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We propose an equilibrium model that allows to analyze the long-run impact of the electricity market design on transmission line expansion by the regulator and investment in generation capacity by private firms in liberalized electricity markets. The model incorporates investment decisions of the transmission system operator and private firms in expectation of an energy-only market and cost-based redispatch. In different specifications we consider the cases of one vs. multiple price zones (market splitting) and analyze different approaches to recover network cost—in particular lump sum, generation capacity based, and energy based fees. In order to compare the outcomes of our multilevel market model with a first best benchmark, we also solve the corresponding integrated planner problem. Using two test networks we illustrate that energy-only markets can lead to suboptimal locational decisions for generation capacity and thus imply excessive network expansion. Market splitting heals these problems only partially. These results are valid for all considered types of network tariffs, although investment slightly differs across those regimes.
In this paper we analyze a uniform price electricity spot market that is followed by redispatch in the case of network congestion. We assume that the transmission system operator is incentivized to minimize redispatch cost and compare a cost-based redispatch (CBR) to a market-based redispatch (MBR) mechanism. For networks with at least three nodes we show that in contrast to CBR, in the case of MBR the redispatch cost minimizing allocation may not be short-run efficient. As we demonstrate, in case of MBR the possibility of the transmission system operator to reduce redispatch cost at the expense of a reduced welfare may be driven by the electricity supply side or the electricity demand side. If, however, the transmission system operator is obliged to implement the welfare maximizing (instead of the redispatch cost minimizing) dispatch by regulation, this will result in an efficient dispatch also in case of MBR.