This paper studies how investment in transmission infrastructure impacts the prices and costs of electricity supply in India. Both economic theory and {it ex-ante} simulation analyses suggest that increasing electricity transmission capacity should (i) decrease price dispersion between previously separated regions and (ii) reduce the overall cost of generation by shifting production to lower-cost plants.

Researchers empirically test these hypotheses by assembling a novel data set on the daily transmission capacities between each of India’s five transmission regions. For the 5 percent of Indian electricity sold on a wholesale power market, we find that a 300 MW increase in transmission capacity leads to a 15 percent reduction in interregional prices wedges. However, for the remaining 95 percent of Indian electricity sold on bilateral contracts, researchers find that changes in transmission capacity have no detectable effect on either the quantity or the average variable cost of generation. Finally, their simulation analysis indicates that counterfactual additions of transmission capacity are unlikely to result in large reductions in average variable costs even if the market was perfectly competitive. These results suggest that absent large changes in the level of demand or the location of production capacity, the short-run economic benefits of incremental investments in transmission infrastructure are likely to be small.