Severin Borenstein

Measuring Market Inefficiencies in California's Restructured Wholesale Electricity Market

We present a method for decomposing wholesale electricity payments into production costs, inframarginal competitive rents, and payments resulting from the exercise of market power. Using data from June 1998 to October 2000 in California, we find significant departures from competitive pricing during the high-demand summer months and near-competitive pricing during the lower-demand months of the first two years. In summer 2000, wholesale electricity expenditures were

An Empirical Analysis of the Potential for Market Power in California’s Electricity Industry

8.98 billion up from

Selling Costs and Switching Costs: Explaining Retail Gasoline Margins

2.04 billion in summer 1999. We find that 21 percent of this increase was due to production costs, 20 percent to competitive rents, and 59 percent to market power.

Market power in California electricity markets

We use demand and plant-level cost data to simulate competition in a restructured California electricity market. This approach recognizes that firms might have an incentive to restrict output in order to raise price and enables us to explicitly analyze each firms ability to do so. We find that, under the current structure of generation ownership, there is potential for significant market power in high demand hours. During some months, congestion over Path 15, the primary in-state north-south transmission line, exacerbates the market power potential in northern California. While these results make deregulation of generation less attractive than if there were no market power, they do not suggest that deregulation would be a mistake. Nearly all markets exhibit some degree of market power. We find that the levels of hydroelectric production and the elasticity of demand are two of the most important factors in determining the severity of market power, having greater impact on equilibrium prices than the proposed divestitures of Californias largest producers. These results indicate that policies promoting the responsiveness of both consumers and producers to price fluctuations can have a significant effect on reducing the market power problem.

The Dominant-Firm Advantage in Multiproduct Industries: Evidence from the U. S. Airlines

Recent theoretical work has shown that price discrimination can take place in imperfectly competitive, as well as monopoly, markets. The persistence of higher retail margins on unleaded than on leaded gasoline during the 1980s suggests that discrimination may occur even in very competitive markets. This article studies a number of cost-based explanations for such gasoline pricing, as well as the possibility of price discrimination. The analysis indicates that gas stations discriminate against groups of customers who are less likely to switch to another station. The conclusions highlight the influence of shopping or search costs on pricing decisions, even in markets thought to be quite competitive.

Why do all the flights leave at 8 am?: Competition and departure-time differentiation in airline markets

Abstract As the electricity industry in California undergoes a process of fundamental restructuring, important new products and markets will be created while others will lose significance. In this paper, we undertake an initial survey of the products and markets that will be prominent in the emerging new electricity industry. We describe approaches to analyzing the prospects for, and the impacts of, market power abuse in these various product markets. The key product markets that are discussed include those for spot electrical energy, for pool-based and physical power contracts, and for reliability services such as load balancing and spinning reserve. Structural measures of market power, such as the Hirschman-Herfindahl Index (HHI), have certain general shortcomings that are exacerbated when applied to restructured electricity markets. Fortunately, the direct estimation of competitive equilibria, such as a Cournot oligopoly equilibrium, appears to be more feasible for this industry than is generally the case.

Understanding Competitive Pricing and Market Power in Wholesale Electricity Markets

In many industries, the largest firms are most successful in entering and competing in individual markets or submarkets. While this success is often attributed to cost or quality differences, it may also reflect reputation advantages or marketing strategies that benefit firms selling a wider variety of products in the industry. I present an approach to estimating the advantages of a dominant firm in the airline industry that allows one to effectively control for cost and quality heterogeneity. Results using data from 1986 indicate that an airline with a dominant presence at an airport will have a significant advantage in attracting customers whose trips originate at that airport, regardless of the specific route on which the customer is traveling.

The Impact of Bankruptcy on Airline Service Levels

Abstract Theoretical models of spatial product differentiation indicate that firms face two opposing incentives: (1) minimize differentiation in order to “steal” customers from competitors, and (2) maximize differentiation in order to reduce price competition. Using data on U.S. airline departure times from 1975, when fares were regulated, and 1986, when fares were not regulated, we empirically estimate the effect of competition on differentiation. We find a negative relationship in both periods. In 1986, however, reductions in exogenous scheduling constraints increase differentiation, implying that firms may be differentiating their products where possible to reduce price competition. This effect is not apparent in the 1975 data.

The economics of costly risk sorting in competitive insurance markets

Discussions of competition in restructured electricity markets have revealed many misunderstandings about the definition, diagnosis, and implications of market power. In this paper, I attempt to clarify the meaning of market power and show how it can be distinguished from competitive pricing in markets with significant short-run supply constraints. I also address two common myths about market power: (a) that it is present in all markets and (b) that it must be present in order for firms to remain profitable in markets with significant fixed costs. I conclude by arguing that, while a finding of market power in an industry does not necessarily indicate that government intervention is warranted, such analysis is an important part of creating sound public policy.

U.S. Domestic Airline Pricing, 1995-2004

The current financial crisis in the commercial airline industry has engendered an active debate over appropriate governmental policies. Proponents of government support, instrumental in legislating a