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the scaled marginal cost approach as under the postage stamp approach. Again, there are incentive problems that, under scaled marginal cost pricing, induce consumers to buy all of their power from the western generator.
When consumers buy all their power from the western generator, dispatch changes as illustrated in Figure 2. The western generator provides all output while the eastern generator stands idle. This dispatch results in total costs of $18,160, $50 more than the efficient dispatch shown in Figure 1.
Figures 1 and 2 illustrate the general result that marginal cost pricing has incentives that are always consistent with efficient dispatch, while postage stamp and scaled marginal cost pricing generally provide incentives that are not consistent with efficient dispatch.
Price vs. Non-price Methods
Transmission congestion occurs when flows through certain transmission facilities are at or near the physical limits of these facilities. To manage this common occurrence, system operators must reduce generation upstream from the congested facilities and increase generation (or reduce loads) downstream from the facilities. The California, New York and PJM ISOs accomplish this balance primarily through price-based mechanisms. The ERCOT, MISO and New England ISOs manage congestion primarily through non-price mechanisms. However, ERCOT is considering adopting an approach similar to that of California, MISO includes a price-based redispatch (for new transmission customers) that is similar to California's, and New England is in the late stages of developing an approach similar to that of New York.
Price-Based Methods. The ISOs have two different schemes for using price to manage transmission congestion. The New York and PJM ISOs take voluntary bids by which individual generators (or loads) offer to increase or reduce output for the purpose of reducing flows over constrained transmission facilities. These bids serve as the basis for calculating locational prices throughout the power system.
The California ISO, by contrast, takes voluntary bids by which merchant firms agree to redispatch their generation and loads for the purpose of reducing flows. Each merchant firm expressly is prohibited from offering to change only the output of a single generator or only the load of a single group of consumers. Instead, the merchant firm must offer the ISO a balanced redispatch in which, for example, the merchant increases output from one generator while equally reducing output from another generator. Thus, each merchant firm's resources fully serve its load both before and after the ISO conducts its redispatch. This balanced redispatch intentionally precludes the ISO from implicitly arranging trades among merchants. Because such trades almost always will allow cost reductions, merchants have the opportunity to trade power among themselves after the ISO conducts its redispatch.
To understand the differences between the New York-PJM and California methods of managing transmission congestion, consider the example presented in Figure 3. In this figure, the power system consists of three busses that are connected by identical transmission lines. Each line is able to handle up to 600 MW of flow, and no power is lost in transmission. The physics of this simple system are such that if 1 MW of power were to be