Wrap up: firms vs. markets

This has been a challenging week. We have moved away from the system perspective with a central planning (you have decided which technologies are to be used in the models before) to a market perspective where different actors (firms) pursue their own objectives and can only be steered indirectly by policy measures.

Firm and market

To achieve this, we have discussed in detail how actors, like firms, can be modelled. You have seen different ways of doing this like the Emission Choice Model (ECM), Output Abatement Choice Model (OACM) or Input Choice Model (ICM). Based on these approaches a new exercise model was designed that introduced the firm perspective.

In a final step, we have introduced the demand side and connected the two sides: we have introduced a market for electricity that clears automatically (by adjusting the market price). This market ensures that the actions taken by the different actors are compatible: it is an ‘invisible hand’ that steers firms and consumers to a situation where total demand for electricity exactly equals total supply.

With this final step, you are in a situation that is similar to the one in the second week of this course: you can describe aggregate electricity demand and aggregate supply and influence both via policy measures. However, now you have a model that takes into account that most societies do not have a dictator that makes all decisions but consist of a number of different actors. The basics of equilibrium modeling.

modeling phases

The building blocks provide you with a robust set of components to design your own market models. Together with the system models and optimization logic of the last week, you now have a sufficiently large toolkit to answer different problems and design fitting models. In addition, we have made our first attempt at using models. Remember, that in order to derive a solution out of your model, you will need as many equations as your model has endogenous variables. And those equations are derived by differentiating the objective of your model with respect to those endogenous variables. We will take a deeper look into how models are solved both for optimization and equilibrium models in the upcoming two weeks.

So far, the actors in our model have behaved nicely: they behave competitively, nobody tries to use market power to get an advantage. This will be changed in the coming week when we enrich our model by having an actor that is bigger than the other ones that tries to use its size to its own advantage (or exert market power). We thus go, again, one step closer to actual energy systems where market power is rather ubiquitous.

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This article is from the free online course:

Exploring Possible Futures: Modeling in Environmental and Energy Economics

University of Basel