Production underlies trade. While trade is a relatively simple process, production is more complex, subject to technical and/or regulatory constraints. What happens if a producer is able to take advantage of the complexity of the production process to fix trade?
This (very) large question is (very) partially answered in this numerical simulation of strategic trade between Québec and New York power systems. We model a two-stage game, solved recursively to obtain a subgame perfect Nash equilibrium. In the second stage, production is optimized to maximize local welfare, subject to various constraints such as production capacity or water availability. In the first stage, traders, who also own the productions assets, set the power flowing between the two regions to maximize their profit. We find that trade may be highly inefficient in this configuration, and may even destroy wealth in the limit.
The obtained game is solved as an equilibrium problem with complementary constraints (EPCC), a game where each player solves a mathematical problem with complementary constraints (MPCC). Given this complexity, we content ourselves with local Nash equilibria solutions.
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