Designing Second-Best Price Zones in Electricity Markets
Jonas Boeschemeier and Sebastian Schwenen
March 2026
In electricity markets, marginal costs vary substantially across space and time, implying welfare losses under spatially or temporally uniform pricing. In practice, prices are typically aggregated into large zones with spatially uniform prices. This paper develops an empirical framework to quantify the welfare loss of zonal pricing and to design welfare-improving price zones. We propose the spatial R2 as a measure of spatial market efficiency and show that economically motivated clustering methods recover efficiency-maximizing zones. Applying the framework to three U.S. wholesale electricity markets, we demonstrate its computational tractability and find that existing zones are misaligned with current network conditions.
JEL-Classification: D40, L11, Q41, Q48
Keywords: imperfect pricing, spatial pricing, electricity, networks
