Supply Function Equilibrium with Taxed Benefits

Authors are encouraged to submit new papers to INFORMS journals by means of a style file template, which includes the journal title. However, use of a template does not certify that the paper has been accepted for publication in the named journal. INFORMS journal templates are for the exclusive purpose of submitting to an INFORMS journal and should not be used to distribute the papers in print or online or to submit the papers to another publication. Supply-function equilibrium models are used to study electricity market auctions with uncertain demand. We study the effects on supply-function equilibrium of a system tax on the observed benefits of suppliers. Such a tax provides an incentive for agents to alter their offers to avoid the tax. We show how this surprisingly can lead to lower prices in equilibrium. The model is extended to a setting in which the agents are taxed on the benefits accruing to them from a transmission line expansion (in order to help fund the line). In these circumstances we study how incentives for agents to alter their bids varies with the relative size of the capacity expansion.