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Efficiency in Deregulated Electricity Markets: Offer Cost Minimization vs. Payment Cost Minimization Auction

Rimvydas Baltaduonis

No 2006-04, Working papers from University of Connecticut, Department of Economics

Abstract: This study of the wholesale electricity market compares the efficiency performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed mechanism. The analysis highlights the importance of considering strategic behavior when comparing different institutional systems. We find that in concentrated markets, neither auction mechanism can guarantee an efficient allocation. The advantage of the current mechanism increases with increased price competition if market demand is perfectly inelastic. However, if market demand has some responsiveness to price, the superiority of the current auction with respect to efficiency is not that obvious. We present a case where the proposed auction outperforms the current mechanism on efficiency even if all offers reflect true production costs. We also find that a market designer might face a choice problem with a tradeoff between lower electricity cost and production efficiency. Some implications for social welfare are discussed as well.

Keywords: strategic behavior; multi-unit auction; efficiency; electricity (search for similar items in EconPapers)
JEL-codes: C72 D44 D61 L94 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2006-03
New Economics Papers: this item is included in nep-com, nep-eff, nep-ene and nep-mic
Note: The author would like to thank the National Science Foundation for financial support under grant ECS-0323685. The author is grateful to the Engineering and Economics faculty and students at the University of Connecticut working on the electricity project, especially to the PI on the grant Peter Luh and Senior Economist Vicki Knoblauch.
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