Does Strategic Ability Affect Efficiency? Evidence from Electricity Markets

64 Pages Posted: 6 Mar 2019

See all articles by Ali Hortacsu

Ali Hortacsu

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Fernando Luco

Texas A&M University

Steven L. Puller

Texas A&M University - Department of Economics; National Bureau of Economic Research (NBER)

Dongni Zhu

Shanghai Lixin University of Accounting and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2019

Abstract

Oligopoly models of price competition predict that strategic firms exercise market power and generate inefficiencies. However, heterogeneity in firms’ strategic ability also generates inefficiencies. We study the Texas electricity market where firms exhibit significant heterogeneity in how they deviate from Nash equilibrium bidding. These deviations, in turn, increase the cost of production. To explain this heterogeneity, we embed a Cognitive Hierarchy model into a structural model of bidding and estimate firms’ strategic sophistication. We find that firm size and manager education affect sophistication. Using the model, we show that mergers that increase sophistication can increase efficiency despite increasing market concentration.

Suggested Citation

Hortacsu, Ali and Luco, Fernando and Puller, Steven Lawrence and Zhu, Dongni, Does Strategic Ability Affect Efficiency? Evidence from Electricity Markets (February 1, 2019). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2019-36, Available at SSRN: https://ssrn.com/abstract=3347192 or http://dx.doi.org/10.2139/ssrn.3347192

Ali Hortacsu (Contact Author)

University of Chicago - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Fernando Luco

Texas A&M University ( email )

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Steven Lawrence Puller

Texas A&M University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

Dongni Zhu

Shanghai Lixin University of Accounting and Finance ( email )

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