Structural versus behavioral remedies in the deregulation of electricity markets : an experimental investigation guided by theory and policy concerns

Abstract

We experimentally study the effects of introducing a forward market and of increasing the number of competitors in a quantity-setting market under strictly convex production costs. Our key interest is to better understand which of these two remedies is more effective at enhancing competition. Allaz and Vila (1993) theorized that forward markets can have a pro-competitive effect under linear production costs. Le Coq and Orzen (2006) and Brandts et al. (2008) investigated this and related issues experimentally. All three experiments (including ours) support the prediction by Allaz and Vila (1993) that introducing a forward market does indeed intensify competition. The results of the present study, however, differ from previous experimental results in that we find the forward market to be the more effective remedy. Brandts et al. (2008) increase the number of competitors by entry, which thus increases the aggregate stock of production assets and makes output cheaper. In contrast, we increase the number of competitors by divestiture, which leaves the aggregate stock of production assets constant. Our results address an important policy issue and provide tentative evidence on the competition-enhancing effect of forward markets, which can be considered a behavioral remedy.