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Identifying Market Power in Electric Generation

Fortnightly Magazine - February 15 1996

from which to consider the exercise of market power.

The greater a competitor's share of output in the competitive equilibrium, the greater its market power, because its output share governs its share of benefits from output restriction.

The cost-benefit tradeoff of restricting output yields several important insights on market power. Given the industry demand elasticity, two factors determine the benefit side of the market power tradeoff for a particular firm: 1) its share of industry output, and 2) how supply from other firms responds to a price increase.

As one firm restricts output and drives up price, the higher price confers benefits on all industry firms that make sales. A given firm's conduct, however, is motivated by its share of those benefits (em i.e., its share of the remaining industry output. This simple point explains why market share forms a central focus of market power inquiries.

A competitor's market power grows as the supply of product offered by rivals (in the neighborhood of the

competitive price) becomes less


As any one firm restricts output, its rivals typically find it profitable to boost production. If rivals make up for the restricted output using resources with the same marginal cost as those from which supply was restricted, then the firm restricting output would have no market power, because the output restriction would not drive up price. If Figures 1 and 2 were modified so that all units carried the same marginal cost, then the owner of even several units would enjoy no market power. As Figures 1 and 2 are drawn, however, the owner of a single unit can exert significant market power because an output restriction could not be made up for by a unit with a marginal cost very close to the competitive price.

Owning resources not used in competitive equilibrium may enhance market power if those resources would become economical when market power was exercised.

It is important to note here that no market power is conferred by owning a resource that is not used in equilibrium. The owners of units 6 or 7 alone would have no market power, since they sell nothing in the competitive equilibrium and thus cannot restrict

output below the competitive level. Nevertheless, this fact does not make units 6 or 7 irrelevant. If a firm owned both units 5 and 6, it would possess more market power than if it owned unit 5 alone, because unit 6 represents the next-best source of supply once output from unit 5 is restricted.

The market power of a particular firm may vary over time as demand conditions vary.

Industry demand may be greater at certain times than it is at the time illustrated by Figure 2. If so, ownership of units 6 and 7 could confer market power at such times.

The smaller the difference between the price and the marginal cost at a particular resource, the greater the market power conferred on the owner, provided that the resource operates in the competitive equilibrium.

On the cost side of the market power tradeoff lies the profit that