EXCERPT FROM THE INTRODUCTION:
In most markets, the price of a good serves to ensure equilibrium between supply and demand, while efficiently allocating goods among purchasers. If demand increases when supply does not, prices rise and purchasers respond: Those who value the good most highly continue to buy it, while those who value it less do not. Price increases also send an important signal to create additional supply. FERC has repeatedly recognized the critical importance of efficient price signals in competitive markets.
Few observers of electricity markets, however, would dispute that those markets often feature a disconnect that prevents price signals from operating effectively. Wholesale prices for electricity in competitive organized markets reflect the minute-to-minute fluctuations in demand and supply. By requiring the use of “locational marginal pricing” or “LMP” in wholesale markets, FERC has tried to ensure that wholesale market participants see—and respond to— appropriate price signals.
But the retail rates paid by consumers are often fixed in advance and do not fluctuate during peak periods. As a result, real-time price signals are not trans- mitted to electricity consumers. Even when the market price (and the cost) of generating an additional megawatt of electricity during a peak-usage period is relatively high, retail customers (who typically have unlimited access to supply at a fixed rate) do not curtail demand in response to the price signal.