & Marzena Rostek & Marek Weretka, 2014. "Demand Reduction and Inefficiency in Multi-Unit Auctions," Review of Economic Studies, Oxford University Press, vol. 81(4), pages 1366-1400.
    15. Severin Borenstein & James Bushnell & Christopher R. Knittel, 1999. "Market Power in Electricity Markets: Beyond Concentration Measures," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 65-88.
    16. Newbery, D, 2008. "Analytic Solutions for Supply Function Equilibria: Uniqueness and Stability," Cambridge Working Papers in Economics 0848, Faculty of Economics, University of Cambridge.
    17. Willems, Bert & Rumiantseva, Ina & Weigt, Hannes, 2009. "Cournot versus Supply Functions: What does the data tell us?," Energy Economics, Elsevier, pages 38-47.
    18. Kristiansen, Tarjei, 2007. "Pricing of monthly forward contracts in the Nord Pool market," Energy Policy, Elsevier, vol. 35(1), pages 307-316, January.
    19. repec:spr:compst:v:60:y:2004:i:2:p:215-238 is not listed on IDEAS
    20. Federico, Giulio & Rahman, David, 2003. "Bidding in an Electricity Pay-as-Bid Auction," Journal of Regulatory Economics, Springer, pages 175-211.
    21. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-124, March.
    22. Holmberg, Pär, 2005. "Numerical Calculation of an Asymmetric Supply Function Equilibrium with Capacity Constraints," Working Paper Series 2005:12, Uppsala University, Department of Economics.
    23. Dahlberg, Matz & Edmark, Karin, 2008. "Is there a "race-to-the-bottom" in the setting of welfare benefit levels? Evidence from a policy intervention," Journal of Public Economics, Elsevier, pages 1193-1209.
    24. Holmberg, Pär, 2009. "Numerical calculation of an asymmetric supply function equilibrium with capacity constraints," European Journal of Operational Research, Elsevier, vol. 199(1), pages 285-295, November.
    25. Parisio, Lucia & Bosco, Bruno, 2003. "Market Power and the Power Market: Multi-unit Bidding and (In)Efficiency in Electricity Auctions," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(4), pages 377-401, August.
    26. Mahenc, P. & Salanie, F., 2004. "Softening competition through forward trading," Journal of Economic Theory, Elsevier, vol. 116(2), pages 282-293, June.
    27. Holmberg, Pär & Newbery, David & Ralph, Daniel, 2013. "Supply function equilibria: Step functions and continuous representations," Journal of Economic Theory, Elsevier, vol. 148(4), pages 1509-1551.
    28. David M. Newbery, 1998. "Competition, Contracts, and Entry in the Electricity Spot Market," RAND Journal of Economics, The RAND Corporation, pages 726-749.
    29. Levitan, Richard & Shubik, Martin, 1972. "Price Duopoly and Capacity Constraints," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 13(1), pages 111-122, February.
    30. Ilan Kremer & Kjell G. Nyborg, 2004. "Divisible-Good Auctions: The Role of Allocation Rules," RAND Journal of Economics, The RAND Corporation, pages 147-159.
    31. Jaime F. Zender & James J.D. Wang, 2002. "Auctioning divisible goods," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 19(4), pages 673-705.
    32. Borenstein, Severin & Bushnell, James, 1999. "An Empirical Analysis of the Potential for Market Power in California's Electricity Industry," Journal of Industrial Economics, Wiley Blackwell, vol. 47(3), pages 285-323, September.
    33. Bushnell, James, 2004. "California's electricity crisis: a market apart?," Energy Policy, Elsevier, vol. 32(9), pages 1045-1052, June.
    34. James Bushnell, 2007. "Oligopoly equilibria in electricity contract markets," Journal of Regulatory Economics, Springer, pages 225-245.
    35. MURPHY, Frederic & SMEERS, Yves, 2005. "Forward markets may not decrease market power when capacities are endogenous," CORE Discussion Papers 2005028, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    36. Par Holmberg, 2007. "Supply Function Equilibrium with Asymmetric Capacities and Constant Marginal Costs," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 55-82.
    37. Ramteen Sioshansi & Shmuel Oren, 2007. "How good are supply function equilibrium models: an empirical analysis of the ERCOT balancing market," Journal of Regulatory Economics, Springer, vol. 31(1), pages 1-35, February.
    38. Oren, Shmuel S., 2005. "Generation Adequacy via Call Options Obligations: Safe Passage to the Promised Land," The Electricity Journal, Elsevier, vol. 18(9), pages 28-42, November.
    39. E. J. Anderson & H. Xu, 2004. "Nash equilibria in electricity markets with discrete prices," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 60(2), pages 215-238, October.
    40. Ilan Kremer, 2004. "Underpricing and Market Power in Uniform Price Auctions," Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 849-877.
    41. 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.
    42. David M. Newbery, 1995. "Power Markets and Market Power," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 39-66.
    43. Ali Hortaçsu & Steven L. Puller, 2008. "Understanding strategic bidding in multi-unit auctions: a case study of the Texas electricity spot market," RAND Journal of Economics, RAND Corporation, vol. 39(1), pages 86-114.
    44. Paul Klemperer, 2004. "Auctions: Theory and Practice," Online economics textbooks, SUNY-Oswego, Department of Economics, number auction1.
    45. Kahn, Alfred E. & Cramton, Peter C. & Porter, Robert H. & Tabors, Richard D., 2001. "Uniform Pricing or Pay-as-Bid Pricing: A Dilemma for California and Beyond," The Electricity Journal, Elsevier, vol. 14(6), pages 70-79, July.
    46. Paul Klemperer, 2004. "Introduction to Auctions: Theory and Practice," Introductory Chapters,in: Auctions: Theory and Practice Princeton University Press.
    47. Ross Baldick & Ryan Grant & Edward Kahn, 2004. "Theory and Application of Linear Supply Function Equilibrium in Electricity Markets," Journal of Regulatory Economics, Springer, vol. 25(2), pages 143-167, March.
    48. Holmberg, Pär, 2008. "Game-theoretical, Strategic forward Contracting in the Electricity Market," Working Paper Series 756, Research Institute of Industrial Economics.
    49. Maskin, Eric, 1986. "The Existence of Equilibrium with Price-Setting Firms," American Economic Review, American Economic Association, pages 382-386.
    50. Holmberg, Par, 2008. "Unique supply function equilibrium with capacity constraints," Energy Economics, Elsevier, vol. 30(1), pages 148-172, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Holmberg, Pär & Philpott, Andrew, 2012. "Supply Function Equilibria in Networks with Transport Constraints," Working Paper Series 945, Research Institute of Industrial Economics, revised 10 Aug 2015.
    2. Machiel Mulder, 2015. "Competition in the Dutch Electricity Market: An Empirical Analysis over 2006-2011," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    3. Pär Holmberg, 2014. "Pro-competitive rationing in multi-unit auctions," Cambridge Working Papers in Economics 1435, Faculty of Economics, University of Cambridge.
    4. Haraguchi, Junichi & Yasui, Yuta, 2017. "Supply Function Equilibria and Nonprofit-Maximizing Objectives," MPRA Paper 82394, University Library of Munich, Germany.
    5. Bigerna, Simona & Andrea Bollino, Carlo & Polinori, Paolo, 2015. "Marginal cost and congestion in the Italian electricity market: An indirect estimation approach," Energy Policy, Elsevier, vol. 85(C), pages 445-454.
    6. Holmberg, Pär & Lazarczyk, Ewa, 2012. "Congestion Management in Electricity Networks: Nodal, Zonal and Discriminatory Pricing," Working Paper Series 915, Research Institute of Industrial Economics.
    7. repec:eee:eneeco:v:67:y:2017:i:c:p:423-438 is not listed on IDEAS
    8. Fiuza de Bragança, Gabriel Godofredo & Daglish, Toby, 2016. "Can market power in the electricity spot market translate into market power in the hedge market?," Energy Economics, Elsevier, vol. 58(C), pages 11-26.
    9. Ritz, Robert, 2016. "Oligopolistic competition and welfare," Cambridge Working Papers in Economics 1680, Faculty of Economics, University of Cambridge.
    10. Pär Holmberg and Ewa Lazarczyk, 2015. "Comparison of congestion management techniques: Nodal, zonal and discriminatory pricing," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    11. Ayzenberg, N. & Kiseleva, N. & Zorkaltsev, V., 2013. "Models of Imperfect Competition in Analysis of Siberian Electricity Market," Journal of the New Economic Association, New Economic Association, vol. 18(2), pages 62-88.
    12. Genc, Talat S., 2016. "Measuring demand responses to wholesale electricity prices using market power indices," Energy Economics, Elsevier, vol. 56(C), pages 247-260.
    13. Delbono, Flavio & Lambertini, Luca, 2016. "Ranking Bertrand, Cournot and supply function equilibria in oligopoly," Energy Economics, Elsevier, vol. 60(C), pages 73-78.
    14. Genc, Talat S. & Aydemir, Abdurrahman, 2017. "Power trade, welfare, and air quality," Energy Economics, Elsevier, pages 423-438.
    15. Reihani, Ehsan & Motalleb, Mahdi & Thornton, Matsu & Ghorbani, Reza, 2016. "A novel approach using flexible scheduling and aggregation to optimize demand response in the developing interactive grid market architecture," Applied Energy, Elsevier, pages 445-455.
    16. Kimbrough, Steven O. & Murphy, Frederic H., 2013. "Strategic bidding of offer curves: An agent-based approach to exploring supply curve equilibria," European Journal of Operational Research, Elsevier, vol. 229(1), pages 165-178.
    17. Alexander Vasin & Marina Dolmatova & Gerhard-Wilhelm Weber, 2016. "Supply function equilibria for uniform price auction in oligopolistic markets," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 24(4), pages 819-831, December.
    18. Pär Holmberg & Frank Wolak, 2015. "Electricity markets: Designing auctions where suppliers have uncertain costs," Cambridge Working Papers in Economics 1541, Faculty of Economics, University of Cambridge.
    19. de Braganca, Gabriel Fiuza & Daglish, Toby, 2012. "Can market power in the electricity spot market translate into market power in the hedge market?," Working Paper Series 4130, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    20. Pär Holmberg & Andy Philpott, 2014. "Supply function equilibria in transportation networks," Cambridge Working Papers in Economics 1421, Faculty of Economics, University of Cambridge.
    21. Moutinho, Victor & Moreira, António C. & Mota, Jorge, 2014. "Do regulatory mechanisms promote competition and mitigate market power? Evidence from Spanish electricity market," Energy Policy, Elsevier, vol. 68(C), pages 403-412.
    22. Edward Anderson & Pär Holmberg, 2015. "Price Instability in Multi-Unit Auctions," Cambridge Working Papers in Economics 1538, Faculty of Economics, University of Cambridge.
    23. Mulder, Machiel & Petrikaitė, Vaiva & Scholtens, Bert, 2015. "Distributed energy generation techniques and the competitive fringe effect in electricity markets," Resource and Energy Economics, Elsevier, vol. 42(C), pages 125-140.

    More about this item

    Keywords

    Wholesale electricity markets; supply function equilibria; auction design; competition policy; market regulation;

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cam:camdae:1016. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jake Dyer). General contact details of provider: http://www.econ.cam.ac.uk/ .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.