Prices and Concentration: A U-shape? Theory and Evidence from Renewables

TL;DR

This paper develops a theory and provides empirical evidence that capacity transfers among firms can create a U-shaped relationship between market prices and concentration, influenced by efficiency and capacity distribution.

Contribution

It introduces a model showing how capacity transfers affect prices and demonstrates this with evidence from Colombia's renewable electricity market, highlighting the impact of capacity reallocation.

Findings

Capacity transfers can lower prices by encouraging output expansion.

Large capacity transfers become anticompetitive and raise prices.

Reallocating 30% of high-cost capacity to the leader reduces prices by 10%.

Abstract

We show that when firms compete via supply functions, transferring high-cost capacity to the largest, most efficient firm--thereby diversifying its production technologies while increasing concentration--can lower prices by prompting the leader to expand output and competitors to aggressively defend market shares. However, large transfers prove anticompetitive, as sizable capacity differences discourage price undercutting. Exploiting renewable intermittencies in Colombia's electricity market, where firms are technology-diversified, we consistently find a U-shape relationship between prices and concentration. Counterfactually reallocating 30% of competitors' high-cost capacities to the leader cuts prices 10%, while larger transfers raise them, revealing how capacity and efficiency influence market power.