Electrical Power and Energy Systems 29 (2007) 397–407

www.elsevier.com/locate/ijepes

The impacts of price responsiveness on strategic equilibrium

in competitive electricity markets q
a,*
Ettore Bompard , Yuchao Ma a, Roberto Napoli a, Graziano Abrate b, Elena Ragazzi b

a
Department of Electrical Engineering, Politecnico di Torino, C.so Duca degli Abruzzi, 24, 10129 Torino, Italy
b
Ceris-CNR, Via Real Collegio, 30, 10024 Moncalieri (TO), Italy

Received 12 October 2005; accepted 17 October 2006

Abstract

One of the most important aspects that may affect market welfare is that related to the low demand responsiveness to price. This
situation may greatly impact the market performance causing low efficiency, high prices and a disproportional allocation of surpluses.
The structure of electricity markets is usually oligopolistic; producers may bid prices higher than their marginal costs to the short run
wholesale market, inducing outcome deviations from the perfect competitive benchmark. The possibility of gaming the market is amplified
in the presence of low demand responsiveness to price. This paper proposes a model to assess the role of demand elasticity in mitigating the
effects of supply side strategic bidding behavior. We model the supply side in a conjectural supply function (CSF) framework, which allows
incorporation of exogenous changes in demand elasticity and different levels of competition in a given market. The impacts of demand
responsiveness on the market performances are assessed through a set of proposed indices that are applied to a model of the Italian market.
 2006 Elsevier Ltd. All rights reserved.

Keywords: Competitive wholesale market; Demand elasticity; Strategic bidding

1. Introduction However, a common feature of electricity wholesale mar-

In Italy, as in many other EU countries, electricity mar-
kets have been recently involved in serious restructuring
aimed at promoting competition among market partici-
pants. One typical market designs often requires electricity
to be sold in a spot wholesale market, where potential buy-
ers (retailers or final consumers) and sellers (generators)
submit their bids for each period, generally each hour, of
the day. The demand and the supply meet in the electricity
power exchange (EPX). The resulting auction yields the
equilibrium prices, which vary over time and space, consid-
ering network constraints and supply/demand balance.
Theoretical foundations of this design can be found in [1].
q
This research has been supported by the LAGRANGE project of
Turin (supported by Institute for Scientific Interchange – ISI Foundation
and CRT Foundation), in addition to HERMES – Higher Education and
Research on Mobility regulation and Economics of local Services – Turin.
*
Corresponding author. Tel.: +39 011 564 7154; fax: +39 011 564 7199.
E-mail address: ettore.bompard@polito.it (E. Bompard).
kets is a lack of price responsiveness measured by the value
of demand elasticity. This is due not only to the peculiar
characteristics of the commodity, such as non-storability,
lack of good substitutes and the relatively small proportion
of the typical consumer’s budget but also to the relation
between wholesale and retail market. In fact, only a small
number of customers are able to submit the hourly bids into
the power exchange; on the contrary, most of them are
worked through retailers that charge retail prices indepen-
dent from the spot price fluctuations [2]. Since end users
simply do not see the ‘‘true’’ spot price, they cannot use this
price when making decisions regarding power withdrawal;
this ‘‘inelastic’’ behaviour is transmitted to retailers, which
have legal obligations to serve their customers, and there-
fore on the wholesale demand. In [3], Taylor shows a funda-
mental study of the demand elasticity.
From the perspective of mitigating market power abuses
by supply side, some approaches have been put forward,
such as encouraging bilateral contracts between suppliers
and large consumers, risk management, price caps, rebate

0142-0615/$ - see front matter  2006 Elsevier Ltd. All rights reserved.
doi:10.1016/j.ijepes.2006.10.003
398 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407
Nomenclature
q/D demand price ($/MW)/quantity (MW)
d1/d2 intercept ($/MW)/slope (negative, $/MW2)
parameters of the demand curve
qr0 =Dr0 reference point, a typical price/quantity pair
Dmax maximum demand quantity
e demand elasticity
k*/D* price ($/MW)/quantity (MW) at perfect compe-
tition equilibrium
k0/D0 price ($/MW)/quantity(MW) under oligopoly
competition equilibrium
c1f /c2f intercept ($/MW)/slope ($/MW2) param-
eters of the marginal cost curve of the producer
f respectively
mechanisms and divestiture of large portfolios that have an
unreasonably large share of the market [4,5].
However, these approaches usually ignore the possibility
of a price-responsive demand and its potential benefits.
Fig. 1 shows this effect on the market clearing price. Up
to now, most of researches on the strategic bidding behav-
iours have been concentrated on the supply side, whereas
the demand side is modelled using linear functions fixed
at load buses [6–8]. Only a few have considered the influ-
ence of the demand-side price responsiveness and most of
them focused mainly on the effects of strategically changing
the consumers’ load profile, which is characterized by the
cross-price elasticity of the demand side [9–11].
In this paper, we want to investigate the mitigating effect
of demand-side behaviour on imperfect competition in an
oligopoly electricity market with reference both to the mar-
ket performances, as measured by prices and efficiency, and
to surplus allocation. This will be done by adjusting differ-
ent values of own-price elasticity in the context of a conjec-
tural supply function (CSF) model [12], which will allow us
to assess the impact of demand price responsiveness on the
market performance.
This paper is organised as follows. The next section pre-
sents a survey of elasticity values found in literature and
will discuss the factors which affect those values. In Section
4 we will introduce how the demand side responsiveness to
price while in Section 5 we will present the CSF model used
to represent the supply side bidding behaviour. Some met-
($/MW)
r Lowly elastic Aggregate supply curve
demand (strategic bidding)
r1
Highly elastic Aggregate supply curve
demand (marginal cost)
r2
Aggregate demand
curve in EPX
o p2 p1 p (MW)
Fig. 1. Effect of low load elasticity on the price spikes due to strategic
bidding.
af/bf intercept ($/MW)/slope ($/MW2) parameters of
the strategic offer curve of the producer f
pf output of the supplier f, MW
P f =P f minimum/maximum output for producer f
(without the hydro units)
Cf production cost of the producer f
Hf output by hydro units of producer f
rf conjecture of producer f about his competitors’
output with respect to the price
SS social surplus
SG
f surplus of the producer f
SD/SG total consumer and total producer surplus
rics and the application of the method to a real market
model will be presented in Sections 6 and 7. In the last sec-
tion some policy indications and suggestions for future
research will be presented.
2. Key factors in the evaluation and improvement of demand
side elasticity in electricity market
A wide range of literature has focused on the measure-
ment of load elasticity, stating that industrial, residential
and commercial consumers will respond to price signals.
However, results vary over a wide range; Borenstein and
Bushnell [13] has run simulations showing how market
power is impacted by varying elasticities from 0.1 to
0.4 and 1.0, pretending to cover most current estimates
of short-run and long-run price elasticity. In 1999, NIEIR
[14] undertook a review of the long run own-price elasticity
of electricity demand and recommended the values of
0.25, 0.35, 0.38 for residential, commercial and indus-
trial customers respectively. Stoft [15] argued that the abso-
lute value of elasticity is much lower than 0.1 when
considering one-day demand elasticity.
For our purposes, more relevant results are found in
[16], during the summer 2002, under Emergency Demand
Response Program, the average calculated demand price
elasticities in the various NYISO pricing zones ranged from
0.02 to 0.16.
Using a sample of British industrial customers, Patrick
and Wolak [17] estimated the customer level price elasticity
under real time pricing. They found substantial heterogene-
ity in own price elasticities across industries and across
hours: the maximum value was 0.27, registered between
9.30 am to 10.00 am for water industry customers. How-
ever, the average values were substantially lower, and in
many cases between 0 and 0.05.
In this section, we want to briefly summarise several fac-
tors which can affect the values presented above.
The unavailability of substitutes: Electricity is indispens-
able in manufacturing and is regarded as essential for the
 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407
quality of life by most individuals in industrialized societies.
It is easy to transmit and distribute and can be effectively
converted into other types of energy, therefore, at present,
there are no good energy substitutes.
Time frame (short run and long run elasticity): Irrelevant
to customer class, since energy involves usage of durable
goods, there is a substantial difference between short run
and long run elasticity. In the short run, given the lack of
good substitutes for electricity, consumers have limited
options for responding to price changes, and elasticity is
usually assumed to be relatively low, at around 0.1. In
the long run, progress in technology and the possibility
of switching to other kinds of energy will offer more oppor-
tunities for price responsiveness, and elasticity is usually
estimated in a range from 0.4 to 0.7 [18].
Customers type, consumers’ income, climate: Customers
have proved to be widely heterogeneous in their ability to
respond to price changes. Different industry characteristics
lead to different elasticities [17]. Aubin et al. [19] ran a vol-
untary dynamic pricing experiment suggesting that high-
income and high-electricity consumers are the most elastic.
Load profile: Estimates for demand elasticity in the Cal-
ifornia Power Exchange Day-Ahead Market indicate that
the percentage of cases with elasticity greater than 1.0 is
higher in the off peak hours than on-peak hours [20].This
is what might be expected because the exigencies of buying
power on-peak are more severe than during off-peak hours.
In this context, the demand is higher, the ability to predict
demand is lower, the network is more constrained, and
therefore supply resources are more strained.
Own-price and cross-price elasticity: Consuming electric-
ity during a certain hour of the day or night usually has dif-
ferent intrinsic values for the consumers (this speaks to the
origin of the peak load problem). Since wholesale prices
vary each hour of the day, it is useful to distinguish between
own-price and cross-price elasticity: (a) the own-price elas-
ticity, which indicates demand variation during a certain
hour to a change in the price in the same hour (for example,
the variation in a peak hour consumption induced by a
change in the peak price), which is the one discussed in this
paper. (b) the cross-price elasticity, shows demand sensitiv-
ity to prices charged in the other time-period (for example,
the sensitivity of the peak demand to a change in an off-peak
price). In this instance, relative prices matter. The own-price
elasticity represents the consumer’s willingness to curtail or
increase consumption in response to higher or lower prices.
On the other hand, the cross-price elasticity corresponds to
the willingness to shift load from peak hours to off-peak
hours in response to price, while keeping overall consump-
tion constant. According to [17], the magnitude of cross-
price elasticity is much lower than own-price elasticity.
Some research work has been done to increase the
demand elasticity for electricity:
• advanced and affordable interval meters and automatic
meter reading to establish effective communication links
between customer and marketplace. The introduction of
399
a two-way communication networks would necessitate a
capital investment of about $70–$90 per residential site
and $350–$1650 per commercial site to build electricity
metering and network technologies [21].
• installing distributed self back-up generators on the
demand side to give customers the ability to make deci-
sions based on the spot price.
• rescheduling customers’ load profile and switching on/
off the discretionary loads [9–11].
• constructing a price sensitive market platform by evolv-
ing the customer’s tariff structure from fixed price (FP)
to demand response price (DRP) and then to real time
price (RTP) [22–25].
3. Demand representation in the electricity power exchange
In the EPX, electricity is usually traded with a double-
side auction, in which both sellers and buyers submit their
own bids. The elasticity at the consumer level is not neces-
sarily the same as the elasticity measured in the EPX, even
if the values are clearly interrelated. Programs which try to
enhance demand participation in the wholesale market typ-
ically involve methods to make the economic incentives of
customers more accurately reflect the time-varying whole-
sale price of electricity. Understanding the link between
wholesale and retail market is very important, as underlined
by Ilic et al. [26]. Given the heterogeneity of customers, the
retailers, or load serving entities (LSE), may play a role as
‘‘intelligent’’ load aggregators, in a way to produce demand
bids more effectively into the wholesale market. In this
respect the demand curve in the EPX is an aggregate bid
curve from all the customers that are eligible for presenting
bid to the EPX. The price responsiveness of the ineligible
customers that purchase electricity at fixed rates cannot
be explicitly modeled; however, if they face time-varying
rates, their behavior in terms of price responsiveness, in
some way, can be incorporated in the bids of brokers and
distributors that are purchasing electricity in the EPX to
supply them. Patrick and Wolak [17] showed how the price
responsiveness of final customer subject to dynamic price
schedules can be incorporated in the bids on the EPX by
the distributor units. Different authors have studied the crit-
ical link between the price responsiveness of final customers
and the demand elasticity on the EPX [24,26].
We represent the demand side in the EPX with a linear
demand curve that is expressed as:
q ¼ d 1 þ d 2D ð1Þ
The demand elasticity is
dD q q
e¼  ¼ ð2Þ
dq D d 2 D
The parameters d1 and d2 may depend on the various
factors described in Section 3, but they can be assumed
constant when considering the typical time frame for an
EPX auction. With other words, the demand side behavior
400 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407
is exogenous to our model, since we assume (1) to represent
the aggregate bid curve of a given market. However, differ-
ent behavior in terms of price responsiveness can be simu-
lated by varying the elasticity at a reference price-quantity
point. In order to assess the impact of the demand respon-
siveness to price on the performance for a given market, we
argue that the maximum power demanded (Dmax), related
to the current level of electric appliances and devices,
should be considered as fixed in the short run, i.e. all pos-
sible demand curves must pass through this point, though
they may have different degree of price responsiveness.
We choose as the reference point a typical price/quantity
pair qr0 and Dr0 of the market in a peak hour and attribute
to that point the reference value of elasticity (er0 Þ to formu-
late the reference demand curve that is given by:
qr qr
q ¼ qr0  r0 þ r 0 r D ð3Þ
e0 e0 D0
Then, we can calculate Dmax (4) and formulate different
scenarios for demand responsiveness at the reference price
qr0 (Fig. 2).
Dmax ¼ Dr0 ð1  er0 Þ
To increase the demand responsiveness means to
increase elasticity when the market price is qr0 ; at this price,
the customer will not buy as much as they did in the former
situation; they will only buy the quantity D1 (or D2), maybe
resorting to their reserve electricity sources to provide the
quantity difference. On the other hand, the customer may
still buy the quantity Dr0 , but in this case they will be willing
to pay a price lower than qr0 . Thus, by adjusting the elastic-
ity er at the fixed price qr0 , we introduce a set of downward
linear curves which pass through the point (0, Dmax) and
that may be expressed as:
qr ð1  er Þ qr0 ð1  er Þ
r
qðe Þ ¼  0 r þ r r D ¼ d 1 ðer Þ þ d 2 ðer ÞD
e e D0 ð1  er0 Þ
We can observe that jer0 j < jer1 j < jer2 j: In fact
Dr0 Dmax Dr1 Dmax
j er0 j¼ ; j er1 j¼ ; j er2 j¼
ODr0 ODr1
Dr0 Dmax < D1 Dmax < D2 Dmax and ODr0 > OD1 > OD2
4. Strategic model of supply side under elastic demand
The supply side (electricity producers) in the electricity
market may be better described in terms of oligopoly than
r $/MW
A W
|e 2r |
|e 1r |
B *
|e 0r |
C
r 0r
r
O D2 D1 D0 Dmax D MW
Fig. 2. Demand model for assessing price responsiveness impacts.
of perfect competition from which it may be rather far
[27,28]. The oligopoly behavior of competitors may be
modeled using game theory to represent the strategic inter-
actions among different players who are aware that their
results depend on the decisions of other producers.
We propose a strategic bidding model for the supply
side based on the CSF [12] and able to account for the
demand elasticity in the formulation of the producers’
offers. The strategic behavior of producers is modeled with
a static game representing one-hour spot market, with sym-
metric information on the marginal costs of the producers
(i.e. all players know the marginal costs of their rivals).
Though this is a strong assumption, it is widely used in lit-
erature [7,8,29,30], because it helps the tractability of the
model. The parameters of the production function are
asymmetric (i.e. marginal costs are different), thus the same
happens for the strategic offers.
Let us consider the market clearing price k*(er) and
quantityD*(er), under perfect competition. The quantity
pf ðer Þ produced by the competitors of producer f is
D ðer Þ  pf ðer Þ where pf ðer Þ is the quantity produced by f.
ð4Þ Producer f will submit to the EPX a linear offer as:
qf bf pf þ af ð6Þ
CSF model describes, for each producer f, the assumed
relationship between the price, qf, offered by producer f and
the quantity, pf, offered by his competitors. pf is assumed
to be a linear function defined by a reference point (pf ðer Þ,
k* (er)) – corresponding to the market equilibrium under
perfect competition – and a slope rf – representing the con-
jecture of producer f about its competitors’ behavior
(Fig. 3). In formulae:
pf ðqf ; er Þ ¼ pf ðer Þ þ rf ðqf  k ðer ÞÞ
¼ D ðer Þ  pf ðer Þ þ rf ðqf  k ðer ÞÞ ð7Þ
ð5Þ
The parameter rf reflects the conjecture of player f on
how his competitors will change their produced quantity
in response to a change in the price bid by producer f. Dif-
Dr2 Dmax ferent estimations of the parameter rf allow for modeling
ODr2 different levels of competition and concentration according
to different oligopoly models (rf = 0 ) Cournot Model –
low competition/high concentration, rf = 1 ) Bertrand
Model – high competition/low concentration [12]).
Each player faces the demand not satisfied by his com-
petitors (residual demand) that is
pf ðqf ; er Þ ¼ Dðqf ; er Þ  pf ðqf ; er Þ ð8Þ
p− f M
rf 3 rf 2
r
p− f (e ) rf 1
O λ*(ε r) f $/MW
Fig. 3. CSF curves with different conjecture parameters at reference pair
based on current demand curve, r1f <r2f < r3f .
 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407 401

and on this demand each player may act as a monopolist, r $/MW

A
defining the optimal intercept af of the offer curve that Aggregate demand curve
maximizes his profit.
Substituting (7) in (8) and use (5) we get Aggregate supply curve
  (strategic bidding)
d 1 ðer Þ 1 lo E
r  r  r
pf ðqf ; e Þ ¼   pf ðe Þ þ rf k ðe Þ þ  r f qf B G F Aggregate supply curve
d 2 ðer Þ d 2 ðer Þ l* (marginal cost)
H
¼ h1 ðer Þ  pf ðer Þ þ rf k ðer Þ þ ðh2 ðer Þ  rf Þqf C
o Do D* Dmax D MW
ð9Þ
Fig. 4. Market clearing without network constraints.
where h1(er) = d1(er)/d2(er); h2(er) = 1/d2(er); and, inver-
sely, we get sidered as a ‘‘surplus’’ and can be used to measure the wel-
h1 ðe r
Þ  pf ðer Þ þ rf k ðer Þ fare of the participants to the market. The social surplus, as
1
qf ðpf ;er Þ ¼  r
þ r
pf ð10Þ measured by the area ACF in Fig. 4, is maximized under
h2 ðe Þ  rf h2 ðe Þ  rf perfect competition, while under oligopoly strategic bid-
From (9) or (10) we see that, although the demand does not ding by the producers would reduce it to the area ABE
take active part in the game, its elasticity will serve as an in Fig. 4. The difference between the two areas above is
exogenous factor in the optimal offer calculation. called dead-weight loss (area EHF) and is commonly used
Each player will choose in (6) the intercept af that max- to measure the inefficiency of the market caused by strate-
imize its surplus while the slope bf is fixed and equal to the gic bidding. The producer surplus (i.e. the social surplus
slope of the marginal cost curve [7,29]. The related optimi- going to the supply side) is increased from the area k*FC
zation problem can be stated as follows: to the area k0 EHC while the consumer surplus (i.e. the
social surplus going to the demand side) is deceased from
max S Gf ¼ qf ðpf ; er Þpf  C f ðpf Þ þ qf ðpf ; er ÞH f ð11Þ the area Ak*F to area Ak0E [30,31].
s:t: pf 6 P f ð12Þ The market clearing without considering the network
 pf 6 P f ð13Þ constraints, based on the strategic offers of the producers,
can be expressed by the following optimization problem
In the definition of the producer surplus function (11) we X
separately take into account of hydropower units. In this max d 1 D þ 0:5d 2 D2  ðaf pf þ 0:5bf p2f Þ ð16Þ
f
paper we want to model the Italian market at a typical
peak load hour and in that period the hydro plants can s:t: pf 6 P f 8f ð17Þ
get the much higher price (set by thermal power plants)  pf 6 P f 8f ð18Þ
bidding zero marginal cost. Furthermore, we consider the X
D¼ pf ð19Þ
hydro power dispatched at least for the capacity features
f
of the Italian market. The Lagrange function of the above
From the optimization problem (16)–(19) we can derive the
optimization problem is
market clearing price k0(er) and quantity p0f (er) at the oli-
Lf ðpf ; lf ; lf Þ ¼ qðpf ; ef Þðpf þ H f Þ  C f ðpf Þ  lf ðpf  P f Þ gopoly competition equilibrium (OCE) under strategic of-
 lf ðP f  pf Þ ð14Þ fer curves of the producers.
P af þc0f c0f d 1 ðer Þ
where lf and lf are Lagrange multipliers for the inequali- 0 r f 2c
 d 2 ðer Þ
0 r
k0 ðer Þ  c0f þ c0f  af
ties (12) and (13). k ðe Þ ¼ P 12f 1
; p f ðe Þ ¼
f 2c2f  d 2 ðer Þ 2c2f
The optimization problem (11)–(13) is a strictly concave
quadratic model due to the negative second derivative ð20Þ
value with respect to the pf. By applying the first order con- where cf and cf are Lagrange multipliers for the inequality
þ r
dition, the price and quantity (qþ r
f ðe Þ; P f ðe Þ, the expres- constraints (17) and (18).
sions are shown in the Appendix) corresponding to the If we assume the offers of each player to be equal to the
maximum surplus can be used to formulate the optimal marginal cost curve, we can obtain, as a reference, market
offer for producer f. clearing price k*(er) and quantity pf ðer Þ at the perfect com-
qf ¼ bf pf þ a ð15Þ petition equilibrium (PCE):
P c1f þcf cf d 1 ðer Þ
where f c
 d 2 ðer Þ k ðer Þ  cf þ cf  c1f
k ðer Þ ¼ P 12f 1
; p  r
f ðe Þ ¼
af ¼ qþ f 2c2f  d 2 ðer Þ 2c2f
þ
f  2c2f P f ; bf ðer Þ ¼ 2c2f
In economic terms, for each quantity sold in the market, ð21Þ
the difference between the willingness to pay of consumers The k*(er)
and pf ðer )
are used to formulate the residual
for 1 unit of electricity (as measured by the demand curve) demand curve (10) and the optimal strategic offer through
and the marginal cost of producing such unit can be con- maximization problem (11)–(13). After then, the OCE
402 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407

results are obtained through the maximization problem shed lights on the efficient allocation of the market
(16)–(19). resources.
The conjectural parameter rf need to be defined a priori Producer surplus comparison index:
and its value impacts on the surplus of producer f. Accord- 0 

ing to the formulation (9) S Gf ðer Þ  S Gf ðer Þ

K Cf ðer Þ ¼  ð25Þ
S G ðer Þ
@S Gf @qf
¼ ðH f þ pf Þ This index should be decreased as elasticity increases to
@rf @rf
 reflect the market power mitigation in terms of the alloca-
k h2 ðer Þ  h1 ðer Þ þ pf ðer Þ þ pf tion of producer surplus.
¼ ðH f þ pf Þ 2
ðhðer Þ  rf Þ Market inefficiency index:
D ðer Þ þ pf ðer Þ þ pf  0
S S ðer Þ  S S ðer Þ S  ðer Þ
¼ ðH f þ pf Þ 2 K S ðer Þ ¼  ¼ S ð26Þ
ðhðer Þ  rf Þ S S ðer Þ S ðer Þ
pf  pf ðer Þ The overall efficiency of the market is generally mea-
¼ ðH f þ pf Þ 2
60 ð22Þ
ðhðer Þ  rf Þ sured by the social surplus SS and by the dead-weight loss
S, area EHF in Fig. 4, which shows the reduction in the
where D*(er) = h1(er) + k*(er) h2(er).
SS with respect to perfect competition.
Note that pf , the output of producer f maximizing his
Production inefficiency index:
surplus, is smaller than pf ðer Þ that is the dispatched quan-
tity at the PCE due to the fact that the strategic offer P 0 P 
f Cf  Cf 
curve is higher than the marginal cost curve in the f 
K C ðer Þ ¼ P  ð27Þ
price-quantity coordinates. The above inequality shows C
f f

 0 r
that the surplus of producer f is a downward curve in D¼D ðe Þ
terms of rf , which means that pf will be decreased when 0 r
where D (e ) is the demand at the oligopoly competition
rf is increased reflecting that the competition level in the
equilibrium, C0 is the actually cost incurred to serve the de-
market is enhanced.
mand D0 due to the strategic behavior of the producers
while Cm is the cost that would be incurred if all the pro-
5. Metrics for the assessment of the impacts of the demand ducers would bid their marginal costs. Thus this index de-
side elasticity scribes, for the same demands, the relative difference
between the total cost based on market power behavior
The elasticity plays a major role in reducing the effects of and total cost derived from least cost dispatch.
the strategic biddings of the producers in many respects. Surplus transfer index:
An elastic load may reduce the market clearing price and
mitigate the market power of the producers. To quantify DS T ðer Þ ¼ ½k0 ðer Þ  k ðer ÞD0 ð28Þ
the strategic bidding impacts under different load respon-
This proposed index can give a quantitative represen-
siveness we use a set of metrics that are summarized in
tation of the surplus amount which is grasped by supply
the following (Perfect competition case is indicated by the
side at the expense of demand side due to market power,
superscript ‘‘*’’ while the oligopoly competition by the
area Ek0 k G in Fig. 4. This amount can partially be
superscript ‘‘0’’):
transferred back to demand side by improving price
Lerner index:
responsiveness.
k0 ðer Þ  k ðer Þ Surplus variation indices:
K k ðer Þ ¼ ð23Þ The dead weight loss S can be split into two parts. The
k0 ðer Þ G r
S (e ), area FGH in the Fig. 4, is referred to the suppliers’
The Lerner index is commonly used as a measure of part while the SD(er), area FGE in the Fig. 4, is referred to
market power and its values can vary between 0 (perfect the consumers. Then, we can define two further indicators,
competition) and 1 (monopoly). When increasing demand KD(er) and KG(er), to represent the variation in consumers’
elasticity, the k0 will be decreased down to the k* mitigating surplus (DSD(er)) and in producers’ surplus (DSG(er)),
the effect on the market clearing price induced by strategic respectively:
bidding behavior from supply side.
Producer surplus share index: DS D ðer Þ ¼ ½DS T ðer Þ þ S D ðer Þ; ð29Þ
G r T r G r
0
S Gf ðer Þ DS ðe Þ ¼ DS ðe Þ  S ðe Þ; ð30Þ
K Sf ðer Þ ¼ 0 ð24Þ D
DS ðer Þ
S G ðer Þ K D ðer Þ ¼ ð31Þ
S S ðer Þ
The total producer surplus will be redistributed among
DS G ðer Þ
producers with the increasing of the demand price respon- K G ðer Þ ¼ ð32Þ
siveness. The analysis of the individual surplus share may S S ðer Þ
 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407 403

6. Market simulation around those values by an improvement in demand respon-

We considered a simulation based on data representing
the Italian electricity market. We assumed that the Italian
supply side can be described by seven generation firms with
different types of power plants (see Table A.1 in the Appen-
dix). The reference price/quantity pair ðqr0 =Dr0 Þ comes from
the actual trade outcome during a peak hour in Italian elec-
tricity market (6 April 2004, h. 10: qr0 ¼ 85:42 $/MW,
Dr0 ¼ 44450 MW, er0 ¼ 0:05Þ. In addition, we assumed
6000 MW of import contract and so, the net hourly
demand is derived by subtracting the total hydro power
and the import electricity from the actual demand quantity
of the hour.
Tables 1 and 2 report the market performance under dif-
ferent levels of demand price responsiveness with different
assumptions on the competition of the market. The high
prices are due to the highly concentrated structure of the
market with two dominant producers.
In Table 1, the results are computed on the base of a
Cournot model, i.e. all the conjectural parameters are
zeros. As expected, when increasing the elasticity erat the
given price qr0 (and consequently the elasticity of the
OCE point, e0), the Lerner index Kk is decreasing (from
86.89% to 33.64%), because of the lower market price at
the OCE. The market inefficiency index KS varies from
14.29% to 8.7%, indicating that overall system opera-
tion efficiency is improved. The surplus transfer index
DST(er) gives a better idea of the economic value for con-
sumers in terms of the price elasticity increasing. Raising
the elasticity from 0.05 to 0.1, the amount of surplus
transferred from demand side to the supply side due to
the market power decreases by 50%. The same behavior
can be found for producers’ and consumers’ surplus varia-
tions, expressed by DSD(e0) and DSG(er). The indices of KD
and KG, that express these variations as percentage of the
perfect competition surplus, decrease at a slower rate
because the total surplus under perfect competition also
varies with different demand slopes.
In general, it can be stated that the lower the elasticity,
the higher the mitigating effect on market power attainable
siveness. In other words, the marginal effect of an increase
in elasticity value is decreasing. Since electricity wholesale
market usually shows very low values of demand elasticity,
0.02 to 0.2, this indicates a positive role for enhancing
demand responsiveness programs.
Table 2 shows the performance indices when the conjec-
tural parameters are set to rf = 135; this value can be some-
how interpreted as the one describing the actual level of
competition in the Italian market. In fact, this is the value
that in our simulation model yields the reference outcome
registered in the market, by assuming rf to be the same
for all firms (comparing row 1 in Table 2 to the reference
data provided above: price = 85.87  85.42 $/MW; quan-
tity = 25.444 MW + 19.000 MW, the latter comes from
hydro and import, 44.450). Also note that the elasticity
value computed at the equilibrium point corresponds to
the reference elasticity (0.05); assuming slightly different
reference elasticities (e.g., 0.01; 0.1) does not signifi-
cantly affect the results.
From Table 2, the benefits from increasing demand elas-
ticity appears mild. From one hand, it has still great impact
on the price level, as reflected in the decreasing Lerner
index. Slightly increasing the demand elasticity from
0.05 to 0.2 makes the market clearing price to decrease,
from 85.87 $/MW to 73.42 $/MW. From the other hand,
the surplus indices show the expected trend only in abso-
lute values, while KD, KG and KS show an opposite trend.
This is due to the fact that the impact on consumption
(which affects the computation of surplus) results to be
higher in oligopoly than under perfect competition (com-
pare column 5 and 6 of Table 2). In other words, the effect
on quantity due to the increased demand slope is higher
than the effect on the strategic behavior of the supply side
(lower intercept for supply curve).
It is also useful to compare the results in Tables 1 and 2
that correspond to a similar level in oligopoly price (e.g.,
roughly, row 6 in Table 1, corresponding to an elasticity
of 0.4, and row 1 in Table 2, where elasticity is 0.05).
Basically, an increase in competition has the same effect
on price with respect to an increase in elasticity, which

Table 1
Market performance indices (Cournot model) r1 = r2 = r3 = r4 = r5 = r6 = r7 = 0)
er e0 k* k0 D*MW D0 MW Kk KS(%) DST(106) DSD(106 DSG(106$) KD(%) KG(%) KC(%)
0.05 0.28 51.5 392.73 25955 20872 0.869 14.29 7.122 7.989 11.385 33.61 47.9 25.54
0.1 0.3 50.5 218.83 25290 20499 0.769 13.00 3.45 3.854 5.46 31.18 44.18 27.47
0.15 0.32 49.7 159.96 24695 20195 0.689 11.71 2.227 2.475 3.714 28.92 40.62 29.31
0.2 0.34 48.9 131.1 24172 19887 0.627 10.82 1.634 1.81 3.477 27.17 38.0 28.13
0.3 0.39 47.6 103.18 23283 19274 0.538 9.80 1.070 1.182 2.531 24.79 34.59 24.57
0.4 0.42 46.6 88.78 22558 18787 0.475 8.81 0.793 0.872 1.649 22.83 31.64 23.61
0.5 0.46 45.7 80.9 21955 18287 0.435 8.72 0.643 0.708 1.209 21.74 30.47 19.96
0.6 0.5 45 75.6 21445 17855 0.405 8.69 0.546 0.601 0.992 20.89 29.58 17.45
0.7 0.53 44.3 71.8 21009 17472 0.382 8.74 0.480 0.528 0.851 20.25 28.98 15.4
0.8 0.56 43.8 68.9 20632 17143 0.364 8.75 0.430 0.474 0.756 19.67 28.42 13.96
0.9 0.59 43.3 66.6 20302 16858 0.349 8.73 0.392 0.432 0.685 19.17 27.90 12.92
1.0 0.61 42.9 64.7 20011 16608 0.336 8.7 0.361 0.398 0.628 18.71 27.41 12.14
404 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407

Table 2
Market performance indices (r1 = r2 = r3 = r4 = r5 = r6 = r7 = 135)
er e0 k* k0 D* MW D0 MW Kk KS (%) DST(106) DSD(106) DSG (106 $) KD (%) KG (%) KC (%)
0.05 0.05 51.5 85.87 25955 25444 0.4 1.65 0.87 0.88 1.28 3.72 5.37 5.45
0.1 0.09 50.5 80.42 25290 24435 0.37 2.67 0.73 0.74 1.07 6.01 8.68 5.93
0.15 0.13 49.7 76.58 24695 23598 0.35 3.41 0.63 0.65 0.94 7.59 11 5.79
0.2 0.17 48.9 73.42 24172 22894 0.33 3.93 0.56 0.58 0.84 8.65 12.6 5.74
0.3 0.23 47.6 68.87 23283 21750 0.31 4.7 0.46 0.48 0.7 10 14.7 5.28
0.4 0.28 46.6 65.54 22558 20865 0.29 5.19 0.395 0.41 0.61 10.76 15.95 4.95
0.5 0.33 45.7 62.96 21955 20157 0.27 5.5 0.35 0.36 0.54 11.1 16.65 4.74
0.6 0.36 45 60.9 21445 19578 0.26 5.71 0.31 0.33 0.49 11.3 17.05 4.59
0.7 0.4 44.3 59.21 21009 19094 0.25 5.85 0.28 0.3 0.45 11.4 17.27 4.49
0.8 0.43 43.8 57.87 20632 18677 0.24 5.98 0.26 0.28 0.42 11.5 17.45 4.33
0.9 0.46 43.3 56.73 20302 18315 0.24 6.09 0.245 0.26 0.4 11.5 17.58 4.18
1.0 0.48 42.9 55.76 20011 18000 0.23 6.18 0.23 0.24 0.37 11.5 17.66 4.05

has been confirmed in [12,32]. However, if a lower price is
obtained by an increase in competition, consumers need
not to ‘‘pay’’ this savings with a reduction of their con-
sumption level.
The production inefficiency index generally decreases
when elasticity is improved, but this trend is not clear for
very low elasticity values, both in Tables 1 and 2. This is
due to the fact that when elasticity is low, the most expen-
sive firms produce up to their maximum capacity, while
dominant firms with lower cost exert market power by
withholding capacity. As elasticity slightly improves (up
to 0.10, 0.15), the most expensive firms still produce
their maximum quantity, because dominant firms still find
it convenient to withhold capacity. Only when elasticity
further increases, dominants firms change their strategic
behavior and most expensive firms are dispatched to a
lower extent.
Fig. 5 shows the variation of the surplus share distribu-
tion among players under Cournot model. The surplus of
firm 1 and 2 are relatively small when there is low demand
elasticity considering their relative high capacity shares
(27.31%, 27.1% respectively) and cheap operation costs
since they have large hydropower plants share (34.62%
for each). Smaller firms benefit disproportionably from
the exercise of market power relative to the competitive
solution and the largest firms see their share of profits fall
as the elasticity decreases.
With the increasing of the demand price responsiveness,
the surplus share of firm 1 and 2 are increased while the
surplus share of other small and expensive firms are
decreasing, showing that larger percentage of the total sur-
plus goes to the more efficient firms. Therefore, the
improvement of demand price responsiveness contributes
to a reallocation of total producer surplus, providing the
proper incentives to efficiency. Similar trend but with mild
effect can be found under the second case with higher con-
jecture parameters.
Fig. 6 shows the surplus comparison index K Cf for an
increase of er up to 0.15. When the elasticity is low, com-
pared with other firms, the comparison indices for firm 1
and firm 2 are low indicating that they do not have a signif-
icant improvement of their surplus with respect to perfect
competition. This is due to the fact that in order to make
the market clearing price high enough (392.73 $/MW,
when the elasticity is 0.05) to earn higher surplus thanks
to their large hydropower capacity, firm1 and firm2 inten-
tionally withhold their output in the spot bidding market
(only 902.02 MW and 1769.9 MW respectively when the
elasticity is 0.05). On the other hand, under perfect com-
petition level, although the market price is low (51.505 $/

30
22
K3C K4C
25 K7S 20

20 K2S K5C
16

K1S
% 15 12
K3S K7C
K4 S %
10 8 K6C
K6S
K2C
5 4
K5S K1C
0 0
0.05 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 0.05 0.07 0.09 0.11 0.13 0.15
r
|e | |e r |
Fig. 5. Producer surplus share index under Cournot. Fig. 6. Producer surplus comparison index under Cournot model.
 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407
MW when er is 0.05), their dispatched outputs in the spot
market are large (6177.4 MW and 5989.3 MW respec-
tively), which also leads to large surpluses. Firm 3, 4, 5, 6
and 7, when elasticity is low, with respect to perfect compe-
tition, can earn large surplus because of the high market
clearing price and for their dispatched output that does
not change too much (4500 MW, 3300 MW, 2000 MW,
2600 MW, 5800 MW compared with 3286.4 MW,
2588.5 MW, 1910.6 MW, 1730 MW, 4272.9 MW under
perfect competition, respectively). With other words, we
could say that dominant firms 1 and 2 (with higher capacity
shares and lower marginal costs) are the ones who drive the
market outcomes, but for low values of elasticity the other
firms are the ones who benefit more from dominant firms’
power withholding strategy. Also, similar trend with mild
effect can be found under the second case with higher con-
jecture parameters. However, when the elasticity increases,
firm 1 and 2 are able to keep a higher part of their surplus
with respect to the other firms and that induces redistribu-
tion in surplus shares.
7. Conclusions
In the competitive electricity markets demand side has
obtained less attention than supply side and its impacts
are less studied. Nevertheless the demand and, particu-
larly, its price responsiveness may play a major role in
determining the performances of competitive electricity
markets.
Due to the specific feature of electricity, the level of
demand price responsiveness, as measured by its elasticity,
is intrinsically low in the wholesale market. Some possible
strategies to increase demand elasticity have been devised
and may lead to an increase in the demand elasticity and
in this respect it is interesting to assess the impacts of the
necessarily small increase of elasticity on the market
outcomes.
Basically the distortion in the market outcomes with ref-
erence to the perfect competition equilibrium is due to the
rise of market power on the supply side that strives for
higher price, lower market efficiency and inefficient alloca-
tion of surpluses. In this paper we have proposed a model
capable of capturing the demand elasticity under different
levels of market competition along with a set of proper
metrics to assess the impact of different values of elasticity.
The validity of the analysis made is conditioned by the
degree of approximation of the model employed to the real
market operation. Conclusions have been presented in con-
text on applications to the Italian market and on the
impact of elasticity that, although derived for a special
market, has a general applicability.
When the competition level is low, e.g., Cournot model,
relatively small changes in elasticity have a great impact on
market outcomes especially at the low level of elasticity
that characterize the electricity market; even small
increases of elasticity produces remarkable decreases in
the market clearing price and increases both the market
405
operating efficiency and the share of social surplus of which
the demand side can benefit. When the competition level is
high, e.g., competition model with a high value of rf, elas-
ticity improvement also provides some positive effects such
as decreasing the market clearing price and transfer the
part of the produce surplus grasped through suppliers’ stra-
tegic behaviour back to the consumer side.
In addition, when elasticity increases, the most efficient
plants earn higher surpluses than their competitors in a
context in which the total producer surplus is decreased
due to an increase in elasticity. That helps in providing
incentives towards a rise in efficiency and technological
development of power plants.
The potential benefits that can derive from an improve-
ment in the demand elasticity justify greater attention and
efforts by regulators and market designers to enhance cus-
tomers’ price responsiveness. Clearly, a demand side partic-
ipation program should be evaluated in a comprehensive
cost-benefits analysis, which requires three types of infor-
mation. First, the effect of an increase in elasticity must
be measured, in terms of effects on prices and market
power, on market efficiency and on welfare. This is the
issue addressed in this paper. The second step would be
to consider the effectiveness of a policy aiming at improv-
ing demand elasticity. Since the market designer need to
choose to which extent it makes sense to favor the imple-
mentation of time-varying retail prices or interruptible tar-
iffs, it is essential to predict how much these policies can
produce a modification in the load response. As seen in
Section 2, different authors have focused on the measure-
ment of price elasticity of different types of consumers,
and this issue is also in our research agenda. By considering
together the first and the second point, the expected bene-
fits of the proposed demand side policy can be properly
assessed. The last step would be to compare the expected
benefits with the costs of the realization of such a policy,
related for example to the installation of real time metering
or to the adoption of automatic energy management
systems.
An additional intriguing direction for future studies is
related to improving the model to incorporate the effects
of network constraints, since price elasticity is expected
to play an important role in the transmission congestion
management. Furthermore, it would be relevant to model
the multiple-period game, to allow the study of more com-
plex strategic behavior of the producer, and to incorporate
explicitly the effect of cross-price elasticities.
Appendix
For each generation firm, we define a cost function
based on the costs and capacity of the different types of
units that are in its generation mix. The aggregate is based
on computing the marginal cost function by using the OLS
(the fit was always satisfactory with an R2 always greater
than 87%) to approximate several types of power plants
within each generation firm: see Tables A.1 and A.2.
406 E. Bompard et al. / Electrical Power and Energy Systems 29 (2007) 397–407

Table A.1
Generation mix of the firms
Generation firms (MW)
1 2 3 4 5 6 7
Typolgy
Hydropower 4500 4500 400 500 1100 800 2200
Comb. cycle 500 0 0 0 0 900 2800
Oil 3000 3500 900 1100 0 0 300
Oil–gas 1600 1600 2400 1800 1100 1300 2200
Oil–coal 1800 1600 900 300 900 0 0
Oil–coal–gas 800 800 0 0 0 0 0
Diesel–oil 0 0 0 100 0 0 300
Turbo–gas 1100 1200 300 0 0 400 200

Table A.2
Marginal cost coefficients of generation firms
Coefficients Generation firms
1 2 3 4 5 6 7
3 2
c2f (10 ) $/MW 3.15 3.15 5.715 6.64 10.77 10.37 4.29
c1f $/MW 12.61 13.76 13.92 17.11 10.33 15.65 14.86
Capacity limit (MW) P f 8800 8700 4500 3300 2000 2600 5800
Pf 0 0 0 0 0 0 0
Capacity share in the hourly spot market (%) 24.65 24.37 12.61 9.24 5.6 7.28 16.25
Hydropower (MW) 4500 4500 400 500 100 800 2200
Hydropower share (%) 34.62 34.62 3.08 3.85 0.77 6.15 16.92
Total share (%) 27.31 27.1 10 7.8 4.31 6.98 16.43

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