We examine investment incentives and market power in an
experimental market. We characterize market power as the strategic
interdependence of subjects' investment decisions and output
decisions. The market is designed so that investment and output
decisions can be jointly characterized as strategies within a game.
A Nash-Cournot equilibrium of the game provides a way of
characterizing how investment incentives and market power interact.
Subjects could invest in two different production technologies and
could produce output to serve as many as two different demand
conditions. The technologies were analogous to "baseload" capacity
and "peaking" capacity in wholesale electricity markets. The
Nash-Cournot benchmark constituted a good indicator of subjects'
output decisions in that output cycled around the Cournot
benchmark. Thus, on average, consumers extracted the surplus
available to them in the equilibrium. While we do not observe
Edgeworth Cycles in prices or outputs, we do see them in the
producer surplus series. Producers dissipated some of the surplus
they could have extracted in the equilibrium by overinvesting in
peaking capacity and underinvesting in baseload capacity.
Inefficient investment diminished total system efficiency, but
producers' investments in total production capacity tracked the
Nash-Cournot benchmark. In contrast, monopoly explanations such as
collusion do not characterize the data.
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