# An adverse selection approach to power pricing

## TL;DR

This paper models the optimal electricity contract design considering consumer heterogeneity and adverse selection, providing explicit solutions and characterizing when contracts should target consumers with specific consumption appetites.

## Contribution

It introduces a novel application of Principal-Agent models to electricity pricing with unique cost structures and derives explicit optimal contract forms.

## Key findings

- Optimal contracts are linear or polynomial in consumption.
- Contracting strategies depend on consumer appetite and outside options.
- Explicit solutions are provided despite unusual cost features.

## Abstract

We study the optimal design of electricity contracts among a population of consumers with different needs. This question is tackled within the framework of Principal-Agent problems in presence of adverse selection. The particular features of electricity induce an unusual structure on the production cost, with no decreasing return to scale. We are nevertheless able to provide an explicit solution for the problem at hand. The optimal contracts are either linear or polynomial with respect to the consumption. Whenever the outside options offered by competitors are not uniform among the different type of consumers, we exhibit situations where the electricity provider should contract with consumers with either low or high appetite for electricity.