| This study develops a method to measure horizontal market power in electricity generation by using an electricity market simulation model, PROSYM, that fully represents the characteristics of electricity cost and production. The major contribution of this method is that it accounts for the effects of potential entry on the ability of firms to exercise market power.;Federal Energy Regulatory Commission and Public Utility Commissions have used market share and concentration measures to analyze horizontal market power in electricity markets. However, in measuring market power, it may be misleading to solely rely on market share and concentration measures, because even when the market is fairly concentrated, the threat of entry by potential suppliers may be strong enough to discipline monopoly pricing by the incumbents. The theory of contestable markets indicates that, even in markets with a single supplier, if the threat of entry is strong enough, the resulting equilibrium price will be at the perfectly competitive level. This implies that market concentration is not a good measure of market power.;The present study analyzes an electricity market with three transmission areas, and it measures the unilateral market power held by a representative utility. The results indicate that, when potential entry is not accounted for, the incumbent utility in question is able to sustain monopoly profits. However, when the utility in question increases market prices it creates incentives for new entry into the market. It is further demonstrated that, if entry occurs, neither monopoly profits of the utility, nor the high market prices are sustainable. The study concludes that, knowing the technology available to the entrants, it is in the utility's best interest to charge competitive prices. Therefore, the market analyzed in this study is contestable. |
