Avoidable Costs and Market Design

Virtually all producers, most notably airlines and electricity generators, face avoidable fixed costs that cause non-convexities in production. Standard bilateral trading institutions such as the continuous double auction produce inefficient and unstable outcomes in the presence of avoidable costs. We design a package market that allows traders to submit schedules of quantity-contingent bids. In an experiment, we compare two continuous double-auction formats to two schedule-based variants. The new mechanisms substantially outperform the continuous double auctions, both in efficiency and in preventing seller losses. Efficiency is highest when schedules can be revised in continuous time. The mechanisms that allow sellers to express non-convex costs restore efficiency in markets where bilateral trading institutions fail.