We consider three models of investments in generation capacity in restructured electricity systems that differ with respect to their underlying economic assumptions. The first model assumes a perfect, competitive equilibrium. It is very similar to the traditional capacity expansion models even if its economic interpretation is different. The second model (open-loop Cournot game) extends the Cournot model to include investments in new generation capacities. This model can be interpreted as describing investments in an oligopolistic market where capacity is simultaneously built and sold in long-term contracts when there is no spot market. The third model (closed-loop Cournot game) separates the investment and sales decision with investment in the first stage and sales in the second stage-that is, a spot market. This two-stage game corresponds to investments in merchant plants where the first-stage equilibrium problem is solved subject to equilibrium constraints. We show that despite some important differences, the open-and closed-loop games share many properties. One of the important results is that the prices and quantities produced in the closed-loop game, when the solution exists, fall between the prices and quantities in the open-loop game and the competitive equilibrium.

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The supply side of an oligopolistic market supplying a homogeneous product noncooperatively is modeled. In this market, there is one leader and N followers. The followers operate under the Cournot assumption of zero conjectural variation and are accordingly called Cournot firms. The leader, called a Stackelberg firm, specifically takes into account the reaction of the Cournot firms to its output. For this situation, we study the behavior and implications of the joint Cournot reaction curve as generated by plausible economic market assumptions. In particular, we study the existence and uniqueness of a Stackelberg-Nash-Cournot equilibrium. In addition, we prescribe an efficient algorithm to determine a set of equilibrating output quantities for the firms.

Allaz and Vila made the seminal contribution that forward contracts mitigate market power on the spot market. This result is widely quoted and elaborated in studies of restructured power markets, where generators can potentially exploit the special characteristics of this industry in order to extract higher prices. Allaz-Vila established their result under the assumption that the production capacities of the players are infinite. We show that the Allaz-Vila result does not hold when capacities are endogenous and constraining generation. Specifically, a forward market can enhance or mitigate market power when capacities are endogenous and demand is unknown at the time of investment. We also show that forward markets do not mitigate market power when capacities are endogenous and demand is known at the time of investment. Our results complement other work that shows that forward markets systematically enhance market power in some symmetric capacity-constrained markets.

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