Market Design and Investment Incentives

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.