Detecting, Modelling and Mitigating Market Power

Policy makers often need to know when market power has been exercised in the past and to be able to predict how market power will be exercised in the future following a change in the market (such as a merger of large generators). Chapter 17 begins with a discussion of how to detect whether market power has been exercised in the past, distinguishing between quantity-withdrawal studies, on the one hand, and price-cost margin studies, on the other hand. The chapter discusses various simple indicators of market power including the Hirschmann-Herfindahl Index (HHI), the pivotal supplier index (PSI) and the residual supply index (RSI). The relationship between these indicators is derived and their pros and cons discussed. The chapter also explores the merits of approaches which focus on the shape of the residual demand curve. The concluding part of the chapter discusses issues that arise in the modelling of electricity market power, including the choice of the type of strategy, the hedge level of the generators and the equilibrium notion. The chapter concludes with a discussion of policies which might serve to mitigate market power.