American Economic Review Vol. 109 No. 12 2019

Does Strategic Ability Affect Efficiency? Evidence from Electricity Markets

Ali Hortaçsu¹; Fernando Luco²; Steven L. Puller³; Dongni Zhu⁴

¹ The Kenneth C. Griffin Department of Economics, University of Chicago, 1126 E. 59th Street, Chicago, IL 60637, and NBER (email: ) · ² Department of Economics, Texas A&M University, 4228 TAMU, College Station, TX 77843 (email: ) · ³ Department of Economics, Texas A&M University, 4228 TAMU, College Station, TX 77843, and NBER (email: ) · ⁴ School of Economics, Shanghai University of Finance and Economics, 111 Wuchuan Road, Shanghai 200433, China (email: )

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.

DOI

10.1257/aer.20172015

Volume

109

Issue

12

Pages

4302-4342

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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