On the Efficiency of Competitive Electricity Markets with Time-Invariant Retail Prices

Severin Borenstein and Stephen Holland

RAND Journal of Economics, 2005, vol. 36, issue 3, 469-493

Abstract: Most customers in electricity markets do not face prices that change frequently to reflect changes in wholesale costs, known as real-time pricing (RTP). We show that not only does time-invariant pricing in competitive markets lead to prices and investment that are not first best, it even fails to achieve the constrained second-best optimum. Increasing the share of customers on RTP is likely to improve efficiency, though surprisingly it does not necessarily reduce capacity investment, and it is likely to harm customers that are already on RTP. Simulations demonstrate that the efficiency gains from RTP are potentially quite significant.

Date: 2005
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