Modern economic theory provides a succinct description of the conditions under which the price system produces optimal outcomes in an idealized "laissez-faire" economy of perfectly competitive markets. This is the "First Welfare Theorem"; any competitive equilibrium is "Pareto optimal" (i.e., no agent in the economy can have his or her well-being increased except at the expense of another agent). Against this benchmark, the theory describes conditions under which policy interventions can, in principle, improve upon the performance of the unregulated market system. The possibility of such improvement arises from the existence of market "failures" or "imperfections," which are factors in or features of particular markets that cause private decision-making to produce less-than-optimal economic outcomes.

Historically, the key imperfection in energy markets was thought to be "economies of scale," or "declining average costs," in electric power generation. This means simply that this was the kind of...