Skoltech Power Markets and Regulation - I PDF

Power Markets and Regulation - I DR. MARINA DOLMATOVA ASS. PROF. OF THE PRACTICE @ SKOLTECH, HEAD OF MARKET MONITORING @ NP MARKET COUNCIL 1 © M.S.Dolmatova, 2024 Course Instructors Professor Marina Dolmatova : main materia...

Power Markets and Regulation - I DR. MARINA DOLMATOVA ASS. PROF. OF THE PRACTICE @ SKOLTECH, HEAD OF MARKET MONITORING @ NP MARKET COUNCIL 1 © M.S.Dolmatova, 2024 Course Instructors Professor Marina Dolmatova : main material, labs (WED, FRI) Professor Elena Gryazina: Journal Club (TUE) Invited lecturer: Labs TA: assistance in Journal Club, Team project work, Labs Javier Penuela, Sahar Moghimian 2 © M.S.Dolmatova, 2024 Course Structure TUE WED FRI 30/01 31/01 – Lecture 02/02 – Lecture 06/02 – Journal Club 07/02 – Lecture 09/02 – Lecture 13/02 – Journal Club 14/02 – Lecture 16/02 – Lecture 20/02 – Journal Club 21/02 – Lecture 23/02 27/02 – Journal Club 28/02 – Invited + Day-Ahead 01/03 – Lab-1 Market Training 05/03 – Journal Club 06/03 – Lab-2 08/03 12/03 – Journal Club 13/03 – Lab-3 15/03 – Lecture 19/03 – Journal Club 20/03 – Team Project defense 22/03 – Exam 3 © M.S.Dolmatova, 2024 Course Assessment Homework Assignments 10% Team Project Work 30% (a mini project assessed by a formal report and a presentation) Lab Reports 30% (understanding and analyzing day-ahead LMP market) Journal Club 5% (+5%) Final Exam 25% 4 © M.S.Dolmatova, 2024 Reading Kirschen, Strbac, “Fundamentals of Power System Economics”, 2nd Edition, Wiley, 2018 Stoft, Steven, "Power System Economics: Designing Markets for Electricity“, 2002 + be attentive in class. 5 © M.S.Dolmatova, 2024 Thinking about economics 6© M.S.Dolmatova, 2024 A Desert Island Economy Robinson 1 fish/hour, 7 fish, 6 coconuts 1 coconut/half an hour 7 © M.S.Dolmatova, 2024 A Desert Island Economy Robinson 1 fish/hour, 7 fish, 6 coconuts 1 coconut/half an hour Friday 1 f/20 min, 12 fish, 12 coconuts 1 c/hh Total 10 hours of work 19 fish, 18 coconuts 8 © M.S.Dolmatova, 2024 A Desert Island Economy Production–possibility frontier tg(alpha) - opportunity cost of coconuts 1 3 tg 𝛼 𝑅 = , tg 𝛼 𝐹 = 2 2 The less the cost the more efficient production ➔ Robinson harvests coconuts (20C), Friday spends 8 hours on fishing and 2 hours on coconuts (24F+4C). 9 © M.S.Dolmatova, 2024 A Desert Island Economy Production–possibility frontier tg(alpha) - opportunity cost of coconuts 1 3 tg 𝛼 𝑅 = , tg 𝛼 𝐹 = 2 2 The less the cost the more efficient production ➔ Robinson harvests coconuts (20C), Friday spends 8 hours on fishing and 2 hours on coconuts (24F+4C). Before meeting After meeting Robinson 7F+6C 10 F + 10 C Friday 12 F + 12 C 14 F + 14C Efficiency and Trade! 10 © M.S.Dolmatova, 2024 Practice Exercise - I Ann and Bob are stuck on a desert island. There are two goods, fish (F) and coconuts (C). Ann has production function F+C=20 , and without trading chooses C=12. Bob has production function F+2C=30 and without trading chooses C=11. Explain an arrangement that can make both better off. Make sure you don’t fall into the trap! 11 © M.S.Dolmatova, 2024 Practice Exercise - II Ann has production function F+C=20 , and without trading chooses C=12. Bob has production function F+2C=30 and without trading chooses C=11. If Ann chooses C=12, that implies F=8. If Bob chooses C=11, that implies F=8. Total w/o trading C=23, F=16. Bob has the comparative advantage in fish, and Ann has the comparative advantage in coconuts. So, Bob should specialize in fish and Ann in coconuts. However, full specialization does not produce enough coconuts. (This is the trap!) So, let Ann make C=20. We still need 3 C, so Bob makes 3 C and 24 F. Ann then trades 8 C to Rod for 12 Fish. Ann now has C=12 and F=12. He is better off. Bob has C=11 and F=12. He is better off. 12 © M.S.Dolmatova, 2024 A society of people, each acting in their own best interest, leads to an increase in the wealth of society as a whole. expounded upon by Adam Smith 13 © M.S.Dolmatova, 2024 What is Economics? Economics is a social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. 14 © M.S.Dolmatova, 2024 Statements to consider … ✓ Economic goods are material or im-material means suited for satisfying human needs. 15 © M.S.Dolmatova, 2024 Statements to consider … ✓ Economic goods are material or im-material means suited for satisfying human needs. ✓ All goods are scarce. 16 © M.S.Dolmatova, 2024 Statements to consider … ✓ Economic goods are material or im-material means suited for satisfying human needs. ✓ All goods are scarce. ✓ Wants are unlimited. 17 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. 18 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. 19 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. Principle 3: Rational people think at the margin. 20 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. Principle 3: Rational people think at the margin. Principle 4: People respond to incentives. 21 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. Principle 3: Rational people think at the margin. Principle 4: People respond to incentives. Principle 5: Trade can make everyone better off. 22 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. Principle 3: Rational people think at the margin. Principle 4: People respond to incentives. Principle 5: Trade can make everyone better off. Principle 6: Markets are usually a good way to organize economic activity. 23 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. Principle 3: Rational people think at the margin. Principle 4: People respond to incentives. Principle 5: Trade can make everyone better off. Principle 6: Markets are usually a good way to organize economic activity. Principle 7: Governments can sometimes improve market outcomes. 24 © M.S.Dolmatova, 2024 Mankiw’s List of Principles of Economics Principle 1: People face tradeoffs. Principle 2: The cost of something is what you give up to get it. Principle 3: Rational people think at the margin. Principle 4: People respond to incentives. Principle 5: Trade can make everyone better off. Principle 6: Markets are usually a good way to organize economic activity. Principle 7: Governments can sometimes improve market outcomes. Principle 8: A country’s standard of living depends on its ability to produce goods and services. Principle 9: Prices rise when the government prints too much money. Principle 10: Society faces a short-run tradeoff between inflation and unemployment. 25 © M.S.Dolmatova, 2024 Utility and Individual Rationality In economics, utility is a measure of the satisfaction that a certain person has from a certain state of the world. a measure of pleasure or happiness (as part of the theory of utilitarianism); a representation of a consumer's ordinal preferences over a choice set (neoclassical economy). Uninformed decisions, hurried decisions – people are not perfectly rational 26 © M.S.Dolmatova, 2024 Utility and Individual Rationality In economics, utility is a measure of the satisfaction that a certain person has from a certain state of the world. a measure of pleasure or happiness (as part of the theory of utilitarianism); a representation of a consumer's ordinal preferences over a choice set (neoclassical economy). Uninformed decisions, hurried decisions – people are not perfectly rational Simplifying assumption: Agents are rational utility maximizers. 27 © M.S.Dolmatova, 2024 Utility and Individual Rationality In economics, utility is a measure of the satisfaction that a certain person has from a certain state of the world. a measure of pleasure or happiness (as part of the theory of utilitarianism); a representation of a consumer's ordinal preferences over a choice set (neoclassical economy). Uninformed decisions, hurried decisions – people are not perfectly rational Simplifying assumption: Agents are rational utility maximizers. Monetization: Using money as a common unit of measure and accounting 28 © M.S.Dolmatova, 2024 Markets 29 © M.S.Dolmatova, 2024 Market Structures Central Planning Markets Government agents are Decentralized decisions as the responsible for making decisions result of thousands of choices by about production, distribution, producers and consumers and pricing of goods. 30 © M.S.Dolmatova, 2024 Market Structures Central Planning Markets Government agents are Decentralized decisions as the responsible for making decisions result of thousands of choices by about production, distribution, producers and consumers and pricing of goods. Knowledge problem competitive markets (+regulation) 31 © M.S.Dolmatova, 2024 A Model for a Market Economy Demand Side Consumers are utility maximizers. 𝐷 𝑝 - represents the amount of good a consumer is willing to buy at the price 𝑝. General properties: 1) convexity ∀𝑝, 𝐷 𝑝 is a point or an interval, 2) closed mapping ∀𝐺𝑟 𝐷 𝑝 = 𝑝, 𝑄 0 ≤ 𝑝 < ∞, 𝑄 ∈ 𝐷(𝑝)} 3) non-increasing for 𝑝 ∀𝑝 < 𝑝′ , ∀𝑄 ∈ 𝐷 𝑝 , 𝑄′ ∈ 𝐷 𝑝 , holds 𝑄 ≥ 𝑄′ 4) 𝐷 𝑝 → 0 𝑓𝑜𝑟 𝑝 → ∞ (for unlimited increase of the price, the demand tends to zero) 32 © M.S.Dolmatova, 2024 A Model for a Market Economy Demand Side A consumer surplus happens when the price consumers pay for a product or service is less than the maximum price they're willing to pay. Consumer surplus equals the area between the demand curve (diagonal line) and market price (P). So, we're looking at the shaded triangle, here. 33 © M.S.Dolmatova, 2024 Practical exercise Calculate the consumers surplus for P = 60 when demand function is P = 90 − 6Q. 34 © M.S.Dolmatova, 2024 Practical exercise Calculate the consumers surplus for P = 60 when demand function is P = 90 − 6Q. P = 60 60 = 90 - 6Q then Q = (90 - 60)/6 = 5 CS = (90 - 60)*5/2 = 75 35 © M.S.Dolmatova, 2024 A Model for a Market Economy Demand Side. Price Elasticity of Demand Price elasticity of demand is a measure of the change in the demand for a product in relation to a change in its price. 𝑑𝑄/𝑄 𝑒 𝐷(𝑝) = 𝑑𝑃/𝑃 𝑒 𝐷(𝑝) ≡ 1 → 𝐷 𝑝 = 𝐾/𝑝 𝑒 𝐷(𝑝) > 1 – high elasticity, 𝑒 𝐷(𝑝) < 1 – low elasticity 36 © M.S.Dolmatova, 2024 Practical exercise Assume demand function for a product in a hypothetical market is P = 40 – 4Q. Calculate the price elasticity of demand when price increases from $16 to $20. 37 © M.S.Dolmatova, 2024 Practical exercise Assume demand function for a product in a hypothetical market is P = 40 – 4Q. Calculate the price elasticity of demand when price increases from $16 to $20. In order to calculate the price elasticity of demand, we need to calculate the price and demand quantity for two points: Point 1: P1 = $16 Q1 = (40 – 16)/4 = 6 (plugging in the P1 in the demand equation to get the Q1) Point 2: P2 = $20 Q2= (40 – 20)/4 = 5 Please note that you need to use the original formal, not the midpoint elasticity, unless it is specifically asked to use the midpoint elasticity equation. 38 © M.S.Dolmatova, 2024 A Model for a Market Economy Supply Side. Cost function Producers are profit maximizers. 𝐶(𝑄) – a cost function, represents the cost of production 𝑄. 39 © M.S.Dolmatova, 2024 A Model for a Market Economy Supply Side. Cost function Producers are profit maximizers. 𝐶(𝑄) – a cost function, represents the cost of production 𝑄. General assumptions: 1) monotonic increasing for 𝑄 ; 2) 𝐶 0 = 0 ; 40 © M.S.Dolmatova, 2024 A Model for a Market Economy Supply Side. Cost function Producers are profit maximizers. 𝐶(𝑄) – a cost function, represents the cost of production 𝑄. General assumptions: 1) monotonic increasing for 𝑄 ; 2) 𝐶 0 = 0 ; ሶ 𝑄 , the right derivative 𝐶+ 3) convexity (the left derivative 𝐶− ሶ 𝑄 ); 4) 𝐶−ሶ 𝑄 → ∞ , for 𝑄 → ∞. 41 © M.S.Dolmatova, 2024 A Model for a Market Economy Supply Side. Cost function Producers are profit maximizers. 𝐶(𝑄) – a cost function, represents the cost of production 𝑄. General assumptions: 1) monotonic increasing for 𝑄 ; 2) 𝐶 0 = 0 ; ሶ 𝑄 , the right derivative 𝐶+ 3) convexity (the left derivative 𝐶− ሶ 𝑄 ); 4) 𝐶−ሶ 𝑄 → ∞ , for 𝑄 → ∞. 𝐶 𝑄 = 𝑇𝐶 = 𝑉𝐶 + 𝐹𝐶 𝐴𝐶 = 𝑇𝐶/𝑄 𝑀𝐶 = (𝛥 𝑇𝐶)/(𝛥 𝑄) = (𝑇𝐶2 – 𝑇𝐶1 )/(𝑄2 − 𝑄1 ) 42 © M.S.Dolmatova, 2024 Marginal Cost (MC) vs. Average Costs (AC) o Both expressed in money/unit (e.g. $/MWh) $/unit MC AC q 43 © M.S.Dolmatova, 2024 Marginal Cost (MC) vs. Average Costs (AC) o Both expressed in money/unit (e.g. $/MWh) o MC = dc(q)/dq = increase in the cost to produce the next/last unit $/unit MC AC q 44 © M.S.Dolmatova, 2024 Marginal Cost (MC) vs. Average Costs (AC) o Both expressed in money/unit (e.g. $/MWh) o MC = dc(q)/dq = increase in the cost to produce the next/last unit o Almost all economics is about marginal costs as they represent incentives: what happens when you change something $/unit MC AC q 45 © M.S.Dolmatova, 2024 Marginal Cost (MC) vs. Average Costs (AC) o Both expressed in money/unit (e.g. $/MWh) o MC = dc(q)/dq = increase in the cost to produce the next/last unit o Almost all economics is about marginal costs as they represent incentives: what happens when you change something o AC= c(q)/q = the average cost over all units produced o MC depend only on the variable cost as the fixed costs are constant $/unit MC AC q 46 © M.S.Dolmatova, 2024 Marginal Cost (MC) vs. Average Costs (AC) o Both expressed in money/unit (e.g. $/MWh) o MC = dc(q)/dq = increase in the cost to produce the next/last unit o Almost all economics is about marginal costs as they represent incentives: what happens when you change something o AC= c(q)/q = the average cost over all units produced o MC depend only on the variable cost as the fixed costs are constant For low y, MC < AC because of the $/unit influence of fixed costs MC AC For high y, MC > AC MC = AC when AC = minimum (i.e. max efficiency but not necessarily max profit as profit depends on the price) q 47 © M.S.Dolmatova, 2024 Proof that MC = AC when AC = minimum $/unit MC 𝑐(𝑞) AC 𝐴𝐶(𝑞) = 𝑞 𝑑𝐴𝐶 𝐴𝐶 = min when =0 𝑑𝑞 q 48 © M.S.Dolmatova, 2024 Proof that MC = AC when AC = minimum $/unit MC 𝑐(𝑞) AC 𝐴𝐶(𝑞) = 𝑞 𝑑𝐴𝐶 𝐴𝐶 = min when =0 𝑑𝑞 𝑑𝐴𝐶 𝑐 ′ 𝑞 𝑞 − 1𝑐(𝑞) q = 2 =0 𝑑𝑞 𝑞 49 © M.S.Dolmatova, 2024 Proof that MC = AC when AC = minimum $/unit MC 𝑐(𝑞) AC 𝐴𝐶(𝑞) = 𝑞 𝑑𝐴𝐶 𝐴𝐶 = min when =0 𝑑𝑞 𝑑𝐴𝐶 𝑐 ′ 𝑞 𝑞 − 1𝑐(𝑞) q = 2 =0 𝑑𝑞 𝑞 𝑐 ′ 𝑞 𝑞 − 𝑐(𝑞) = 0 𝑐(𝑞) 𝑐′(𝑞) = 𝑀𝐶 = = 𝐴𝐶 𝑞 50 © M.S.Dolmatova, 2024 A Model for a Market Economy Supply Side A producer surplus is the total revenue that a producer receives from selling their goods minus the marginal cost of production. Supply elasticity: 𝑑𝑄/𝑄 𝑒 𝑆(𝑝) = Consumer surplus equals the area 𝑑𝑃/𝑃 between the supply curve (diagonal line) and market price (P). So, we're looking at the shaded triangle, here. 51 © M.S.Dolmatova, 2024