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Journal of Economic Theory

Supply Function Equilibria: Step Functions and Continuous Representations

Scientific Article in English
Reference
Holmberg, Pär, David Newbery and Daniel Ralph (2013). “Supply Function Equilibria: Step Functions and Continuous Representations”. Journal of Economic Theory 148(4), 1509–1551. doi.org/10.1016/j.jet.2013.04.020

Authors
Pär Holmberg, David Newbery, Daniel Ralph

In most electricity markets generators must submit step-function offers to a uniform price auction. These markets are often modelled as simpler pure-strategy Supply Function Equilibria (SFE) with continuous supply functions. Critics argue that the discreteness and discontinuity of the required steps drastically change Nash equilibria, invalidating predictions of the SFE model. We prove that there are sufficient conditions, offered quantities can be continuously varied, offered prices are selected from a finite set, and the density of the additive demand shock is not too steep, where the resulting stepped SFE converges to the continuous SFE as the number of steps increases, reconciling the apparently very disparate approaches to modelling electricity markets.

Pär Holmberg

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