Fridrik M. Baldursson

Irreversible investment and industry equilibrium

Abstract.We establish the equivalence of competitive industry equilibrium with a central planners decision problem under uncertainty, when investment is irreversible. The existence of industry equilibrium is derived, and it is shown that myopic behavior on the part of small agents is harmless, in the sense that it leads to the same decisions as full rational expectations do. Our model is set in continuous time and allows for very general forms of randomness. The methods are based on the probabilistic approach to singular stochastic control theory and its connections with optimal stopping problems.

Irreversible investment under uncertainty in oligopoly

Abstract An oligopoly is studied where firms facing a stochastic inverse demand curve use capacity as strategic variable. Capacity may be adjusted continuously over time with linear cost. The analysis uses the technique of a fictitious social planner and the theory of irreversible investment under uncertainty. Examples indicate that qualitatively the price process will be similar in oligopoly and competitive equilibrium. When firms are nonidentical, e.g. in initial size, and even if they are alike in other respects, substantial time may pass until they are all the same size. Much of that time, one firm may dominate the market.

Utilization of the Icelandic Cod Stock in a Multispecies Context

The purpose of this paper is to discuss rules for deciding Total Allowable Catch (TAC) for Icelandic cod. For this purpose, a bioeconomic model describing harvesting and processing of cod, capelin, and shrimp in the Icelandic marine ecosystem is constructed and estimated. The model is used to analyze the probable effects of harvesting strategies on biomass, catch, and economic benefits from the exploitation of these species. Simulations are used to investigate probability profiles of biological and economic variables, taking into account inaccuracies in assessments and uncertainties in predictions. Optimal harvesting strategies are also investigated using a deterministic version of the model and taking into account problems of unemployment, overcapacity, and aversion to fluctuations in consumption. The analysis shows that it is beneficial to reduce fishing from the cod stock in order to allow the stock to recover to its optimum size. This increase in the cod stock will result in big decreases in the catch of capelin and shrimp.

A WHITER SHADE OF PALE: ON THE POLITICAL ECONOMY OF REGULATORY INSTRUMENTS

We consider an intertemporal policy game between changing governments that differ in their attitudes towards a particular feature of market outcomes, exemplified with environmental pollution. When in power, a government will choose policy instruments and set strictness of regulation with a view to influencing the policy of future, possibly different, governments. We demonstrate that a ‘brown’ government favours emission quotas over effluent taxes, as quotas establish property rights that are costly to reverse. Conversely, a ‘green’ government prefers to regulate by taxes, in order to limit the incentives of future ‘brown’ governments to ease regulations. Strategic behaviour tends to exaggerate policy differences (making ‘green’ governments ‘greener’ and ‘brown’ governments ‘browner’) compared to when such strategic considerations were not an issue.

Price Volatility and Risk Exposure: On the Interaction of Quota and Product Markets

We consider an industry with firms that produce a final good emitting pollution to different degree as a side effect. Pollution is regulated by a tradable quota system where some quotas may have been allocated at the outset, i.e. before the quota market is opened. We study how volatility in quota price affects firm behaviour, taking into account the impact of quota price on final-good price. The impact on the individual firm differs depending on how polluting it is—whether it is ‘clean’ or ‘dirty’—and whether it has been allocated quotas at the outset. In the absence of long-term or forward contracting, a grandfathering regime—where clean firms are allocated no quotas and dirty firms are allocated quotas for a part of their emissions—minimizes the impact on firm behavior relative to a risk-neutral benchmark.With forward contracts and in the absence of wealth effects initial quota allocation has no effect on firm behaviour. Allowing for abatement does not change the qualitative nature of our results.

Cross-Border Exchange and Sharing of Generation Reserve Capacity

This paper develops a stylized model of cross-border balancing. We distinguish three degrees of cooperation: autarky, reserves exchange and reserves sharing. The model shows that TSO cooperation reduces costs. The gains of cooperation increase with cost asymmetry and decrease with correlation of real-time imbalances. Based on actual market data of reserves procurement of positive and negative automatic frequency restoration reserves in Belgium, France, Germany, the Netherlands, Portugal and Spain, we estimate the procurement cost decrease of exchange to be 160 million euro per year and of sharing to be 500 million euro per year. The model also shows that voluntary cross-border cooperation could be hard to achieve, as TSOs do not necessarily have correct incentives.

Welfare Optimal Reliability and Reserve Provision in Electricity Markets with Increasing Shares of Renewable Energy Sources

We develop an analytical model to derive the competitive market equilibrium for electricity spot and reserve markets under stochastic demand and uncertain renewable electricity generation. We then derive the welfare-optimal provision of reserves. At rst-best, cost of reserve capacity is balanced against expected cost of outages. The rst-best market equilibrium of the model implies an increase of reserve provision with a growing share of renewable generation. Furthermore, a growing share of renewable generation decreases the level of reliability as measured in energy not served. Additionally, required reserves to balance higher expected deviations will be more expensive, resulting in a trade-o between higher reserve costs and costs of energy not served.

Optimal reliability and reserve provision in electricity markets with increasing shares of renewable energy sources - analytical insights

We develop a simple analytical model to derive the first-best market equilibrium for electricity spot and reserve markets under stochastic demand and uncertain renewable electricity generation. We then derive the welfare-optimal provision of reserves. At first-best, cost of reserve capacity is balanced against expected cost of outages. We illustrate the analytical results by calibrating the model to the German electricity market. The first-best market equilibrium of the model implies an increase of reserve provision with a growing share of renewable generation. Furthermore, a growing share of renewable generation decreases the level of reliability as measured in energy not served (ENS). Additionally, required reserves to balance higher expected deviations will be more expensive, resulting in a trade-off between higher reserve costs and costs of ENS.

Multi-TSO system reliability: Cross-border balancing

This paper develops a stylized analytical model that analyses reliability management of multiple TSOs. First we analyse the possibilities for TSO cooperation on reserves dispatch and procurement, with a focus on European network codes. Then we propose a model that theoretically analyses cross-border reserve cooperation. We distinguish two degrees of cooperation: reserves exchange and reserves sharing. Our model first determines the non-cooperative TSO equilibrium i.e. the autarkic provision of reserves. Next we compare this with the socially optimal (cooperative) policy of generation reserves procurement. The paper shows why reserves sharing is economically superior to reserves exchange. Sharing allows cost arbitrage and pooling of reserve needs while reserves exchange only takes care of cost arbitrage. The benefits of reserves exchange and reserves sharing depends on cost asymmetry and correlation of reserve needs between the TSO zones.

Fees and the Efficiency of Tradable Permit Systems: An Experimental Approach

The paper presents the results of an economic experiment in which the effects of fees on allocative efficiency of tradable utilization permits (e.g. pollution permits) are explored. Laboratory subjects (university students) play the roles of firms whose generic product requires a specific input or permits. Scarcity is exogenously introduced by a fixed supply of tradable production permits. Three treatments are compared: No fee imposed (N); a fixed tax per permit (T); and partial retraction of permits and subsequent redistribution by auction (A). Treatments T and A represent two different ways of imposing fees, which are designed to be revenue equivalent. Our results indicate that, after controlling for deviation of permit prices from a prediction based on fundamentals, fees have an impact on distribution of permits. Interestingly, a fixed tax enhances efficiency compared to the case of no fees while retraction and reallocation by auction tends to reduce efficiency. Apparently, subjects’ decision making is affected by the imposition of fees, but how and to what extent depends on the method used.