Merit Order

Price formation in a power exchange

• Single-price auction: all accepted sellers receive, and all accepted buyers pay, the same clearing price.
• Incentive: producers bid their variable cost (Plant Economics), consumers bid their max willingness to pay.
• Bids sorted cheapest → most expensive = merit order = the market supply curve (horizontal sum of MC → Supply Curve).
• Clearing price = VC of the marginal generator (the last accepted plant).
• → cheapest plants run, consumers who value power most are served → efficient ($P = MC$, Perfect Competition).

Merit order effect (renewables)

Wind/solar have VC ≈ 0 → enter at the front → all other plants shift right → demand meets a cheaper marginal plant → price falls.

Shortage

Demand > total capacity → price set by demand (willingness to pay) → Investment Cost Recovery. Demand is very price-inelastic → may need curtailment (rolling blackouts).

Links: Plant Economics, Investment Cost Recovery, W2.2 Competition in Electricity Markets