Rational Rationing: A Price-Control Mechanism for a Persistent Supply Shock

Reyer Gerlagh, Matti Liski, and Iivo Vehviläinen,

October 2022

We propose a simple price-control mechanism correcting for a missing short-run response of demand to prices. It effectively implements an aggregate demand response by a time-varying price cap that optimally adjusts to information on the social value of rationing. A quantification obtains this information from supply and demand bids to the Nordic power market, showing how the mechanism could be incorporated to the market-clearing routines. The mechanism does not bind in normal times but gains traction in a persistent supply shock and stops binding
again when the market has adjusted to the new normal.

Keywords: Rationing; price caps; supply shock; electricity market

JEL Classification: D45, D61, Q41, Q48