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liberalized electricity markets when firms behave strategically. We have derived equilib- rium investment and compared it to the benchmark cases of perfect competition (welfare maximization), monopoly (profit maximization) and the so called second best solution de- rived in the peak load pricing literature. Interestingly, under imperfect competition firms have a strong incentive to invest into low marginal cost technologies in order to influence their competitors’ spot market outputs. We have been able to establish properties under which this strategic effect is so intense that equilibrium investment in low marginal cost technologies in oligopoly is even above the welfare optimal level.

We finally have calibrated the theoretical framework to the problem of investment choice in the German electricity market. As a main result we find that investment of strategic firms in base–load technologies (producing at marginal cost below 25 /MWh, such as nuclear and lignite plants) exceeds first best investment levels. Strategic under–investment takes place exclusively in middle– and peak–load technologies (such as gas, or oil-fired plants). Our empirical results confirm that the framework established in the present article provides a new and powerful tool in order to analyze investment behavior of strategic firms in electricity markets. It allows to assess the potential for the exercise of market power in liberalized electricity markets in the long run, by taking firms investment decisions into account.

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