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Market Design and Investment Incentives


  •  Corresponding author: María-Ángeles de Frutos, Universidad Carlos III de Madrid, Calle Madrid 126, 28903 Getafe, Madrid, Spain. Email:

  • We thank the Editor, David Myatt and three anonymous referees, for their detailed suggestions. We are also grateful for comments from Roberto Burguet, Kai-Uwe Kühn, Rob Porter, Patrick Rey, Steve Puller and seminar participants at the CEPR Conference on Applied IO (Tarragona), Jornadas de Economía Industrial (IESE, Barcelona), UCEI (University of California, Berkeley), the Conference on the Economics of Energy Markets (IDEI, Toulouse), Workshop on Designing Electricity Auctions (IFN, Stockholm), Workshop on Inequalities in Contests (ESOP, University of Oslo), the University of Manheim and M-MIAOW Seminars (Madrid). Eduardo Gil, Antonio Jesús Sánchez and Jan Henrik Wold provided excellent research assistance. All errors remain our own responsibility. The first and third authors acknowledge support from the Consolider-Ingenio 2010 Programme; the first author also acknowledges support from Project S2007/HUM-0444, while the third from Project SEJ 2007-04339-001.


The purpose of this study was to understand how market design affects market performance through its impact on investment incentives. For this purpose, we model capacity choices by two ex ante identical firms which compete in the product market. We analyse a number of different market design elements, including (i) two commonly used auction formats, the uniform-price and discriminatory auctions, (ii) price caps and (iii) bid duration. We find that although the discriminatory auction tends to lower prices, this does not imply that investment incentives at the margin are poorer; indeed, aggregate capacity is the same under both auction formats.