The article traces the development of “spot pricing” for electrical power, which has provided the technique for calculating electricity prices in wholesale markets in most of the United States, and is rapidly becoming the standard in many other countries. The model was first formalized by a group of engineers and economists associated with the engineering professor Fred Schweppe, at MIT. From his position as a leading control theorist, well known in the industry, Schweppe proposed an expansion of control theory that he argued would help break the deadlock in regulatory politics and benefit producers and consumers of power alike. He introduced the approach, which he called “homeostatic control,” around 1978 in a seminar of the MIT Energy Lab. Derived by way of a biological metaphor, homeostatic control conceives of a self-correcting system that maintains its equilibrium state in the face of a changing environment. Schweppe’s group envisioned bringing consumers of power into the control system by constantly feeding them signals in the form of prices. The MIT team discovered through the contact between economists and engineers that the calculation for determining efficient prices is identical to the calculation used by engineers for meeting system load while minimizing costs. The Lagrange multipliers, or lambdas, derived from the engineering optimization are the best estimates of the marginal cost, and therefore the efficient prices, at each node of the system.

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