A framework of Peak Load Pricing with strategic firms∗

In this article we analyze firms investment incentives in liberalized electricity mar-kets. Since electricity is economically non storable, it is optimal for firms to invest in a differentiated portfolio of technologies in order to serve strongly fluctuating demand. Prior to the Liberalization of electricity markets, for regulated monopolists, optimal investment and pricing strategies haven been analyzed in the peak load pricing lit-erature (compare Crew and Kleindorfer (1986)). In restructured electricity markets regulated monopolistic generators have often been replaced by competing and poten-tially strategic firms. This article aims to respond to the changed reality and model investment decisions of strategic firms in those markets. We derive equilibrium investment for strategic firms and compare to the benchmark cases of perfect competition and monopoly outcomes. We find that strategic firms have an incentive to overinvest in base–load technologies but choose total capacities too low from a welfare point of view. By fitting the framework to a specific electricity market (Germany) we are able to empiricall