Lecture 7: Regulation Flashcards
How is the profit maximizing in the competitive market and monoply?
Competitive output choice
Price = marginal cost,
so where the marginal cost curve (demand curve) meets the Demand curve, we have the competitive market equibilirum. At this point we have surpluses, one there is producer surplus and other there is consumer surplus
Monopoly output choice
Marginal revenue = marginal cost
this gives us the quantity, the price corrospending to that quantity is to be found in the respecting Demand Curve
High fixed costs competition can not be sustained due to the resulting …… Why?
Fixed Costs and constant marginal costs imply that avarege costs are falling in output (je höher die Output, desto geringer avarage cost). In that kind of cost structure a single producer is strictly more efficient than multiple producers.
the avarage cost might not be falling in the whole output range but only in releavnt demand range. *
(However, this decrease in average cost doesn’t continue indefinitely. There comes a point where making even more lemonade doesn’t reduce your average cost anymore. This is because you might have limited space or equipment, or it becomes difficult to manage everything efficiently. This is the relevant demand region we mentioned earlier.
So, the minimum efficient scale is the output level (the amount of lemonade you make) that minimizes your average cost. It’s the point where you’re producing the right amount of lemonade to keep your costs as low as possible while meeting the demand from your customers. It’s like finding the perfect balance between making enough lemonade to make a profit and not making too much that it becomes inefficient and costly.)
*
If the MES is comparable to demand at minimum Avarage Cost Market cannot support two profitable competitors -Monoply
if the MES is much smaller than the demand at minimum Av. Cost market is able to have mire competitors
Definition of Natural Monopoly
A natural Monopoly is a monopoly created
and sustained by economies of scale over the
relevant range of output for the industry
How to deal with natural monopolies? Four generic policy options
A) Socialization
* Regulation that sets p = MC: welfareoptimal
* Losses are covered by subsidy
B) Average cost pricing (“Second-best”)
* Operate at p = AC: higher than welfareoptimal
price
* Firm breaks even, no subsidy required
* Firm benefits from short-term cost savings
C) Licensing
* Operate at p = MR: higher than AC
* Society profits from monopoly rent in the
form of license payments
* Incentives for operational efficiency are
preserved
D) “Let it be”
* Operate at p = MR
* Incentives for both entrepreneurial activity
and operational efficiency are preserved
Inefficient price and output choice can create
substantial welfare loss; society does not
profit from
What is the typical choice of the public service industries? How about dynamic industries, such as software.
A) Socialization
* Regulation that sets p = MC: welfareoptimal
* Losses are covered by subsidy
B) Average cost pricing (“Second-best”)
* Operate at p = AC: higher than welfareoptimal
price
* Firm breaks even, no subsidy required
* Firm benefits from short-term cost savings
C) Licensing
* Operate at p = MR: higher than AC
* Society profits from monopoly rent in the
form of license payments
* Incentives for operational efficiency are
preserved
D) “Let it be”
* Operate at p = MR
* Incentives for both entrepreneurial activity
and operational efficiency are preserved
Inefficient price and output choice can create
substantial welfare loss; society does not
profit from
Case B- Avarage cost pricing,
Case D- Let it be
Grid operation is considered a natural monopoly, generation and
distribution are not, why?
Because the “Natural” market structure is governed by cost structure and in the grid operation side there are lot of investment costs involved with very low marginal costs, where as in the generation side there is multiple MES, which means diffrent componies with diffrent cost structures can meet the demand
What are the key determinants of the competitiveness of a power market?
1) Demand elasticity
* Low electricity demand elasticity
Ø Increase operating reserve à increase of operator´s demand elasticity
Ø Introduction of real-time prices à Increase demand elasticity
2) Supplier concentration
* Low supplier concentration in the power market
Ø Reduce market power by reducing supplier concentration
3) Extent of long-term contracting
* Market power cannot be exercised in derivatives (forwards and future) and dayahead
markets
* Market power can be exercised in real-time markets
Ø Increase extent of long-term contracting
4) Extent of supply curve bidding
* Set price above marginal cost but below the price cap of a specific quantity
* Supply bids are used to exercise market power when demand is uncertain
* Supply bids are more profitable if only one supplier applies it
* If all suppliers apply supply bids, all of their profits are reduced
* Supply-bidding increases competition
Which two options of smart grid running did we learned?
Who should own the smart grid? Do we need new regulation?
Depending on the regulation, the smart grid may look very different.Two extreme organization forms can be envisioned. Distributors (whole sale market) run ICT or Grid operators run ICT.
explain the smart grid which is run by the distribution companies?
A smart grid run by distribution companies will focus on smart meter marketing:
§ Establishing and marketing smart metering in the retail business may be the main development driver
§ Competition around attractive and innovative retail power products (services, tariffs)
§ Due to unbundling regulation it is unclear how grid operator could benefit from smart grid monitoring capabilities
§ Distributors may seek heterogeneity of smart metering
landscapes to facilitate retail customer lock-in – multiple
smart grids per distribution grid
§ Competitive smart grid operation may limit access for
smaller players – large integrated firms in advantageous
position
Defining Market Power
- Economic definition
- “The ability to alter profitably prices away from competitive levels.”
(Mas-Colell et al. 1995; emphasis R.M.) - Regulatory definition
- “Market power to a seller is the ability profitably to maintain prices above
competitive levels for a significant time.” (DOJ, 1997) - Three-step process:
1) An exercise of power
2) An effect on price and quantity
3) An impact on market participants - Strategy of withholding
- “Producing less than would be profitable, assuming all output could be sold at
the market price. Not acting as a price-taker. This strategy may be executed
“financially” by bidding high or “physically” by curtailing output.”
The grid can be conceptualized into three “layers”, which are they?
Markets & business models
(EEX, OTC, balancing
power markets)
ICT layer (grid control and
monitoring systems)
§ Physical layer (cable,
transformers, switches)
Intelligent grids are already in place in the high and medium voltage grids:
High- and medium voltage grids are generally
equipped with network control technology
Markets for electricity and balancing power provide
incentives for investments in appropriate technologies
Intelligent grids not yet in place in the low voltage grid hierarchy
So far only punctual field test experiences with “intelligent” low voltage grids
Business models:
Nothing except run-of-themill
retail electricity contracts
- Three participating parties interact with, and mutually influence, each other in the grid regulation process:…….., …………, ………..
Betwenn them there is ….., the lack of property rights and information …..
Arising conflicts likely between the goals of the ….. (as the principal) and the ….. (as the agents)
The regulator’s target is to raise/maximize ….. (by reducing total energy system costs etc.), the DSOs aim at ……
the …. aims at inciting the DSOs to act in a more efficient and welfareoriented way – by linking their profits to societal goals
- (1) Legislator
- (2) Regulatory authority
- (3) Regulated DSOs
-Principal Agent Problems
-Assymetries
- regulatory authority
- DSOs
\ - social welfare
- Profit Maximazation
incentive regulation
\
Agrell2013
In which 4 ways DSO / DER regulation can be effected?
- Integrated regulation:
- Decentralized regulation:
- Centralized independent regulation
- Centralized conditional regulation
What is Integrated regulation
An integrated DSO/DER entity considers the total cost of undertaking smart grid investments; the regulator, who does not know the costs but only forms expectations, makes a take-it-or-leave-it offer to the integrated entity.
What is Decentralized regulation?
- Regulator makes an offer to the DSO, and the latter decides what to offer to
the DER investor. - If the DSO investment costs exceeds the budget alone no investment can take
place. - The regulator’s desire to limit the DSO-DER information rents will generally
lead to underinvestment. - The DER investor is rationed more harshly than the DSO, because the DSO
must pass on information rents to the DER investor.
What is Centralized independent regulation
- The regulator signs separate and independent contracts with the DSO and DER, and rations to lower information rents.
- Implies a unilateral commitment by the regulator to finance the investment irrespective of the coordination in the supply chain.
What is Centralized conditional regulation
- First, the regulator offers an investment possibility to the DER investor
- If the latter accepts and undertakes the investment, the regulator also offers the
investment to the DSO - Obvious advantage: avoids situations where the DSO invests but the DER
investor does not - Outcome may often be that the regulator should refrain from any investment
to begin with (i.e. like in the variant with individual regulation). - Assumption that the regulator can make a conditional regulation in the sense
that a separate contract is offered to the DSO and the DER investor first - An accepted contract by one party becomes only valid if the other party
accepts the contract it was offered, too (thus avoiding the losses inherent in the
unconditional centralized variant that arise when only one party accepts)
Explain the EEG act and the Feed-in tariff system and what the problem was?
The problem was that due to the overachievment of the capacity golas the EEG Levy got up to 30cent per kWh, which then increase the cost of the customer. and with the higher prices PV systems are increasingly used to cover own consumption instead of feeding the entire generated electricity into the grid
UE07
Q1) Explain the concept of market power. When does a frim exercises market power?
What is the central Idea?
A firm exercises market power when it reduces its output or raises the minimum price at which it is willing to sell output (its offer price) in order to change the market price
* Firm risks to sell less, but raises price
* Profitable because the gain in profit by selling all the output (after the market price is increased), is greater than the loss it faces by selling fewer units (if that occurs)
Central idea behind market power is In a market where all output is sold at (or nearly at) the same price, a firm that can influence price in the market will do so in order to raise the price for all the production it sells
UE07
Who is a price taker firm?
A firm that is unable to exercise market power
The firm takes the price it faces for its output as given
It sells all of its output at the market price, which is set by the interaction of demand and all supply in the market
The price taking firm is willing to sell at the market price any output that it can produce at a marginal cost less than the market price
UE07
There is no economic argument for the necessity of market power to ensure the viability of the industry. What is the main arguement for necessity of market power:
In absence of market power marginal cost pricing will leave nothing to cover fixed costs and firms will not be profitable enough to survive
Reason in a competitive market with no barriers to entry: In the long run equilibrium, all generators are able to cover their fixed costs and no other generator could enter and cover its fixed costs at the current market prices
Process of entry and exit:
New generation enters market if the net revenue earned (after covering variable operating
costs) is more than enough to cover the fixed costs for some type of generation
* Generation exits the market if the net revenue is less than enough to cover the fixed costs
for some type of generation
supply curve in the industry shifts to the left and the equilibrium market prices rise
all remaining firms earn higher prices and greater contributions to fixed costs
