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Strategic capacity choice under uncertainty: the impact of market structure on investment and welfare

Author

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  • Grimm, Veronika
  • Zoettl, Gregor

Abstract

We analyze a market game where firms choose capacities under uncertainty about future market conditions and make output choices after uncertainty has unraveled. We show existence and uniqueness of equilibrium under imperfect competition and establish that capacity choices by strategic firms are generally too low from a welfare point of view. We also demonstrate that strategic firms choose even lower capacities if they anticipate competitive spot market pricing (e.g. due to regulatory intervention). We finally illustrate how the model can be used to assess the impact of electricity market liberalization on total capacity and welfare by fitting it to the data of the German electricity market.

Suggested Citation

  • Grimm, Veronika & Zoettl, Gregor, 2008. "Strategic capacity choice under uncertainty: the impact of market structure on investment and welfare," FAU Discussion Papers in Economics 01/2008, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
  • Handle: RePEc:zbw:iwqwdp:012008
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    File URL: https://www.econstor.eu/bitstream/10419/29557/1/612408817.pdf
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    More about this item

    Keywords

    Investment incentives; demand uncertainty; cost uncertainty; Cournot competition; First Best; Second Best; capacity obligations; spot market regulation;

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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