Suppose you are a merchant transmission line operator with a DC power line linking point A to point B. Some potential customers prefer to buy transmission capability the day before the power flow, while others would like to buy monthly, annual, or even multi-year contracts. While some customers want 24-hour delivery, others seek “peak hour” (6 AM to 10 PM) or “off peak” contracts (10 PM to 6 AM). The economic value of transmission capability depends on the difference in the price of power at points A and B. While this difference is not completely unpredictable, it does vary a great deal over the course of a day and from season to season.
The transmission line operator’s problem is to determine how it will divide up its transmission capability to sell to customers: how much to long term contracts and how much to shorter duration contracts, how much to 24-hour contracts and how much to peak or off-peak packages, and so on.
Perhaps the market design for the job is a “product mix auction.” Paul Klemperer describes it as:
My design is straightforward in concept – each bidder can make one or more bids, and each bid contains a set of mutually exclusive offers. Each offer specifies a price (or, in the Bank of England’s auction, an interest rate) for a quantity of a specific “variety”. The auctioneer looks at all the bids and then selects a price for each “variety”. From each set of offers in each bid, the auctioneer accepts the one that gives the bidder the greatest surplus evaluated at the selected prices or no offer if all the offers would give the bidder negative surplus. All accepted offers for a variety pay the same (uniform) price for that variety.
The idea is that the menu of mutually exclusive bids allows each bidder to approximate a demand function, so bidders can, in effect, decide how much of each variety to buy after seeing the prices chosen. Meanwhile the auctioneer can look at demand before choosing the prices. (Allowing the auctioneer to choose the prices ex post creates no problem here because it allocates to each bidder precisely what that bidder would have chosen given those prices in the environments for which the auction is proposed.) Importantly, offers for each variety provide a competitive discipline on the offers for the other varieties, because they are all being auctioned simultaneously….
The product-mix auction yields better “matching” between suppliers and demanders, reduced market power, greater volume and liquidity, and therefore also improved efficiency, revenue, and quality of information than feasible alternatives. Its potential applications therefore extend well beyond the financial context.
For more information see Klemperer, Paul (2009). “The Product-Mix Auction: A New Auction Design for Differentiated Goods”.