Investment Incentives and Market Power: An Experimental Analysis
Dean V. Williamson, Céline Jullien, Lynne Kiesling,
Carine Staropoli, EAG 06-5, January 2006
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Abstract:
We examine investment incentives and market power in an experimental market. We
characterize market power as the strategic interdependence of subjects' investment
decisions and output decisions. The market is designed so that investment and output
decisions can be jointly characterized as strategies within a game. A Nash-Cournot
equilibrium of the game provides a way of characterizing how investment incentives and
market power interact. Subjects could invest in two different production technologies and
could produce output to serve as many as two different demand conditions. The
technologies were analogous to "baseload" capacity and "peaking" capacity in wholesale
electricity markets. The Nash-Cournot benchmark constituted a good indicator of subjects'
output decisions in that output cycled around the Cournot benchmark. Thus, on average,
consumers extracted the surplus available to them in the equilibrium. While we do not
observe Edgeworth Cycles in prices or outputs, we do see them in the producer surplus
series. Producers dissipated some of the surplus they could have extracted in the
equilibrium by overinvesting in peaking capacity and underinvesting in baseload capacity.
Inefficient investment diminished total system efficiency, but producers' investments in
total production capacity tracked the Nash-Cournot benchmark. In contrast, monopoly
explanations such as collusion do not characterize the data.