Investment Effects of Pricing Schemes for Non-Convex Markets

European Journal of Operational Research 289(2), 712-726 (2021)

39 Pages Posted: 18 Jun 2018 Last revised: 10 Mar 2021

See all articles by Jacob Mays

Jacob Mays

Cornell University

David Morton

Northwestern University - Department of Industrial Engineering and Management Sciences

Richard P. O'Neill

Government of the United States of America - Office of Economic Policy

Date Written: June 18, 2018

Abstract

Non-convex markets, such as those organized by electricity system operators, lack uniform clearing prices. To help resolve the incentive compatibility issues that arise when clearing these markets, operators have introduced a variety of price formation and uplift payment schemes. We investigate the impact that the choice of pricing scheme can have on generator entry and exit decisions. Our results suggest that despite the presence of fixed production cost elements, prices derived from marginal costs support the optimal capacity mix. The use of uplift payments to supplement these prices could lead to significant distortion of the capacity mix arising in competitive markets. Pricing schemes designed to reduce the need for uplift payments may at the same time reduce prices, leading to lower levels of capacity in equilibrium. Schemes intended to raise prices, to the extent they eliminate the need for discriminatory side payments, may allow system operators to support a higher level of capacity with less distortion to the capacity mix.

Keywords: Equilibrium pricing, market design, capacity expansion, uplift

Suggested Citation

Mays, Jacob and Morton, David and O'Neill, Richard P., Investment Effects of Pricing Schemes for Non-Convex Markets (June 18, 2018). European Journal of Operational Research 289(2), 712-726 (2021), Available at SSRN: https://ssrn.com/abstract=3198423 or http://dx.doi.org/10.2139/ssrn.3198423

Jacob Mays (Contact Author)

Cornell University ( email )

Ithaca, NY 14853
United States

David Morton

Northwestern University - Department of Industrial Engineering and Management Sciences ( email )

2145 Sheridan Road
Room C210
Evanston, IL 60208
United States

Richard P. O'Neill

Government of the United States of America - Office of Economic Policy ( email )

888 First St., N.E.
Washington, DC 20426
United States
202 208-2220 (Phone)
202 208-0193 (Fax)

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