Competitive Bidding Behavior in Uniform-Price Auction Markets, Report to Federal Energy Regulatory Commission, Dockets EL00-95-075 and EL00-98-063

Profit-maximizing bidding in uniform price auction markets involves bidding above marginal cost. It therefore is not surprising that such behavior is observed in electricity markets. This incentive to bid above marginal cost is not the result of coordinated action among the bidders. Rather, each bidder is independently selecting its bid to maximize profits based on its estimate of the residual demand curve it faces. The supplier bids a price for its energy capacity to optimize its marginal tradeoff between higher prices and lower quantities. Price response from either demand or other suppliers prevents the supplier from raising its bid too much. Profit maximizing bidding should be expected and encouraged by regulators. It is precisely this profit maximizing behavior that guides the market toward long-run efficient outcomes. 1