Demand response in adjustment markets for electricity

This article examines the participation of consumers in adjustment markets for electricity, which enable participants to respond to random supply shocks occurring after quantities have been contracted. If markets were perfect, opening the adjustment market to consumers would always increase ex post efficiency, hence welfare, as expected. In reality, some consumers hold private information on their value for electricity. We prove that under such information asymmetry, allowing consumers to participate in the adjustment market may reduce welfare. This arises because electricity suppliers in the model propose inefficient ex ante retail contracts to make them incentive compatible and to limit the information rents they must leave on the table for consumers to prevent them from misreporting their private information. If the value of ex post efficiency gains due to consumers’ participation in adjustment markets is low, whereas the information distortion is high, the overall net effect is a welfare decrease. Copyright Springer Science+Business Media New York 2015