Welfare, Pricing, and Market Power in Utility Markets
Saturday, Jan. 4, 2020 10:15 AM - 12:15 PM (PDT)
- Chair: Frank A. Wolak, Stanford University
Welfare Analysis of Equilibria with and without Early Termination Fees in the United States Wireless Industry
AbstractWe study social welfare implications of early termination fees in the U.S. wireless industry. It is hypothesized that elimination of the long-term contracts at the end of 2015 was a transition from one market equilibrium to another. We use a theoretical model to illustrate that the endogenous choice of consumer switching costs by service providers does not necessarily raise firms' prots and hurts consumers. Forward-looking behavior of consumers facing switching costs results in significant downward pressure on prices. Service fees may be so low that consumers are better off and firms are worse off in an equilibrium with switching costs. Empirically, we find that without early termination fees firms would increase prices by two to five percent on average such that consumer surplus unambiguously increases. Firms' profits derived from monthly service fees also increase. However, if we consider additional revenues from the contract termination payments, the cost of processing these payments should be large enough for producer profits to be higher in the new equilibrium.
Market Power and Incentive-Based Capacity Payment Mechanisms
AbstractCapacity markets provide guaranteed payments to electricity generation unit owners for having the "firm capacity" to produce electricity. Historically, these markets are plagued by the weak incentives they provide for plants to be available during high-demand hours. The reliability payment mechanism in the Colombian electricity market provides market-based incentives for plants to produce during periods of system scarcity. This market has served as a model for the design of capacity markets in a number of jurisdictions in North America and Europe. We demonstrate severe shortcomings of this mechanism. By adjusting their price and quantity offers, generators with the ability to exercise unilateral market power can choose whether or not a scarcity condition exists. We find that this mechanism can make it privately profitable for a firms to withhold output and create a scarcity condition. We illustrate this problem using hourly data from the first ten years of operation of the reliability payment mechanism in Colombia. The mechanism not only fails to minimize the cost of meeting electricity demand but also creates perverse incentives for electricity generators that could reduce the reliability of electricity supply. We quantify the cost of the perverse incentives caused by this capacity payment mechanism by computing a counterfactual dynamic oligopoly equilibrium for the 2015–16 El Niño event in Colombia.
Hydro Power Market Might
AbstractA central tenet of economic theory is that market power induces deadweight loss. This claim rests on an assumption that is difficult to verify empirically. Namely, that dominant firms produce less than the social optimum. I provide evidence of such restrictive behaviour using a rich dataset of Norwegian hydropower firms. The research design exploits exogenous variation in market power, arising from transmission bottlenecks and the formation of localized electricity markets. The unique production traits of hydropower production further helps to avoid empirical complications associated with marginal cost estimation and endogenous variation in the supply mix. This allows me to identify the causal impact of market power on firm behaviour without imposing strong structural assumptions on the data. I show that a firm's gaining pivotal status may cause it to withhold production by as much as a two to five percent. My results suggest that even nominally competitive markets are susceptible to strategic manipulation and welfare losses.
- L9 - Industry Studies: Transportation and Utilities
- R4 - Transportation Economics