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Forward markets may not decrease market power when capacities are endogenous

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  • MURPHY, Frederic
  • SMEERS, Yves

Abstract

This paper analyzes the properties of three capacity games in an oligopolistic market with Cournot players. In the first game, capacity and the operation of that capacity is determined simultaneously. This is the classic open-loop Cournot game. In the second game capacity is decided in the first stage and the operation of that capacity is determined in the second stage. The first stage decision of each player is contingent on the solution of the second-stage game. This is a two-stage, closed-loop game. We show that when the solution exists, it is the same as the solution in the first game. However, it does not always exist. The third game has three stages with a futures position taken between the capacity stage and the operations stage and is also a closed-loop game. As with the second game, the equilibrium is the same as the open-loop game when it exists. However, the conditions for existence are more restrictive once a futures market is added. When both games have an equilibrium, the solution values are identical. The results are very different from games with no capacity stage as studied by Allaz and Vila (1993), which have been used to argue that futures markets can ameliorate market power.

Suggested Citation

  • 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).
  • Handle: RePEc:cor:louvco:2005028
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    References listed on IDEAS

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    1. Le Coq, Chloe & Orzen, Henrik, 2006. "Do forward markets enhance competition?: Experimental evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 61(3), pages 415-431, November.
    2. Gregory Goering & Michael Pippenger, 2002. "Durable Goods Monopoly and Forward Markets," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 9(2), pages 271-282.
    3. Frank Wolak, 2000. "An Empirical Analysis of the Impact of Hedge Contracts on Bidding Behavior in a Competitive Electricity Market," International Economic Journal, Taylor & Francis Journals, vol. 14(2), pages 1-39.
    4. Green, Richard, 1999. "The Electricity Contract Market in England and Wales," Journal of Industrial Economics, Wiley Blackwell, vol. 47(1), pages 107-124, March.
    5. Rajnish Kamat & Shmuel Oren, 2004. "Two-settlement Systems for Electricity Markets under Network Uncertainty and Market Power," Journal of Regulatory Economics, Springer, vol. 25(1), pages 5-37, January.
    6. Powell, Andrew, 1993. "Trading Forward in an Imperfect Market: The Case of Electricity in Britain," Economic Journal, Royal Economic Society, vol. 103(417), pages 444-453, March.
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    Cited by:

    1. David, Laurent & Le Breton, Michel & Merillon, Olivier, 2007. "Regulating the Natural Gas Transportation Industry: Optimal Pricing Policy of a Monopolist with Advance-Purchase and Spot Markets," IDEI Working Papers 488, Institut d'Économie Industrielle (IDEI), Toulouse.
    2. Roques, F.A. & Savva , N.S., 2006. "Price Cap Regulation and Investment Incentives under Demand Uncertainty," Cambridge Working Papers in Economics 0636, Faculty of Economics, University of Cambridge.
    3. Holmberg, Pär & Newbery, David, 2010. "The supply function equilibrium and its policy implications for wholesale electricity auctions," Utilities Policy, Elsevier, vol. 18(4), pages 209-226, December.
    4. Marek Kočan, 2008. "Cyclic behavior in dynamic investment decisions for deregulated energy 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. 16(1), pages 67-78, March.
    5. Scholz, Sebastian, 2010. "Derivatives and Default Risk," Discussion Papers in Economics 11317, University of Munich, Department of Economics.

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