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Investment Incentives and Market Power: An Experimental Analysis

  • Dean V. Williamson

    (Economic Analysis Group, Antitrust Division, Department of Justice)

  • Céline Jullien

    (Université de Grenoble)

  • Lynne Kiesling

    (International Foundation for Research in Experimental Economics (IFREE) and Department of Economics, Northwestern University)

  • Carine Staropoli

    (Université Panthéon-Sorbonne)

We examine investment incentives and market power in an experimental market. We characterize market power as the strategic interdependence of subjects' investment decisions and output decisions. The market is designed so that investment and output decisions can be jointly characterized as strategies within a game. A Nash-Cournot equilibrium of the game provides a way of characterizing how investment incentives and market power interact. Subjects could invest in two different production technologies and could produce output to serve as many as two different demand conditions. The technologies were analogous to "baseload" capacity and "peaking" capacity in wholesale electricity markets. The Nash-Cournot benchmark constituted a good indicator of subjects' output decisions in that output cycled around the Cournot benchmark. Thus, on average, consumers extracted the surplus available to them in the equilibrium. While we do not observe Edgeworth Cycles in prices or outputs, we do see them in the producer surplus series. Producers dissipated some of the surplus they could have extracted in the equilibrium by overinvesting in peaking capacity and underinvesting in baseload capacity. Inefficient investment diminished total system efficiency, but producers' investments in total production capacity tracked the Nash-Cournot benchmark. In contrast, monopoly explanations such as collusion do not characterize the data.

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File URL: http://www.justice.gov/atr/public/eag/221877.pdf
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Paper provided by Department of Justice, Antitrust Division in its series EAG Discussions Papers with number 200605.

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Length: 29 pages
Date of creation: Jan 2006
Date of revision:
Handle: RePEc:doj:eagpap:200605
Contact details of provider: Postal: Department of Justice Antitrust Division 450 Fifth Street NW Washington, DC 20530
Web page: http://www.justice.gov/atr/
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  1. Frank A. Wolak & Robert H. Patrick, 2001. "The Impact of Market Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market," NBER Working Papers 8248, National Bureau of Economic Research, Inc.
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  11. Klemperer, Paul D & Meyer, Margaret A, 1989. "Supply Function Equilibria in Oligopoly under Uncertainty," Econometrica, Econometric Society, vol. 57(6), pages 1243-77, November.
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