Market Dynamics and Investment in the Electricity Sector∗

We model dynamic competition in which firms make initial capital investment decisions followed by repeated entry and exit choices as demand fluctuates. We show a correspondence between competitive equilibrium and the solution to a planner’s problem, which establishes equilibrium existence and provides a platform for computation. We apply the framework to model electricity generator investment decisions, incorporating generator startup costs as the entry/exit friction. Market frictions are particularly important when evaluating renewable energy policies. The presence of startup costs reduces wind turbine profits, leading to as much as 60% lower uptake of wind investment for a given renewable subsidy level. University of Arizona Economics Working Paper 17-05 ∗We thank Ignacio Esponda, Gautam Gowrisankaran, Derek Lemoine, Glenn MacDonald, and Ignacia Mercadal as well as participants at the Berkeley Energy Institute seminar for helpful comments. Chuan Chen provided valuable research assistance. †Olin Business School, Washington University in St Louis, St Louis, MO, [email protected] ‡Department of Economics, University of Arizona, Tucson, AZ, [email protected]