Artificial power markets and unintended consequences

Administrative pricing rules that try to mimic economic equilibria often fail to capture the complexity of real markets, and in that failure can distort incentives as much as or more than cost-based pricing. In this paper we will provide three examples of the failure of administrative mechanisms meant to mimic a market. Two of those examples are very relevant to current debates over industry restructuring. In each case, the pricing rule fails to maximize social welfare even though (in the last two examples) production cost is minimized.