Residual Demand Based Competitive Analysis: an example, Summaries of Business Management and Analysis

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Residual Demand Based

Competitive Analysis:

an exampleJames Bushnell

MSC

Market Structure

Capacity with costs at or below

Native Demand

$15/MWh

$30/MWh

$45/MWh $60/MWh $75/MWh

Firm A

Firm B

Firm C

Firm D

Firm E

Small Instate

Import

Total

Competitive “Fringe” Supply

120 100 80 60 40 20 0 0

10000

20000

30000

40000

50000

60000

Inverse Residual Demand

120 100 80 60 40 20 0 0

10000

20000

30000

40000

50000

60000

Solution Options

•^

Iterative grid search– each firm iteratively searches for best Q given Q’s of

other firms. Repeat until convergence• deals well with discontinuities like steps in the residual

demand function

• may not converge – possibly multiple equilibria

•^

Analytic solution– Simultaneously solve FOC for each Cournot firm

• should yield unique solution• can accommodate optimal hydro scheduling• requires a fit of smooth function to fringe supply curve

Residual Demand

y = -7779.8Ln(x) + 42313

5000 0 45000 40000 35000 30000 25000 20000 15000 10000

0

20

40

60

80

100

120

Solutions for example

• Perfect competition

– price = $30.00, qi = 3170

• Cournot with no contracts

– price = $44.64, qi = 2552

• Cournot with contract qc = 2000 for each

Cournot firm– price = $34.25, qi = 2999

Other Issues

• Threshold mark-up levels

– should be higher than for benchmark studies– can examine uncertainty from the “fit” of the

import curve – develop confidence intervals

– Price cap level may effect average mark-up

• Treatment of energy limited

– can optimize or “peak shave”

• Treatment of derivative contracts