RSP 6

MODERN INSTITUTE OF TECHNOLOGY AND RESEARCH CENTRE, ALWAR
Name of Faculty: Gauri Shankar Sharma
Subject: RPS
Semester: V Session: 2021-22 (Odd Sem)
Branch: EE Batch: A
Unit: VI Date of Submission: 11/11/21
Page Total
Topics Covered
No. Page
29 Introduction of transmission pricing 78-81 4
Principle of Transmission Pricing, Classification of

30 82-84 3
transmission pricing
Rolled in transmission pricing paradigm, Postage Stamp

31 85-88 4
Method
Attributes of a perfectly competitive market, the firm’s

32 89-92 4
supply decision
33 Imperfect Market competition, OLIGOPOLY, Monopoly 93-96 4
34 Effect of Market Power, Identifying Market power 97-99 3
35 HHI Index, Entropy coefficient, Lerner Index 100-103 4

MODERN INSTITUTE OF TECHNOLOGY AND RESEARCH CENTRE, ALWAR
Name of Faculty: Gauri Shankar Sharma
Subject: RPS
Semester: V Session: 2021-22 (Odd Sem)
Branch: EE Batch: A
Unit: VI Date of Submission: 11/11/21
Plagiarism
Topics Covered
29 Introduction of transmission pricing 62
Principle of Transmission Pricing, Classification of

30 48
transmission pricing
Rolled in transmission pricing paradigm, Postage Stamp

31 52
Method
Attributes of a perfectly competitive market, the firm’s

32 56
supply decision
33 Imperfect Market competition, OLIGOPOLY, Monopoly 61
34 Effect of Market Power, Identifying Market power 48
35 HHI Index, Entropy coefficient, Lerner Index 49
Average: 54%
Unit-6 EE-5 Sem. Restructured Power System
UNIT-6 (PRICING OF TRANSMISSON NETWORK USAGE

AND MARKET POWER)
LECTURE NO:-29
INTRODUCTION OF TRANSMISSON PRICING
Transmission pricing and loss allocation are highly debated issues after the deregulation of
power industry. In the post deregulated era, the transmission provision gets a good deal of
importance. Strong transmission system forms the backbone of any successful deregulated
power industry. As per the planning policies developed in most of the countries, more
emphasis was given on adding more generation to the system rather than improving and
strengthening the transmission network. But after restructuring of the power industry, the
issue of open access has compelled policy makers to re-think their approach towards
transmission planning. Open access demands sound transmission corridor availability for a
transaction to become viable. After deregulation, the transmission system is owned and
operated by a separate company that is popularly known as Transco. For well-known
reasons, the transmission activity remains a monopoly rather than being a competitive
activity. And since open access demands a non-discriminatory access to the transmission
system by any qualified entity in the business, this monopoly entity has to be regulated by a
higher governmental agency. In many countries, the Transco are the dis-aggregated part of
the then original vertically integrated utility that existed in the region, prior to deregulation.
The original concept of reforms and restructuring was mainly aimed at gaining economic
benefits to all dispersed entities in the market. However, success or failure of a market
depends on the design of its market rules. The power sector reforms are full of uncertainties
and due to its large scale, wrong or inappropriate market rules may bring disaster instead of
the economic gains at large. Transmission pricing rules form one of the important parts of
the market rules. As we all know, one of the basic prerequisites of establishing a
competitive market is the transmission open access. Successful competition at the
generation level calls for a successful, fair and non-discriminatory open access for the
transacting entities in the market. Pricing of transmission services plays an important role in
78
Gauri Shankar Sharma
determining whether providing transmission open access and allied services is economically
beneficial to both the wheeling utility and wheeling customers.
Few years back, electricity transmission pricing was more of an academic interest, rather
than practical use. This is because generation, transmission and distribution were vertically
integrated. The vertically integrated utilities used to sell their power inside their territory, or
exchange power with the neighboring utilities. Hence, the need for having a formal
mechanism for pricing of transmission did not exist. The costs incurred by the vertically
integrated utilities were recovered by embedding them in the electricity price billed to the
consumers. However, in recent times, as a primary step towards reforms, generation and
transmission businesses have been separated from each other in many countries and hence,
transmission prices are used to charge the transactions. One important fact about the
transmission pricing issue is that it is a technical issue rather than an engineering problem
[8]. To some extent it couples operational aspect of the power system with it, so long as
provision of correct economic signals is considered. Engineering analysis which deals
mainly with determining the feasibility and the cost of providing transmission services is
only one of the many considerations in the overall process of pricing transmission services.
Loss allocation is another issue, where no single solution can be ultimate solution. The loss
allocation problem is different from loss supply. Loss allocation is all about allocating costs
of losses amongst various participants. Loss allocation problem is a contentious issue
because of the non-linearity associated with power flows.
What is Power Wheeling?
To define formally, wheeling is the transmission of electrical energy from a buyer to a

seller, through transmission or distribution lines owned by a third party. Call a selling utility
as Utility S, the buying utility, Utility B. Suppose they are non-contiguous and they are
connected by several parallel paths through different utilities in between. One of the utilities
connecting them is Utility K. In the context of the term wheeling, the obvious question to be
asked is, what does it mean to say that Utility S is wheeling to Utility B, via Utility K? The
answer to this question is not straightforward where every other entity in the business has its
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own perception and that is why the issue of wheeling and its pricing becomes highly
debatable. Two issues are highly debated upon [6].
Displacement or Movement?
It is a popular argument that power doesn't actually move from injecting point to load point.
Rather, displacement of power takes place by addition and withdrawal of some MW of
power at injecting and take-off points respectively. One analogy given by proponents of this
concept is that of a lake that is filled to its maximum capacity. Pouring water at one end of a
lake makes an equivalent amount of flow at the other end. However, the poured water does
not travel from one end to the other. The electricity pushed into a power pool would also
behave in a similar fashion. Thus, it is argued that the transmission users should pay a flat
fee regardless of distance between two points.
The opponents of this view state that suppose x gallons of water is added at one end of the
lake, it may not travel all the way to the other end, but it causes incremental disturbance in
every gallon in the lake. Similarly, pushing some MWs at one point and withdrawing from
the other would create an equivalent total change in the system flow. Hence, the user should
pay as if its power had been moved over this much distance.
Distance Dependency: High or Low?
One of the debating point is how much transmission delivery price should depend on
distance? This question did not exist in case of a vertically integrated utility as all generation
as well as loads were looked after by a single utility. In this case, neither a load near
generating station got advantage nor the distant loads felt the brunt of their location.
But in a de-regulated era, the buyers have the choice to choose their generator as local or
distant producers. There is an argument that the customers should pay towards transmission
usage on the basis of the distance. However, the counter argument to this is that, why should
a customer be penalized for its geographical location, which is not in its hand? Thus, one
aspect of this distance parameter is the fairness. The other aspect is the generation of price
signals
80
From the economists' viewpoint, low price as a function of distance creates a competitive
market, which is the motivating factor for de-regulation. On the other hand, high long
distance transmission charges would encourage construction of local generation so as to
discourage long distance transmission of power, leading to loss reduction. In other words,
high dependency of prices on distance would lead to engineering efficiency.
In spite of having different opinions on the debatable issues, one thing is agreed upon by
everybody and that is the charges for transmission system use should cover all the costs and
provide a small, regulated level of profit for the owners of the transmission facility. Thus,
the real debate over pricing focuses on how the cost of the system is allocated among its
users? Apart from cost recovery, can the pricing provide any other information? Based on
this, some principles of transmission pricing have been developed.
References
1. https://economictimes.indiatimes.com/definition/monopoly
2. https://corporatefinanceinstitute.com/resources/knowledge/economics/market-
power/
3. https://www.e-education.psu.edu/ebf483/node/732
4. https://nptel.ac.in/courses/108/101/108101005/
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LECTURE NO:-30
Principle of Transmission Pricing
To operate the power system under the regime of transmission open access, a trade-off has
to be solved: Economic marketing of energy has to be given importance while at the same
time; it should be ensured that the whole system operates in a reliable and secure manner.
The main purpose of any transmission pricing scheme is not limited to recovery of the sunk
costs involved in bringing up the transmission infrastructure. The transmission pricing
scheme should do much more than that. In line with the above, following principles should
be followed while designing the transmission pricing schemes [3]:
 The transmission prices should be devised so as to promote the efficiency of day-to-

day operation of bulk power market.
 The transmission prices should signal locational advantages for investment in
generation and demand.
 They should signal the need for investment in the transmission system.
 The transmission prices should recover the costs of existing transmission assets.
 Transmission pricing mechanism should be simple and transparent.
 The mechanism should be politically implementable. 
Out of these, the first three objectives are concerned with derivation of appropriate
economic signals to either utility or the consumer. However, the fifth objective states that
the signals should not be so complicated that one can not decipher the same and react to it.
Fourth and sixth objectives are associated with the allocation strategy of the pricing
mechanism. Briefly speaking, the first objective speaks about the short term efficiency,
numbers 2-4 with long term efficiency and 5, 6 with implementation.
There is different transmission pricing mechanisms prevailing in different parts of the

world. They differ on a lot of parameters like: whether they use incremental methods to
price the transactions or they go for rolled-in cost methods; whether generator pays the
wheeling charge or the consumer pays for it, or both pay a part of it in some proportion, etc.
It is expected that while designing a transmission pricing mechanism, following cost
components for providing transmission service should be taken into account [11]:
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 Operating Cost: This includes the cost mainly due to generator rescheduling,
maintaining system voltage, reactive power support and line flow limits.
 Opportunity Cost: It is the cost which a transmission company (Transco) has to
forgo due to operating constraints that are caused by the transmission transaction.
 Reinforcement Cost: This cost is charged to only firm transactions and includes
capital cost of new facilities required to meet the transaction.
 Existing System Cost: The investment cost of existing transmission facilities used by
the transmission transaction.
Classification of transmission pricing
Almost all existing and proposed transmission pricing models are cost based. That means,
they allocate all or part of the existing and new transmission systems to wheeling customers.
Based on this, transmission pricing paradigms can be defined which convert the
transmission costs into transmission charges [10]. Three basic paradigms are:
 Rolled-in (embedded) transmission pricing

 Marginal transmission Pricing
 Composite transmission pricing
An alternative way of classifying transmission pricing schemes is based on when they are
calculated, i.e., ex-ante or ex-post . In the ex-ante schemes, the entities taking part into the
power market activities know the transmission prices a priori. While, in ex-post schemes,
the transmission charges are calculated only after the real time has elapsed and power flow
snap-shot is available. These schemes can further be categorized into transaction based and
non-transaction based. The transaction based schemes essentially should have a defined
source point and a sink point (bilateral transaction). On the other hand, non-transaction
based schemes refer to the power exchange (PX) trades, where it is not possible to identify
source-sink pair. Figure 7.1 shows the broad categorization of various transmission pricing
schemes.
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Figure 7.1: Classification of transmission pricing schemes
In the above figure, the transmission pricing schemes are classified on the basis of whether
they are calculated ex-ante or ex-post. Generally, the ex-ante schemes are made up of
pricing methods under rolled-in paradigm. As mentioned earlier, the total costs to be
recovered are known a-priori and then they are transformed into transmission prices. The
ex-post schemes, on the other hand, rely upon the incremental or marginal pricing
mechanism. Moreover, the incremental schemes lack the property of recovering
transmission sunk costs and hence rely upon schemes under the domain of rolled-in
paradigm to overcome this lacuna. This gives rise to the composite paradigm.
References
power/
84
LECTURE NO:-31
Rolled in transmission pricing paradigm
In this paradigm, all the costs incurred during building the infrastructure and the future
investment, operating, maintenance costs are summed up (rolled-in) together and then are
allocated to various wheeling customers on various basis. The basic philosophy behind this
paradigm of transmission pricing paradigm is shown in Figure 7.2.
Figure 7.2: Rolled-in Paradigm
Effectively, this boils down to directly or indirectly quantifying the extent of usage of the
network by each transaction. The diversity of underlying assumptions, methodologies, etc.
lead to many choices or versions of methods under this category. Some of the commonly
practiced methods are as follows:
 Postage Stamp Method (transaction / non-transaction)

 Contract Path Method (transaction based)
 Distance Based MW-Mile Method (transaction based)
 Power Flow Based MW-Mile Method (transaction based)
 Power flow tracing based on proportionate sharing principle (non-transaction)
85
 Equivalent bilateral exchange (EBE) method (non-transaction)

 Zbus based method (non-transaction)
There are some methods that allocate costs to individual bilateral transactions. These
methods are known as transaction based methods. On the other hand the rest of the methods
allocate the total costs to all the participants of the pool. These methods are called as non-
transaction based methods. All these methods will be explained one by one with an
illustrative example in the following sub-sections.
Postage Stamp Method
Postage stamp methodology is the simplest and easy to implement methodology of

transmission pricing. A postage stamp rate is a fixed charge per unit of power transmitted
within a particular zone. The rate does not take into account the distance involved in the
wheeling. There are various versions of postage stamp methodology. In some versions,
both, generators and loads are charged for transmission usage, while in others, only loads
pay for the same. Some variants charge loads for their peak value while in others, they are
charged on the basis of average loads. A simpler version of postage stamp mechanism is
explained with the help of following illustration.
Figure 7.3: Sample 5 bus system
Suppose that the rolled-in cost of a region INR1000/day and that there are bilateral
transactions as shown in Table 7.1.
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There are various ways of expressing the postage stamp rates. Normally it is given in INR/
MW/ day for Indian system. Let us assume that the loads make the whole payment towards
the transmission charges. Then, the transmission charges paid by each load will be
proportional to its MW. Hence, the transmission price paid per day by each load will be as
given in Table 7.2.
The postage stamp rates are based on average system costs and may have a variety of rate
designs based on energy charges, capacity charges, or both. Rates may include separate
charges for peak and off-peak periods, may vary by seasons and in some cases may be
different for weekdays and weekends. Some of the advantages of Postage Stamp Method are
as follows:
 The method is simple and easy to implement.

 It is transparent and is easily understood by all.
87
 There is no mathematical rigor involved.

 Recovers sunk cost of transmission system.
 Being very simple and straightforward, it is easy to get political backing for it to be
implemented.
Disadvantages of the Postage Stamp Method can be quoted as follows:
 Pancaking: In case a transaction takes place such that the power is transmitted
through multiple intermittent utilities or zones, pancaking of access charges takes
place.
 No economic signal: With regard to the principles discussed in the earlier sections,
postage stamp allocation does not create an economic signal associated with the
effect of a particular transaction.
 No extent of use of network: Postage stamp allocation does not take into
consideration the extent of use of the network by a particular transaction. The
transmission charges paid by two loads, out of which, one is very near to a
generator, while the other is miles apart, is the same. It is obvious that transmission
network use by the other load is more than the first.


References
power/
88
LECTURE NO:-32
Attributes of a perfectly competitive market, the firm’s supply

decision
A Perfect Competition market is that type of market in which the number of buyers and
sellers is very large; all are engaged in buying and selling a homogeneous product without
any artificial restrictions and possessing perfect knowledge of the market at a time.
In other words it can be said—A market is said to be perfect when all the potential buyers
and sellers are promptly aware of the prices at which the transaction take place. Under such
conditions the price of the commodity will tend to be equal everywhere
In this connection Mrs. Joan Robinson has said—”Perfect Competition prevails when the
demand for the output of each producer is perfectly elastic.” According to Bounding—”A
Perfect Competition market may be defined as a large number of buyers and sellers all
engaged in the purchase and sale of identically similar commodities, who are in close
contact with one another and who buy and sell freely among themselves.
Characteristics of Perfect Competition:
The following characteristics are essential for the existence of Perfect Competition:
1. Large Number of Buyers and Sellers: The first condition is that the number of buyers
and sellers must be so large that none of them individually is in a position to influence the
price and output of the industry as a whole. In the market the position of a purchaser or a
seller is just like a drop of water in an ocean.
2. Homogeneity of the Product: Each firm should produce and sell a homogeneous
product so that no buyer has any preference for the product of any individual seller over
others. If goods will be homogeneous then price will also be uniform everywhere.
3. Free Entry and Exit of Firms: The firm should be free to enter or leave the firm. If there
is hope of profit the firm will enter in business and if there is profitability of loss, the firm
will leave the business.
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4. Perfect Knowledge of the Market: Buyers and sellers must possess complete
knowledge about the prices at which goods are being bought and sold and of the prices at
which others are prepared to buy and sell. This will help in having uniformity in prices.
5. Perfect Mobility of the Factors of Production and Goods: There should be

perfect mobility of goods and factors between industries. Goods should be free to move to
those places where they can fetch the highest price.
6. Absence of Price Control: There should be complete openness in buying and selling
of goods. Here prices are liable to change freely in response to demand and supply
conditions.
7. Perfect Competition among Buyers and Sellers: In this purchasers and sellers
have got complete freedom for bargaining, no restrictions in charging more or demanding
less, competition feeling must be present there.
8. Absence of Transport Cost: There must be absence of transport cost. In having less
or negligible transport cost will help complete market in maintaining uniformity in price.
9. One Price of the Commodity: There is always one price of the commodity available
in the market.
10. Independent Relationship between Buyers and Sellers: There should not be
any attachment between sellers and purchasers in the market. Here, the seller should not
show prick and choose method in accepting the price of the commodity. If we will see from
the close we will find that in real life “Perfect Competition is a pure myth.”
A perfectly competitive firm has only one major decision to make—namely, what quantity
to produce. To understand why this is so, consider a different way of writing out the basic
definition of profit:
 Since a perfectly competitive firm must accept the price for its output as determined
by the product’s market demand and supply, it cannot choose the price it charges.
 This is already determined in the profit equation, and so the perfectly competitive
firm can sell any number of units at exactly the same price.
 It implies that the firm faces a perfectly elastic demand curve for its product: buyers
are willing to buy any number of units of output from the firm at the market price.
90
 When the perfectly competitive firm chooses what quantity to produce, then this
quantity—along with the prices prevailing in the market for output and inputs—will
determine the firm’s total revenue, total costs, and ultimately, level of profits.
Determining the Highest Profit by Comparing Total Revenue and Total

Cost
 A perfectly competitive firm can sell as large a quantity as it wishes, as long as it

accepts the prevailing market price.
 Total revenue is going to increase as the firm sells more, depending on the price of
the product and the number of units sold.
 If you increase the number of units sold at a given price, then total revenue will
increase. If the price of the product increases for every unit sold, then total revenue
also increases.
 A higher price would mean that total revenue would be higher for every quantity
sold. A lower price would mean that total revenue would be lower for every quantity
sold.
 What happens if the price drops low enough so that the total revenue line is
completely below the total cost curve; that is, at every level of output, total costs are
higher than total revenues? In this instance, the best the firm can do is to suffer
losses.
 But a profit-maximizing firm will prefer the quantity of output where total revenues
come closest to total costs and thus where the losses are smallest.
Comparing Marginal Revenue and Marginal Costs
 Firms often do not have the necessary data they need to draw a complete total cost
curve for all levels of production.
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The intersection of the average variable cost curve and the marginal cost curve, which
shows the price where the firm would lack enough revenue to cover its variable costs, is
called the shutdown point. If the perfectly competitive firm can charge a price above the
shutdown point, then the firm is at least covering its average variable costs. It is also making
enough revenue to cover at least a portion of fixed costs, so it should limp ahead even if it is
making losses in the short run, since at least those losses will be smaller than if the firm
shuts down immediately and incurs a loss equal to total fixed costs. However, if the firm is
receiving a price below the price at the shutdown point, then the firm is not even covering
its variable costs. In this case, staying open is making the firm’s losses larger, and it should
shut down immediately. To summarize, if:
price < minimum average variable cost, then firm shuts down.
price = minimum average variable cost, then firm stays in business.
References
power/
92
LECTURE NO:-33
Imperfect Market competition
Imperfect competition is a competitive market situation where there are many sellers, but
they are selling heterogeneous (dissimilar) goods as opposed to the perfect competitive
market scenario. As the name suggests, competitive markets that are imperfect in nature.
Imperfect competition is the real world competition. Today some of the industries and
sellers follow it to earn surplus profits. In this market scenario, the seller enjoys the luxury
of influencing the price in order to earn more profits. If a seller is selling a non identical
good in the market, then he can raise the prices and earn profits. High profits attract other
sellers to enter the market and sellers, who are incurring losses, can very easily exit the
market.
Monopolistic competition is a type of imperfect competition such that many producers sell
products that are differentiated from one another (e.g. by branding or quality) and hence are
not perfect substitutes. In monopolistic competition, a firm takes the prices charged by its
rivals as given and ignores the impact of its own prices on the prices of other firms.
In the presence of coercive government, monopolistic competition will fall into

government-granted monopoly.
Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic
competition are often used to model industries.
Examples of industries with market structures similar to monopolistic competition include

restaurants, cereal, clothing, shoes, and service industries in large cities.
The "founding father" of the theory of monopolistic competition is Edward Hastings

Chamberlin, Monopolistically competitive markets have the following characteristics:
 There are many producers and many consumers in the market, and no business has
total control over the market price.
 Consumers perceive that there are non-price differences among the competitors'
products.
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 There are few barriers to entry and exit.[4]

 Producers have a degree of control over price.
The long-run characteristics of a monopolistically competitive market are almost the same
as a perfectly competitive market. Two differences between the two are that monopolistic
competition produces heterogeneous products and that monopolistic competition involves a
great deal of non-price competition, which is based on subtle product differentiation.
A firm making profits in the short run will nonetheless only break even in the long run
because demand will decrease and average total cost will increase.
This means in the long run, a monopolistically competitive firm will make zero economic
profit. This illustrates the amount of influence the firm has over the market; because of
brand loyalty, it can raise its prices without losing all of its customers.
This means that an individual firm's demand curve is downward sloping, in contrast to
perfect competition, which has a perfectly elastic demand schedule. There are six
characteristics of monopolistic competition (MC):
 Product differentiation
 Many firms
 Freedom of Entry and Exit
 Independent decision making
 Some degree of market power
 Buyers and sellers do not have perfect information (Imperfect Information)[5][6]
Product Differentiation MC firms sell products that have real or perceived non-price
differences. However, the differences are not so great as to eliminate other goods as
substitutes. Technically, the cross price elasticity of demand between goods in such a
market is positive.
MC goods are best described as close but imperfect substitutes. The goods perform the same
basic functions but have differences in qualities such as type, style, quality, reputation,
appearance, and location that tend to distinguish them from each other. For example, the
basic function of motor vehicles is the same—to move people and objects from point to
94
point in reasonable comfort and safety. Yet there are many different types of motor vehicles
such as motor scooters, motor cycles, trucks and cars, and many variations even within these
categories.
Many firms -There are many firms in each MC product group and many firms on the side
lines prepared to enter the market.
A product group is a "collection of similar products".[8] The fact that there are "many
firms" gives each MC firm the freedom to set prices without engaging in strategic decision
making regarding the prices of other firms and each firm's actions have a negligible impact
on the market. For example, a firm could cut prices and increase sales without fear that its
actions will prompt retaliatory responses from competitors.
How many firms will an MC market structure support at market equilibrium? The answer
depends on factors such as fixed costs, economies of scale and the degree of product
differentiation. For example, the higher the fixed costs, the fewer firms the market will
support.
OLIGOPOLY
Oligopoly is a market structure with a small number of firms, none of which can keep the
others from having significant influence. The concentration ratio measures the market share
of the largest firms. A monopoly is one firm, duopoly is two firms and oligopoly is two or
more firms. There is no precise upper limit to the number of firms in an oligopoly, but the
number must be low enough that the actions of one firm significantly influence the others.
 Oligopoly is when a small number of firms collude, either explicitly or tacitly, to

restrict output and/or fix prices, in order to achieve above normal market returns.
 Economic, legal, and technological factors can contribute to the formation and
maintenance, or dissolution, of oligopolies.
 The major difficulty that oligopolies face is the prisoner's dilemma that each member
faces, which encourages each member to cheat.
 Government policy can discourage or encourage oligopolistic behavior, and firms in
mixed economies often seek government blessing for ways to limit competition.
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Monopoly
Definition: A market structure characterized by a single seller, selling a unique product in

the market. In a monopoly market, the seller faces no competition, as he is the sole seller of
goods with no close substitute.
Characteristics of a Monopoly
A monopoly can be recognized by certain characteristics that set it aside from the other
market structures:
 Profit maximizer: a monopoly maximizes profits. Due to the lack of competition a

firm can charge a set price above what would be charged in a competitive market,
thereby maximizing its revenue.
 Price maker: the monopoly decides the price of the good or product being sold. The
price is set by determining the quantity in order to demand the price desired by the
firm (maximizes revenue).
 High barriers to entry: other sellers are unable to enter the market of the
monopoly.
 Single seller: in a monopoly one seller produces all of the output for a good or
service. The entire market is served by a single firm. For practical purposes the firm
is the same as the industry.
 Price discrimination: in a monopoly the firm can change the price and quantity of
the good or service. In an elastic market the firm will sell a high quantity of the good
if the price is less. If the price is high, the firm will sell a reduced quantity in an
elastic market.
References
power/
96
LECTURE NO:-34
Effect of Market Power, Identifying Market power
“Market power is the ability of single firm or a group of competing firms in a market, to
profitably raise prices above competitive levels and restrict output below competitive levels
for a sustained period of time”.
Factors influencing Market Power
1. Number of companies in a market
For a company to hold extensive market power in the industry in which it operates, the
industry must not be heavily populated. Market power is inversely related to the number of
companies present in the market. Fewer companies mean greater market power is available
to each player.
2. Elasticity of demand
For a company to exert market power, it must be faced with an inelastic demand from its
customers. This means that regardless of the price of the product, there is a persistent need
for the product. Companies can achieve an inelastic demand curve by providing unique
products and services that create value for the customer.
3. Product differentiation
If a company can provide differentiated products and services that are able to fill a hole in
the market, it will gain market power. In industries where comparable substitute
products are readily available, companies don’t usually hold much market power.
4. Ability of companies to make above “normal profit”
In a perfectly competitive market, where buyers and sellers are both price takers, it is not
possible to make above-normal profits in the long run. If there is a scenario where
companies can make profits above the normal profit range, more companies will join the
industry seeking the same, and this will dilute the position of each player and bring down
97
the profits to normal. A company with great market power will be able to make profits
above “normal profit.”
5. Pricing power
If a company offers distinguished products and services or holds extensive market share, it
can, to some extent, dictate the pricing of its products and meet the inelastic demand from
customers. A high degree of pricing power helps a company achieve market power.
6. Perfect information
If an industry enjoys a perfect flow of information and there is no mismatch between facts
and information available to sellers, players will not achieve market power.
7. Barriers to entry or exit
If an industry has high barriers to entry, the players typically hold market power. High
barriers to entry mean the existing players are protected, because few new players can enter
to disrupt the marketplace.
8. Factor mobility
If an industry provides equal ease of access to inputs of its products or services, the market
power of individual firms will not be better off.
Market Power in Different Market Concentrations
2. Perfect competition
In a perfectly competitive market, multiple sellers sell a standardized product to multiple

buyers. There are many sellers in a homogeneous market that enjoy fluid factor availability.
Barriers to entry do not exist, and companies cannot make above “normal profits” in the
long run.
Buyers in a perfectly competitive market will enjoy perfect information regarding the
product or service. Since all products in the market are substitutes for one another, the
98
demand for products is extremely elastic. All companies are price takers and hold zero
market power.
3. Monopolistic competition
Monopolistic competition is a kind of imperfect competition wherein a smaller number of

sellers slightly differentiate their products by branding or customization in function.
Because of such traits, the products in the market are not perfect substitutes for each other,
and sellers can demand variable prices.
In the long run, however, the demand is elastic as companies can eventually modify their
products to suit the market’s needs. Barriers to entry do exist, but they may be low. Perfect
information is not available to the buyers and sellers; there is ambiguity to be exploited by a
more knowledgeable player. Sellers in a monopolistic market are price setters and hold
market power.
4. Monopoly
In a monopoly, a single company is the sole seller of a distinct type of product or service.
The products are not merely customized by a different specialized category in their sphere.
Due to the unique nature of the product, the demand remains inelastic, and the company can
exercise extensive pricing power and make profits that are above “normal profits.”
The industry is characterized by extremely high barriers to entry, as the existing company
may be protected by patents and the factor mobility does not exist. Buyers are unable to
access perfect information and, in some cases, the sole seller can exploit the market by
indulging in price discrimination. A monopolistic firm enjoys extremely high, if not
absolute, market power.
References
power/
99
LECTURE NO:-35
HHI Index, Entropy coefficient, Lerner Index
HHI Index
Typically, a firm will possess structural market power if that market is concentrated,
meaning that there are very few firms, or if one firm has a very large market share. One of
the most widely used metrics for market concentration is the Herfindahl-Hirschman Index
(HHI). The HHI is defined based on the sum of the squared market shares of all firms in the
relevant market:
In the HHI equation, Si represents the market share of the i-th firm, written as a whole
number rather than a decimal. For example, if Firm M has a 10% market share, we would
write that as SM = 10 and not as SM = 0.1.
As a simple example of how to calculate the HHI, suppose that there were two firms in the
market, one with a 60% market share and one with a 40% market share. The resulting HHI
for this market would be:
The HHI is bounded from above by 10,000 and from below by zero. This is also easy to see
- if a market has one firm (a monopolist) then the HHI would be 1002 = 10,000. If a market
had a huge number of firms, each of which had a very very small market share (much less
than 1%) then the HHI would be very, very small.
It is sometimes helpful to keep in mind what the HHI would look like for markets with
certain numbers of equally sized firms.
 A market with two equally sized firms would have an HHI of 5,000
 A market with three equally sized firms would have an HHI of 3,333
100
 A market with four equally sized firms would have an HHI of 2,500
 A market with five equally sized firms would have an HHI of 2,000
 A market with six equally sized firms would have an HHI of approximately 1,800
As a rule of thumb, markets with an HHI of 2,000 or greater are judged to be highly
concentrated. Proposed mergers that would increase the HHI much beyond 2,000 generally
get a high level of regulatory scrutiny, on the grounds that such a concentrated market
would harm competition.
While the HHI is used very commonly (and if you read the State of the Market reports from
the various IMMs, you will see the HHI used), it is of limited usefulness for electricity
markets. Let's look at the HHI for California's failed electricity market as an example. The
table below shows the market shares and their squares for the largest firms in California's
electricity market.
If we were to calculate the HHI for California's electricity market, we would get 632, as
shown in the table. This is roughly equivalent to a market with around sixteen equally sized
firms - hardly the stuff that would make competition regulators nervous. But we have
already seen that California's market was highly susceptible to manipulation. How is this
possible if the market is really that unconcentrated?
101
Entropy Coefficient
 Entropy is a measure of randomness. Much like the concept of infinity, entropy is

used to help model and represent the degree of uncertainty of a random variable.
 Entropy is used by financial analysts and market technicians to determine the
chances of a specific type of behavior by a security or market.
 Entropy has long been a source of study and debate by market analysts and traders.
It is used in quantitative analysis and can help predict the probability that a security
will move in a certain direction or according to a certain pattern.
Lerner Index
The Lerner Index is a measure of market power in an industry.
The Lerner index measures the price-cost margin - it is measured by the difference between
the output price of a firm and the marginal cost divided by the output price
Under conditions of perfect competition, output prices equal marginal costs (leading to an
electively efficient equilibrium output) while prices move increasingly above marginal cost
as market power increases and we head towards an oligopoly, duopoly or monopoly.
We can interpret the index by saying that the Lerner index lies between zero (perfect
competition) and one (strong market power)
The chart below tracks the estimated Lerner Index for the UK commercial banking industry
and suggests that the industry was becoming more concentrated in the years leading up to
the Global Financial Crisis.
Whether or not the entry of a number of challengers banks eventually causes the retail
banking sector in the UK to become significantly more competitive remains to be seen.
Most of the challenger banks are very small relative to the existing established commercial
banks. Some including Metro Bank have already run into significant financial difficulty.
102
When we calculate the assets of the three largest commercial banks as a share of total
commercial banking assets in the UK we find that the leading banks have nearly 70 per cent
of assets - a clear indication of an oligopoly.
References
power/
103

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MODERN INSTITUTE OF TECHNOLOGY AND RESEARCH CENTRE, ALWAR

Name of Faculty: Gauri Shankar Sharma

Semester: V Session: 2021-22 (Odd Sem)

Unit: VI Date of Submission: 11/11/21

Principle of Transmission Pricing, Classification of

Rolled in transmission pricing paradigm, Postage Stamp

Attributes of a perfectly competitive market, the firm’s

33 Imperfect Market competition, OLIGOPOLY, Monopoly 93-96 4

34 Effect of Market Power, Identifying Market power 97-99 3

35 HHI Index, Entropy coefficient, Lerner Index 100-103 4

Name of Faculty: Gauri Shankar Sharma

Semester: V Session: 2021-22 (Odd Sem)

Unit: VI Date of Submission: 11/11/21

29 Introduction of transmission pricing 62

Principle of Transmission Pricing, Classification of

Rolled in transmission pricing paradigm, Postage Stamp

Attributes of a perfectly competitive market, the firm’s

33 Imperfect Market competition, OLIGOPOLY, Monopoly 61

34 Effect of Market Power, Identifying Market power 48

35 HHI Index, Entropy coefficient, Lerner Index 49

UNIT-6 (PRICING OF TRANSMISSON NETWORK USAGE

INTRODUCTION OF TRANSMISSON PRICING

What is Power Wheeling?

To define formally, wheeling is the transmission of electrical energy from a buyer to a

Distance Dependency: High or Low?

Principle of Transmission Pricing

 The transmission prices should be devised so as to promote the efficiency of day-to-

There is different transmission pricing mechanisms prevailing in different parts of the

Classification of transmission pricing

 Rolled-in (embedded) transmission pricing

Figure 7.1: Classification of transmission pricing schemes

Rolled in transmission pricing paradigm

Figure 7.2: Rolled-in Paradigm

 Postage Stamp Method (transaction / non-transaction)

 Equivalent bilateral exchange (EBE) method (non-transaction)

Postage Stamp Method

Postage stamp methodology is the simplest and easy to implement methodology of

Figure 7.3: Sample 5 bus system

 The method is simple and easy to implement.

 There is no mathematical rigor involved.

Disadvantages of the Postage Stamp Method can be quoted as follows:

Attributes of a perfectly competitive market, the firm’s supply

Characteristics of Perfect Competition:

5. Perfect Mobility of the Factors of Production and Goods: There should be

Determining the Highest Profit by Comparing Total Revenue and Total

 A perfectly competitive firm can sell as large a quantity as it wishes, as long as it

Comparing Marginal Revenue and Marginal Costs

Imperfect Market competition

In the presence of coercive government, monopolistic competition will fall into

Examples of industries with market structures similar to monopolistic competition include

The "founding father" of the theory of monopolistic competition is Edward Hastings

 There are few barriers to entry and exit.[4]

 Oligopoly is when a small number of firms collude, either explicitly or tacitly, to

Definition: A market structure characterized by a single seller, selling a unique product in

 Profit maximizer: a monopoly maximizes profits. Due to the lack of competition a

1. Number of companies in a market

4. Ability of companies to make above “normal profit”

7. Barriers to entry or exit

Market Power in Different Market Concentrations

In a perfectly competitive market, multiple sellers sell a standardized product to multiple

Monopolistic competition is a kind of imperfect competition wherein a smaller number of

 Entropy is a measure of randomness. Much like the concept of infinity, entropy is

The Lerner Index is a measure of market power in an industry.