Analysis of short-run and long-run marginal costs of electricity generation in the power market

This paper examines the roles of long-run and short-run marginal costs (LRMC and SRMC) in shaping electricity prices and ensuring investment cost recovery, particularly when generation capacity is used across multiple long-term periods. Using a stylized capacity expansion model with two generators and two periods, we developed a five-step methodology to characterize all possible LRMC pricing profiles and prove cost recovery under each case. We showed how shared capacity affects intertemporal cost allocation, revealing that even when cheaper technologies are marginal, more expensive shared capacity can still recover its cost through distribution across periods. On the SRMC side, we identified a form of degeneracy caused by fixed invested capacities, leading to multiple valid marginal prices. To resolve price degeneracy, we add a small demand elasticity centered on the LRMC reference point. This yields a unique SRMC price that coincides with LRMC and guarantees cost recovery under energy-only pricing. Extensions to the model, such as increasing temporal resolution, adding storage, or including more generators, demonstrated the robustness of our findings.