Module 10 — A New Approach to Market Design
Lesson 5 of 10
Distributed and Hierarchical Pricing
Learning objectives
By the end of this lesson you should be able to:
- Understand what is meant by distributed pricing.
- Explain the concept of hierarchical pricing within electricity networks.
- Recognise how local conditions can influence the value of electricity.
- Appreciate how prices can act as distributed coordination signals.
- Understand why distributed pricing naturally complements stateful, continuously clearing markets.
Introduction
In many electricity markets, prices are determined through a central market-clearing process.
Participants submit bids.
The market determines allocations.
Prices are then calculated from the resulting market outcome.
An alternative perspective is to view prices not simply as the outcome of a market, but as signals that coordinate behaviour throughout the electricity system.
Rather than having a single price determined at one location, prices can emerge throughout the network wherever resources become scarce.
This idea forms the basis of distributed and hierarchical pricing.
Prices as coordination signals
Prices perform an important function in markets.
They communicate information.
A high price indicates that a resource is relatively scarce.
A low price indicates that it is relatively abundant.
Participants respond to these signals by adjusting production, consumption or investment.
From this perspective, prices are not simply financial quantities—they are coordination signals that help allocate limited resources.
Why location matters
Electricity is delivered through a network.
Conditions are rarely identical everywhere.
At any moment, different parts of the network may experience different:
- levels of demand,
- generation availability,
- network loading,
- operating constraints,
- available flexibility.
As a result, the value of supplying or consuming an additional unit of electricity may differ between locations.
Distributed pricing allows these differences to be reflected in the coordination signal.
A hierarchy of networks
Electricity systems are naturally hierarchical.
Individual devices connect to local distribution networks.
Distribution networks connect to higher-voltage distribution systems.
These connect to regional transmission networks, which together form the national electricity system.
Each level of the network has its own operating constraints and available resources.
Distributed pricing recognises this hierarchical structure by allowing prices to emerge wherever coordination is required.
Local and system-wide conditions
Some changes affect the entire electricity system.
For example:
- widespread increases in demand,
- reductions in renewable generation,
- changes in fuel availability.
Other changes are local.
Examples include:
- a heavily loaded distribution feeder,
- a constrained transformer,
- abundant rooftop solar generation,
- local battery storage.
A distributed pricing framework allows both local and system-wide conditions to influence allocation decisions.
Prices emerge from scarcity
Within a stateful allocation mechanism, prices are updated as the state of the system evolves.
As available resources become more constrained, the corresponding coordination signal changes.
Conversely, where resources become more abundant, the signal reflects this increased availability.
Rather than being fixed until the next market interval, prices evolve alongside the condition of the electricity system.
Coordination across the hierarchy
Different levels of the electricity network influence one another.
A constraint on a local feeder may affect a neighbourhood without affecting the wider transmission system.
Conversely, a shortage of generation at the national level may influence prices across the entire network.
Hierarchical pricing allows these different levels of coordination to coexist.
Local conditions influence local decisions, while wider system conditions continue to influence the overall allocation process.
Supporting decentralised decision-making
One advantage of distributed pricing is that it supports decentralised decision-making.
Individual participants do not need to understand the complete state of the electricity system.
Instead, they respond to the coordination signals relevant to their own location and operating conditions.
This allows many independent decisions to contribute towards the overall coordination of the network.
Building on previous lessons
Distributed pricing builds directly upon the ideas introduced earlier in this module.
The market:
- maintains a continuously updated system state,
- evaluates requests whenever they arrive,
- ensures every allocation remains physically feasible.
Prices then emerge from this evolving state and provide the information needed to coordinate future decisions.
In this way, allocation and pricing evolve together.
A systems perspective
From a systems engineering perspective, prices can be viewed as feedback signals.
As conditions within the electricity system change, the pricing signals also change.
Participants respond to these updated signals, altering future demand and supply.
Those responses change the system state once again.
The market therefore operates as a closed feedback loop in which prices continuously communicate the changing availability of resources throughout the network.
A key insight
Distributed and hierarchical pricing treats prices as coordination signals that emerge from the evolving condition of the electricity system.
Rather than relying on a single centrally determined price, coordination signals can develop throughout the network wherever changing resource availability requires them.
Key takeaways
- Prices communicate information about the availability of resources.
- Electricity networks experience different conditions at different locations.
- Distributed pricing allows coordination signals to reflect local as well as system-wide conditions.
- Hierarchical pricing mirrors the physical structure of electricity networks.
- Prices evolve alongside the continuously updated state of the electricity system.
- Distributed pricing supports decentralised decision-making while maintaining overall system coordination.
Looking ahead
Distributed pricing allows the market to communicate changing system conditions throughout the network.
The next lesson introduces fairness memory, exploring how the market can also remember previous allocations so that fairness is considered not only at a single moment in time, but across the ongoing operation of the electricity system.