Efficiency and Marginal Cost Pricing in Dynamic Competitive Markets with Friction

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In-Koo Cho and Sean Meyn

 

 

Abstract: This paper examines a dynamic general equilibrium model with supply friction. With or without friction, the competitive equilibrium is efficient. Without friction, the market price is completely determined by the marginal production cost. If friction is present, no matter how small, then the market price fluctuates between zero and the ``choke-up'' price, without any tendency to converge to the marginal production cost, exhibiting considerable volatility. The distribution of the gains from trading in an efficient allocation may be skewed in favor of the supplier, although every player in the market is a price taker.

Keywords: Dynamic general equilibrium model with supply friction, Choke-up price, Marginal production cost, First
welfare theorem.

Power prices in markets around the world can appear entirely irrational. In 2007, prices for power reached $10,000 Aus. in Victoria, many times greater than the ususal value near $50. At the same time, prices crashed to a negative value in Tasmania (-$1,000 Aus). Similar high prices are seen today in European and North American markets.

Plenary lecture, Stochastic Processes and Applications 2007, Paris France; Eurandom LOIS Lecture January, 2009 Newton Institute Tutorial Lecture & Panel Lecture, May, 2010 (see also the Cambridge website)

 

References

@article{chomey10,
Author = {I.-K. Cho and S. P. Meyn},
Journal = {Theoretical Economics},
Number = {2},
Pages = {215-239},
Title = {Efficiency and marginal cost pricing in dynamic competitive markets with friction},
Volume = {5},
Year = {2010}}

@unpublished{meynegwankowsha10,
Author = {S. Meyn and M. Negrete-Pincetic and G. Wang and A. Kowli and E. Shafieepoorfard},
Title = {The Value of Volatile Resources in Electricity Markets},
Note = {Proc. of the 49th Conf. on Dec. and Control},
Year = {2010}}

@inproceedings{wankownegshamey10,
Title = {A Control Theorist's Perspective on Dynamic Competitive Equilibria in Electricity Markets},
Address = {Milano, Italy},
Author = {G. Wang and A. Kowli and M. Negrete-Pincetic and E. Shafieepoorfard and S. Meyn},
Booktitle = {Proc. 18th World Congress of the International Federation of Automatic Control (IFAC)},
Year = {2011}}

@unpublished{chomey09a,
Author = {Cho, I.-K. and Meyn, S. P.},
Note = {Submitted for publication, {SIAM J. Control and Optimization.}},
Title = {A Dynamic Newsboy Model for Optimal Reserve Management in Electricity Markets},
Year = {2009}}

@article{chechomey06a,
Author = {Chen, M. and Cho, I.-K. and Meyn, S.P.},
Journal = {Automatica},
Month = {August},
Pages = {1267-1281},
Title = {Reliability by design in a distributed power transmission network},
Volume = {42},
Year = {2006}}

@article{chomey07,
Author = {Cho, In-Koo and Meyn, S.},
Journal = {Decision and Control, 2007 46th IEEE Conference on},
Month = {Dec.},
Pages = {771-778},
Title = {Efficiency and marginal cost pricing in dynamic competitive markets with friction},
Year = {2007}}

@inproceedings{chomey03b,
Author = {Cho, I.-K. and Meyn, S. P.},
Booktitle = {Proceedings of the 42nd IEEE Conference on Decision and Control},
Month = {December 9-12},
Pages = {2094- 2099},
Title = {The dynamics of the ancillary service prices in power networks},
Volume = {3},
Year = {2003}}