Capacity Markets: Prices vs. Quantities

15 November 2010
By Jonathan Falk

Economists know full well the advantages of competitive, efficient markets. They also know that relying on them may be unsustainable. Politicians and regulators seem to dislike electricity markets that encourage investment by giving generators high prices and high profits at precisely those times when they are providing too little capacity. The prospect of regulators intervening in electricity markets at such times does not encourage an efficient outcome. Capacity markets may not be perfect, but they only have to be better than the alternative. In this issue of NERA's Energy Market Insights, Vice President Jonathan Falk discusses two different designs for a capacity market. In doing so, he observes that there is no obvious preference for setting prices or setting quantities. Only a detailed understanding of economic risks and incentives can explain the choices that designers make.

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