Since the inception of ISOs, Locational Marginal Prices (LMPs) alone were not market
clearing or incentive compatible because an auction winner who offered its avoidable costs could
lose money at the LMPs. ISOs used make-whole payments to ensure that market participants did
not lose money. Make-whole payments were not public, creating transparency issues. Over time,
the ISOs employed methods to raise the price. They reduced, but did not eliminate make-whole
payments. In addition, the new ‘LMPs’ were too high to send a good marginal entry signal and
too low to send an incremental entry signal. Some ISOs introduced capacity markets to remedy
this problem. Capacity markets brought their own set of issues. The objective of the paper is to
introduce a pricing scheme that improves on current schemes and is more aligned with the theory
of markets with scale economies. It eliminates make-whole payments, increases transparency,
allocates the costs to period that caused them, sends better price signals, and lowers capacity
market prices. We introduce the average incremental cost (AIC) pricing for two-sided markets to
the multi-period model with multistep marginal cost functions, ramp and transmission constraints,
and a co-optimized reserves. AIC prices address these issues in a positive economic way. Market
rules and locational incremental energy price (LIPs) together with LMPs produce incentive
compatibility. No market participant dispatched who offers its avoidable costs loses money. LIPs
eliminate make-whole payments, making the market more transparent. Generally, LIPs and LMPs
send good entry signals and have better economic design properties. These properties are proved
theoretically, demonstrated on small examples, and demonstrated on actual ISO market problems.
With mitigated market power, the most profitable way to participate in the ISO markets is to
bid or offer true value and costs to the extent possible, as prescribed by the participation model.
AIC pricing with bid-in demand eliminates MWP, has a no-losers guarantee, sends good entry
and exit signals, and the additional elasticity of demand reduces or eliminates market power and
increases market surplus. It has endogenous (crowd-sourced) scarcity pricing, reduces curtailment
with economic dispatch, and the market is more resilient.