Understanding how market power can arise in network competition: a game theoretic approach

Abstract

This paper considers competition in electric networks and how the network structure affects the competition. The approach is to examine non-cooperative behavior among producers and calculate a Nash equilibrium under different market specifications. Unlike most other treatments of this problem, which utilize either Cournot or Bertrand models of competition, the model used here examines supply function competition. Two and four node networks are considered. Several results that differ from traditional economic theory are found. In both a two-node and four-node market with imperfect competition among producers, transmission constraints increase their profits (compared to an unconstrained network)—but with little or no change in consumer prices or quantities produced. This is because generators profit primarily at the expense of the owner of transmission rights. The size of the increase in profits depends on the number of firms at each node and the size of the transmission constraint. In the four-node case, an example was found in which decreasing market concentration by breaking up suppliers worsens market efficiency, even if there are no cost diseconomies. In particular, increasing competition at one node increases the consumer price at a second node, and causes an overall decrease in consumer surplus. In general, the cases presented here show that strategic behavior on electric networks may produce results that differ from those predicted by traditional economic theory due to the network structure of the problem.