Prices and Concentration: A U-shape? Theory and Evidence from Renewables (2407.03504v2)

Abstract: We show that when firms compete via supply functions, transferring high-cost capacity to the largest, most efficient firm--thereby diversifying its production technologies while increasing concentration--can lower prices by prompting the leader to expand output and competitors to aggressively defend market shares. However, large transfers prove anticompetitive, as sizable capacity differences discourage price undercutting. Exploiting renewable intermittencies in Colombia's electricity market, where firms are technology-diversified, we consistently find a U-shape relationship between prices and concentration. Counterfactually reallocating 30% of competitors' high-cost capacities to the leader cuts prices 10%, while larger transfers raise them, revealing how capacity and efficiency influence market power.