Electricity markets have many features that make them prone to the exercise of market power at certain times. This chapter explores the definition of market power, the measurement of market power and the factors that affect market power, in the context of a power system with no network constraints and therefore a single spot price for electricity. In Chapter 16, we extend these ideas to the case when network constraints are binding.
What exactly is market power? And why is it harmful? These are important preliminary questions that should be clearly addressed at the outset.
What is market power? Across the economics literature there are a range of definitions of market power. For example, Productivity Commission (2002) states that a firm has market power ‘if it can profitably sustain prices above the efficient cost of supply for a significant period of time’. Baumol and Blinder (2008) define market power as the power to ‘prevent entry of competitors and to raise prices substantially above competitive levels’. Church and Ware (2000), in a widely used economics textbook, say that ‘A firm has market power if it finds it profitable to raise prices above marginal cost’.
However, there is a broad strand of the economics literature that simply defines a firm as having market power if it is not a price taker. There is a broad consensus that a price-taking ...