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
Date Written: November 2010
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
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