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Imperfect competition and macroeconomics : Theory and quantitative implications

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The relative efficiency of market-based environmental policy instruments with imperfect compliance

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The New Macroeconomics: Imperfect Markets and Policy Effectiveness by Huw David Dixon

Monetarism New classical macroeconomics New Keynesian economics. Categories : Schools of economic thought. Hidden categories: Webarchive template wayback links. Namespaces Article Talk. Views Read Edit View history. By using this site, you agree to the Terms of Use and Privacy Policy. Part of a series on. Numerous analysts suggested that the same approach could be used to build interconnections.

Why not authorize "merchant" interconnections, which would rely on wholesale markets to cover their investment cost? A natural solution would be to grant interconnection investors the new financial rights that the interconnection creates. Paul Joskow and Jean Tirole examine this problem, observing that investments in the transmission network are "discrete" and not continuous, and sequential.

Under reasonable assumptions, one can show that as the interconnection capacity increases, the price difference between the extremities decreases. The socially optimal capacity is such that the price difference precisely equals the marginal capacity cost. Under imperfect competition, the first investor strategically selects its line's capacity.

It can maximize its profits, for instance by building a line with capacity lower than optimal to capture a larger price difference. It can also attempt to block another investor's entry by building a line such that the post-construction price difference would be too low to allow competitors in. How did these papers influence public policies?

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Most of the North American and European electricity markets have gradually chosen financial rights over physical ones, and regulators subject merchant interconnections to specific scrutiny, e. Thus, recommendations from these papers have been followed. It is never easy to attribute public policy to papers published in academic journals. In the s most analysts thought that competition in electricity retailing was sufficiently high that only light oversight — if any — would be required. Consequently, electricity supply activities and natural gas ones did not attract much academic research.

Yet, Paul Joskow and Jean Tirole observe a significant imperfection in electricity retailing. Since most consumers do not have real-time meters, suppliers are selling to them based on an estimated load profile, which does not necessarily reflect their actual consumption. Since electricity prices on the wholesale market fluctuate greatly, flawed estimates can have considerable financial implications. In this case, the imperfection comes from the metering technology.

Joskow and Tirole rigorously examine competition on the supply side when including this imperfection, and show that lack of real-time metering reduces the efficiency of this downstream market. Competition in the retail market has become a critical issue for the electric power industry.

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For example, policy makers and regulators in the United Kingdom have opened in a retail market investigation, suspecting collusion. In addition, the emergence of demand response operators in the United States and many European countries has revived attention for the structure and economics of the retail industry.

The article by Joskow and Tirole offers a clear conceptual framework to examine these issues.

Perfect and Imperfect market

Starting in the mid's, policy makers and academics began turning their attention to investment in electric generation capacity. Are we sure that the market's invisible hand will lead to sufficient investment to guarantee security of supply? In other words, will competition not cause too many outages? Here again, if the markets are perfect, the invisible hand works and investment is optimal.

However, California's crisis — where market power exerted by some electricity producers and traders caused blackouts in one of the world's most advanced economies — shook the faith of analysts in the efficiency of electricity markets. One solution proposed by some academics and implemented in most North American markets is to create capacity markets: four or five years before a given date, the Transmission System Operator purchases capacity from producers.

At expiry, the latter receive a capacity payment, which remunerates their contribution to security of supply, whether or not they produce any power. Paul Joskow and Jean Tirole examine the issue by relaxing several assumptions about perfect markets 7. Their paper develops a rigorous economic representation of the coexistence between industrial consumers who adjust to wholesale prices and others facing a fixed price over time primarily residential consumers , which enables an accurate definition of security of supply.

Joskow and Tirole then lay out the conditions under which capacity markets lead to optimal investment and those under which other instruments are required.

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This paper is as relevant today as it was then.