Supply Function Equilibria in Networks with Transport Constraints
73 Pages Posted: 19 Dec 2012 Last revised: 12 Aug 2015
Date Written: August 10, 2015
Transport constraints limit competition and arbitrageurs' possibilities of exploiting price differences between goods in neighbouring markets, especially when storage capacity is negligible. We analyse this in markets where strategic producers compete with supply functions, as in wholesale electricity markets. For networks with a radial structure, we show that existence of supply function equilibria (SFE) is ensured if demand shocks are sufficiently evenly distributed, and solve for SFE in symmetric radial networks with uniform multi-dimensional nodal demand shocks. An equilibrium offer in such networks is identical to an SFE offer in an isolated node where the symmetric number of firms has been scaled by a market integration factor, the expected number of nodes that are completely integrated with a node in the symmetric network. The analysis can be extended to mesh networks (as in electricity systems) although the resulting models do not simplify as in the radial case.
Keywords: Oligopoly market, Divisible-good auction, Transmission network, Graph theory, Market integration, Wholesale electricity markets
JEL Classification: D43, D44, C72, L91
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