We consider the combination of a network design and graph partitioning model in a multilevel framework for determining the optimal network expansion and the optimal zonal configuration of zonal pricing electricity markets, which is an extension of the model discussed in  that does not include a network design problem. The two classical discrete optimization problems of network design and graph partitioning together with nonlinearities due to economic modeling yield extremely challenging mixed-integer nonlinear multilevel models for which we develop two problem-tailored solution techniques. The first approach relies on an equivalent bilevel formulation and a standard KKT transformation thereof including novel primal-dual bound tightening techniques, whereas the second is a tailored generalized Benders decomposition. For the latter, we strengthen the Benders cuts of  by using the structure of the newly introduced network design subproblem. We prove for both methods that they yield global optimal solutions. Afterward, we compare the approaches in a numerical study and show that the tailored Benders approach clearly outperforms the standard KKT transformation. Finally, we present a case study that illustrates the economic effects that are captured in our model.
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