The Economics of Electricity Markets

9Efficient Investment in Generation and Consumption Assets

In this chapter, we focus on the characteristics of investment in generation assets and, to an extent, in buyer-side consumption assets. In Chapter 10, we go on to ask whether or not this outcome can be achieved in a competitive market.

9.1 The Optimal Generation Investment Problem

We will start by setting out the general problem of optimal generation investment. In the following sections we will clarify aspects of this model by looking at special cases.

The problem of optimal generation investment is a problem of choosing the right amount of investment, of the right type, in the right location, at the right time. We will assume that we have a range of different generation types available at each location. The optimal generation investment problem is then a question of choosing the optimal capacity of each generation type at each location.

Importantly, this is inherently a long-term decision. The capacity of a generator is assumed to be fixed in the short-run. We therefore need a model that makes a distinction between short-run and long-run.

We will model short-run effects as follows. We have seen that the willingness of generators to produce can be represented in the cost function and the willingness of customers to consume can be represented in the demand function . In the previous chapters these were taken as fixed. ...