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

Severin Borenstein, Stephen P. Holland

NBER Working Paper No. 9922
Issued in August 2003
NBER Program(s):   IO   EEE

The standard economic model of efficient competitive markets relies on the ability of sellers to charge prices that vary as their costs change. Yet, there is no restructured electricity market in which most retail customers can be charged realtime prices (RTP), prices that can change as frequently as wholesale costs. We analyze the impact of having some share of customers on time-invariant pricing in competitive electricity markets. Not only does time-invariant pricing in competitive markets lead to outcomes (prices and investment) that are not first-best, it even fails to achieve the second-best optimum given the constraint of time-invariant pricing. We then show that attempts to correct the level of investment through taxes or subsidies on electricity or capacity are unlikely to succeed, because these interventions create new inefficiencies. In contrast, 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.

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Document Object Identifier (DOI): 10.3386/w9922

Published: Borenstein, Severin and Stephen Holland. "On The Efficiency Of Competitive Electricity Markets With Time-Invariant Retail Prices," Rand Journal of Economics, 2005, v36(3,Autumn), 469-493. citation courtesy of

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