Efficient Tariffs for Cost Revelation in a Price and Quantity Constrained Electric Power Market

We analyze a market in which an auctioneer or system operator must satisfy a fixed demand at a fixed price, and attempts to minimize cost as indicated by sellers’ bids. This situation may arise in wholesale electricity markets, e.g. when generation price caps are in effect. We show that no equilibrium exists in this situation, and the operator can not identify low-cost generators from bids. As a remedy, we propose a simple tariff on generation, proportional to the spread between market price and bid. With a tariff imposed, generators’ Nash equilibrium bids diverge from marginal cost but contain information sufficient to identify the least-cost bidders. In a simple case, generators make the same profit as they would in a second-price Vickrey auction, regardless of the tariff rate or number of generators. ∗Both are at WVU Department of Economics, PO Box 6025, Morgantown, WV, 26506-6025. Serhiy Kotsan can be reached at [email protected]. Stratford Douglas phone number is (304)-293-7863, e-mail [email protected]