Dynamic Pricing & Learning in Electricity Markets

We analyze the price-formation process in an infinite-horizon oligopoly model where hydroelectric generators engage in dynamic Bertrand competition. We provide a simple characterization of a Markov Perfect Equilibrium (MPE) in terms of “indifference” prices — i.e. prices that equate the gains from releasing or withholding water. Although the MPE solution represents an equilibrium consistent with dynamic strategic behavior, it requires computational sophistication by market participants. However, under certain assumptions a basic “learning” procedure converges to the Markov Perfect Equilibrium (MPE). Subject Classification: Games: Stochastic, Noncooperative; Natural Resources: Energy, Water Resources; Economics: Restructured Electricity Markets, Dynamic Auctions. ∗The first two authors gratefully acknowledge partial support from NSF grant ECS-0224747 and a University of Virginia Bankard Fellowship.