Why Higher Price Sensitivity of Consumers May Increase Average Prices: An Analysis of the European Electricity Market

FCN Working Paper No. 16/2010

27 Pages Posted: 19 Dec 2010  

Tobias Paulun

RWTH Aachen University - Institute of Power Systems and Power Economics

Eberhard Feess

Frankfurt School of Finance & Management gemeinnützige GmbH

Reinhard Madlener

RWTH Aachen University

Date Written: November 2010

Abstract

We develop a model of the European electricity market that allows analyzing the impact of consumers' price sensitivity, defined as the willingness to change energy providers, on equilibrium prices. The model is parameterized with publicly available data on total demand, marginal costs and capacity constraints of power generators. Comparably precise data on the price sensitivity is not available, so that we analyze its impact in a range of simulations. Contrary to apparently straightforward expectations, we find that a higher price sensitivity increases average prices under reasonable assumptions. The reason is that, when price sensitivity is high, the most efficient energy providers can attract sufficiently many consumers for operating at full capacity, even when price differences to their less efficient competitors are small. Hence, incentives to reduce prices are higher when the price sensitivity is low. We conclude that the widespread view that high electricity prices can (partially) be attributed to a low willingness of consumers to change their providers is flawed.

Keywords: Electricity Market, Price Sensitivity, Heterogenous Oligopoly, Price Competition, Capacity Constraints

Suggested Citation

Paulun, Tobias and Feess, Eberhard and Madlener, Reinhard, Why Higher Price Sensitivity of Consumers May Increase Average Prices: An Analysis of the European Electricity Market (November 2010). FCN Working Paper No. 16/2010 . Available at SSRN: https://ssrn.com/abstract=1727271 or http://dx.doi.org/10.2139/ssrn.1727271

Tobias Paulun (Contact Author)

RWTH Aachen University - Institute of Power Systems and Power Economics ( email )

Schinkelstraße 6
Aachen, 52062
Germany

Eberhard Feess

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

Reinhard Madlener

RWTH Aachen University ( email )

School of Business and Economics / E.ON ERC
Mathieustraße 10
Aachen, 52074
Germany
+49 241 80 49 820 (Phone)
+49 241 80 49 829 (Fax)

HOME PAGE: http://www.eonerc.rwth-aachen.de/fcn

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