American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Does Strategic Ability Affect Efficiency? Evidence from Electricity Markets
American Economic Review
vol. 109,
no. 12, December 2019
(pp. 4302–42)
Abstract
Oligopoly models of price competition predict that strategic firms exercise market power and generate inefficiencies. However, heterogeneity in firms' strategic ability also generates inefficiencies. We study the Texas electricity market where firms exhibit significant heterogeneity in how they deviate from Nash equilibrium bidding. These deviations, in turn, increase the cost of production. To explain this heterogeneity, we embed a cognitive hierarchy model into a structural model of bidding and estimate firms' strategic sophistication. We find that firm size and manager education affect sophistication. Using the model, we show that mergers which increase sophistication can increase efficiency despite increasing market concentration.Citation
Hortaçsu, Ali, Fernando Luco, Steven L. Puller, and Dongni Zhu. 2019. "Does Strategic Ability Affect Efficiency? Evidence from Electricity Markets." American Economic Review, 109 (12): 4302–42. DOI: 10.1257/aer.20172015Additional Materials
JEL Classification
- D24 Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
- D43 Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection
- G34 Mergers; Acquisitions; Restructuring; Voting; Proxy Contests; Corporate Governance
- L13 Oligopoly and Other Imperfect Markets
- L25 Firm Performance: Size, Diversification, and Scope
- L94 Electric Utilities