Electricity markets have had their problems: price spikes, market power, overbuilding, under-investment—all caused by attempts to use spot markets with flawed demand to solve the adequate-capacity problem. Electricity "experts" are fond of saying:
1. "Competitive spot markets induce optimal capacity." (economists)
This is meant as a reply to engineers and regulators who say
2. "Electricity markets need help building optimal (adequate) capacity."
But the word "optimal," in result #1, has nothing to do with "optimal" in concern #2. Result #1 is actually true only under the strict assumption that capacity is more than adequate and provides 100% protection from supply shortfalls. Then, result #1 tells us, the spot market will build capacity not for reliability, but to the point where long- and short-run marginal costs are equal—that is economically efficient (optimal). This confusion has lasted 10 years.
When economists say "optimal" they mean economically optimal assuming there is always a market-clearing price. When engineers say "optimal" they mean the optimal level of involuntary load shedding (1-day-in-ten-years), in other words, the optimal frequency of market breakdowns—times when there is no market clearing price. The economic concept has nothing to do with the engineering concept. There is no economic theory stating that a market can optimize the amount of time during which the market will fail to clear. This idea is pure nonsense.
