Supply-Demand Dynamics: The Economics of Electricity
Understanding how electricity markets balance supply and demand through price signals and merit order dispatch
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Section 2 of 5How Electricity Markets Work
Electricity markets operate on the fundamental principle of supply and demand, but with critical differences from other commodities. Supply must exactly match demand at every instant, and electricity cannot be easily stored at scale. This creates unique market dynamics where price signals drive both short-term balancing and long-term investment decisions.
The "merit order" determines which power plants operate when. Generators bid their costs into the market, and the cheapest sources are dispatched first. The price is set by the most expensive generator needed to meet demand. This system ensures efficient use of resources but creates volatility when supply is tight.
Time-of-Day Pricing
Demand varies dramatically throughout the day. Morning and evening peaks can be 2-3 times higher than overnight lows. Smart pricing encourages consumers to shift usage to off-peak hours, reducing the need for expensive peaking plants.
Interactive Supply-Demand Market Simulator
Select Time of Day
Supply Stack Control
Merit Order Stack
Key Insights
- • Supply sources are dispatched in order of cost (merit order)
- • The most expensive active source sets the market price
- • Supply shortages cause extreme price spikes
- • Time-of-day demand patterns create price volatility