Equilibria in Network Constrained Markets with System Operator

TL;DR

This paper models a networked market with multiple producers and a system operator, analyzing equilibrium existence, uniqueness, and the impact of network constraints on prices, validated with Italian electricity market data.

Contribution

It introduces a strategic game framework for network-constrained markets, establishing equilibrium conditions and linking capacity constraints to price differences.

Findings

Existence of pure-strategy Nash equilibria under standard assumptions.

Conditions for the game to be an exact potential game with unique equilibrium.

Capacity bottlenecks lead to price differences across markets.

Abstract

We study a networked economic system composed of $n$ producers supplying a single homogeneous good to a number of geographically separated markets and of a centralized authority, called the market maker. Producers compete \`a la Cournot, by choosing the quantities of good to supply to each market they have access to in order to maximize their profit. Every market is characterized by its inverse demand functions returning the unit price of the considered good as a function of the total available quantity. Markets are interconnected by a dispatch network through which quantities of the considered good can flow within finite capacity constraints and possibly satisfying additional linear physical constraints. Such flows are determined by the action of a system operator, who aims at maximizing a designated welfare function. We model such competition as a strategic game with $n+1$ players: the producers and the system operator. For this game, we first establish the existence of pure-strategy Nash equilibria under standard concavity assumptions. We then identify sufficient conditions for the game to be exact potential with an essentially unique Nash equilibrium. Next, we present a general result that connects the optimal action of the system operator with the capacity constraints imposed on the network. For the commonly used Walrasian welfare, our finding proves a connection between capacity bottlenecks in the market network and the emergence of price differences between markets separated by saturated lines. This phenomenon is frequently observed in real-world scenarios, for instance in power networks. Finally, we validate the model with data from the Italian day-ahead electricity market.