From: hibbert@netcom.com
Date: Wed Jan 17 2001 - 11:06:58 MST
Hal wrote:
>> This pricing rule sounds stupid, but I want to defend it, or at least
>> explain why it is not as absurd as it sounds.
I actually know a bit about auctions, so I'm willing to go into
more depth on this issue. (For those without the relevant background,
there's a good intro at http://www.agorics.com/new.html. It doesn't
cover commodity auctions in any detail, but it does compare first and
second price auctions, and the effects of open- versus sealed bid from
the perspective of how they effect anyone's incentive to game the
system.)
I'll start by agreeing that first price auctions aren't unreasonable
in general. I strongly question whether the variation used in this
market is appropriate.
I want to clear up some terminology first. I don't think it's
appropriate to refer to this as a "first price" auction. You said:
>> the highest-price rule (also called first-price auction rules).
As I understand what I've read, there is a continuing auction for
power throughout the day, which can be treated as a series of
auctions. If they were first price auctions, then each of the
auctions throughout the day would be settled at the highest price
bid. (Second price auctions settle at the price bid by the second
highest bidder, which reduces the incentives for buyers to exagerate
their desire for the commodity.)
In the California power market, (as I understand it) there are a
series of auctions throughout the day, each one awarding power to the
highest bidder. At the end of the day, the highest clearing price for
any of the day's auctions is charged to all the winning bidders. In
this institution, it's possible for the price someone pays to be
controlled by auctions in which they didn't participate at all!
Reactions to some of your other points:
>> it is entirely common in commodity markets to pay the same price
>> for all supplies of the commodity.
I didn't know this, but it makes sense when the commodities are
non-perishable. This is decidedly not the case for electricity.
There are limits on how much power any producer can produce at any
point in time, and (in general) you can't make it early in the day and
save it for later.
>> If we accept this general principle, then in the case of the electricity
>> market there remain two questions. First, is it reasonable to use the
>> same price for all the electricity delivered during the day, given that
>> supply and demand fluctuate during the day? And second, if we are going
>> to do this, should we use the highest-price rule (also called first-price
>> auction rules).
>>
>> I think the justification for using the same price all day is twofold.
>> First, given how the market works, demand is almost completely insensitive
>> to price. Inter-day price variations aren't passed on to customers,
>> so they do not adjust their demand in response. Therefore there is less
>> advantage than in some markets to adjusting the price on an hour by hour
>> basis since it will not affect demand.
The problem has to do with charging a price to all users throughout
the day that depends on the day's greatest congestion, when much of
the use can't be time-shifted.
>> Secondly, this might actually reduce some of the opportunities for
>> "gaming" the system (using strategies to achieve higher than competitive
>> rates). If they actually got their hour-by-hour prices, companies which
>> knew that electricity was going to be worth more in the afternoon than
>> in the morning would hold their electricity off the market until then.
>> If you were selling a product that would be worth three times more at 4
>> PM than at 10 AM, wouldn't you do the same? By giving the sellers the
>> same price all day it eliminates this kind of manipulation.
This particular argument doesn't work since so little of the supply
can be time-shifted. I don't think this set of rules reduces the
opportunities for gaming. The institution has the wrong incentives
even if no one is trying to exploit the rules. This design ensures
that the sellers get a "windfall" price as long as there is at least
one time during the day when (price-insensitive) demand approaches or
exceeds supply (which is unable to expand in response to price.)
>> Now we come to the question of first-price auctioning, that is, using
>> the highest price rather than the average price or some other rule.
>> The justification for first-price auctions is, again, that it tends to
>> reduce some forms of gaming and manipulation. Without this kind of rule
>> companies have to second-guess what other suppliers are going to ask.
>> They want to set their price as high as possible, but not substantially
>> higher than everyone else. This involves guessing and invites collusion.
>> With a simple auction rule like first-price auctioning there is less of
>> this kind of gamesmanship.
Actually, this is precisely backward. First price auctions encourage
participants to manipulate the amount of their bids since their bids
affect the price they pay. Second price rules mean that the price
one participant bids only affects whether or not they get some of the
commodity; the price is set by the bids of the other participants.
>> Besides, if we changed the rules it would not necessarily save money.
>> The prices we are paying ultimately are due to the fact that demand is
>> coming up against the limits of supply. Changes to the market rules
>> won't change this fundamental fact.
It's certainly true that supply is limited and that's a primary cause
of the problem. Another possible solution is to allow the utilities
to make long-term contracts. (Davis wants to negotiate the contracts
himself, which is not at all the same thing.)
>> Imagine that eBay, the online auctioner, adopted a rule to "save money
>> to buyers". Whatever price an auction closed at, the buyer only had to
>> pay HALF that price to the seller. So if an item sold for $100, the
>> buyer would only have to pay $50. It should be clear that this would
>> not actually save any significant amount to buyers. Items would simply
>> sell for twice what they do now, so that the actual amount paid would be
>> the same. The real prices are set by supply and demand and the auction
>> rules have a relatively minor effect.
Your description of your example is reasonable. The analogy doesn't
apply, unless I've misunderstood the way the California power auctions
are run.
Chris
---
Chris Hibbert It is easy to turn an aquarium into fish soup, but
hibbert@netcom.com not so easy to turn fish soup back into an aquarium.
-- Lech Walesa on reverting to a market economy.
http://discuss.foresight.org/~hibbert/home.html
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