Scandinavian Working Papers in Economics
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Research Institute of Industrial Economics (IFN) Working Paper Series

No 788:
Supply Function Equilibria: Step Functions and Continuous Representations

Pär Holmberg (), David Newbery and Daniel Ralph

Abstract: In most wholesale electricity markets generators must submit step-function offers of supply to a uniform price auction, and the market is cleared at the price of the most expensive offer needed to meet realised demand. Such markets can most elegantly be modelled as the pure-strategy, Nash Equilibrium of continuous supply functions, in which each supplier has a unique profit maximising choice of supply function given the choices of other suppliers. Critics argue that the discreteness and discontinuity of the required steps can rule out pure-strategy equilibria and may result in price instability. This paper argues that if prices must be selected from a finite set the resulting step function converges to the continuous supply function as the number of steps increases, reconciling the apparently very disparate approaches to modelling electricity markets.

Keywords: Auctions; Supply Function Equilibria; Convergence of Step-Functions; Electricity Markets; (follow links to similar papers)

JEL-Codes: C62; D43; D44; L11; L13; L94; (follow links to similar papers)

48 pages, January 29, 2009

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This paper is published as:
Holmberg, Pär, David Newbery and Daniel Ralph, (2013), 'Supply Function Equilibria: Step Functions and Continuous Representations', Journal of Economic Theory, Vol. 148, July, No. 4, pages 1509-1551

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