A Monopoly of Electricity and Government Intervention to Regulate Appropriate Traits of Monopoly - Assignment Example

The Monopoly of Electricity in NSW Name Institution Course Tutor Date Introduction Consumers of different goods and services have always been faced by some forms of exploitations. The government not only come to their rescue but also controls certain factors. The market situations present different structures that may either be competitive or not competitive at all. Where there is a natural monopoly situation, there may be a case for government intervention, either in the form of price regulation (for example, average cost pricing; stipulating a profit level or rate that must be earned), or government ownership. This paper seeks to analyze the government inventions as far as electricity supply in New South Wales is concerned and to critically show that government intervention usually has good intentions, but often has unintended, side- effects. The following arguments in terms of questions and answers will comprehensively aid in the analysis of the side effects of government interventions and how to help negate the problems. Explain why a government might want to regulate a monopolist? A monopoly is regarded as any enterprise that is the only seller of a good or services in a particular market. Monopolist is the price setter and the price taker in this kind of market and is free to usually set price it chooses without the intervention of the government, thus yielding the maximum profit possible1. There has never been any effort by any government to destroy any company, corporation, or any organization for that matter, simply because they are the only sellers of a product and therefore strong. However, governments regulate industries where monopoly exists, or where the goods and services sold are of necessity to human life. In this case, regulating monopolists by government would ensure preservation of competition for quality production and price fairness, growth and freedom of entry for smaller (and infant companies), and control prices. Development of other companies in the same industry is very difficult if the market share is mainly controlled by one company. For instance, the cost of supplying and transmitting electricity has gone higher than 50 percent of the total household power cost and this figure keeps on rising. It is very difficult for other companies to get the opportunity of supplying equal amount electricity in NSW since commissions such as ELcom have become monopolies in the supplies and transmission of electricity for long2. This creates a lot of pressure of social nature when regulations are not induced upon them by the government. Lack of competition, among many other factors, leads to inflated prices or the excess price. Without the interventions of the government through their regulations, the monopolies can go to great extents of frustrating other upcoming firms so that they can maintain their abnormal levels of inflated pricing. The aftermath of such practices are the instances of allocative inefficiency and reduced level of consumer welfare. All this may also have some other serious macroeconomic effects to the economy like unemployment and inflations3. When the provision of a particular product or service is monopolized by a firm, its incentives and the drive to produce and offer good and quality services may become limited. In this case, the government regulations will ensure that there are minimum standards of service that firms must meet. This would ensure they provide quality services and products to their customers. In cases of natural monopoly, the government only comes in to regulate such firms in order to prevent them from misusing their monopolistic powers in the market. Some industries are monopolies by nature since they have high economies of scale and have only one very highly efficient firm. It is very difficult to succeed through competition in such an industry and therefore the government essentially regulates such firms4. A monopolistic firm may dictate its monopsonistic powers even to its suppliers as the only firm that purchases their goods or services and squeeze the profit margins of its suppliers. In such a situation of monopsony, the government regulations may also prevent such firms from exploiting their suppliers, for instance farmers who supply agricultural firms. Economic critics against monopoly argues that monopoly reduces aggregate welfare (society’s income) when they charge high prices for the goods and services they offer in order to reap their super abnormal profits. In this case, the government steps up to regulate this manner of manipulation of prices for the monopolists’ gain. What is cost padding? Sometimes when faced with the government regulatory standards, the monopolist make attempts to falsify costs of operations in order to increase cost of return it would receive in the end by the regulator. Cost padding therefore implies practices by the monopolist to include extra cost that is not significant in its overall cost estimation. How does cost padding affect the way governments might regulate a natural monopoly? Just as mentioned above, many monopolies cost- pad to falsify their cost estimations by the regulating body like the government. In this case, they go forward to counter the effect of the regulating control of the government and thus maintain their monopolistic power. This is one of the instances of economic inefficiencies. Cost-padding includes insignificant costs to the overall costs of production by a company thereby increasing estimations. The firm thereafter engages in reduction ways of the cost of investments before it signs any regulatory contracts with the government. This behavior of increase and reduction of costs have significant effects on the quality of the government assessment of the monopolistic power and reduces the effectiveness and certainties of the government intervention to control natural monopoly5. What is gold-plating? It is the situation whereby a company excessively invests in a project, for instance, excessive investment in electricity network. Gold plating describes the survival tendency of monopolies to increase their capital and labor ratios in the process of counter-evading the rate-of-return regulating system. Such monopolies engage in exclusively high amounts of capital accumulation so that they can increase their chances of making high volumes of profit. Not in the original scopes of operation, the monopolistic firms do gold-plate their operations by creating additional investments so that they increase their incentives of the capital-labor rate base of return. In the end they, they still maintain their high grip of the market, but makes the market highly inefficient. How does gold-platting impact on the cost effective supply of electricity? For effective supply of electricity, the government exercises its regulatory standards to protect the consumers. However, gold plating affects the efficiency of investment upon which the regulating standards are based. The overall investment of a company is considered relevant since they are considered an improvement. It may become e very difficult for the government regulating agency particularly when information on real investment in the concerned is asymmetrical. This makes it hard for the government to effectively regulate electric provisions and hence its supply. In addition, giving the Electricity commission of NSW (ELcom) the statutory authority to generate electricity and the concerned bulk transmission has created much inefficiency associated with the monopolistic power accorded to it. Despite other deregulations by the Australian state government, the Corporation still has been able to control the charging competition, provisions of numerous customer choices, and even the provisions of relatively cheaper electricity. Gold-platting has had great impacts on the cost of supplying electricity through its overvaluations of the investments in electricity supply6. This has reduced and damaged the cost effectiveness due to this inefficient monopolistic system. The government aims to step up its efforts in controlling the monopolistic power in supplying electricity through its legislative and regulative interventions. This has however been met by the effects of gold-platting. Such effects have denied the consumers of the government’s protections against such exploits to great extent. How can governments negate the adverse side-effects of gold pl-plating and cost-padding? In order to remove and avoid the side effects of gold platting, incentives foe wasteful or rather over-investment should be removed. The government should put in mechanisms to counter check with or inspect the real investments electricity network and eliminate the excessive and the wasteful investments when determining the regulations upon electricity supply. The regulator thus simply set the allowed revenue for the company and reduces the network charges, thereby reducing the effects of gold plating and the cost of electricity. In the end, the incentive to over invest in the network shall be eliminated and the effects of gold plating removed7. On the other hand, cost padding can also be negated through endogenous determination of distribution costs. The effects of falsifying costs so as to increase the overall cost of investment is a contractual based mechanism which can be easily wiped out if the regulator makes the increment of costs very expensive for the company. This is known as the direct effect of a pre contractual choice on investments. Firms may choose to lower their investment and despite the fact that low investments are still associated with cost padding, the endogenous determination of investment costs will predominantly still reduce the effects of cost falsifications8. In addition, the government may choose to remove or reduce the risk borne by the private-owned and the public-owned companies by reducing the interest rate they charge on their investments. The price of electricity reflects the cost of capital invested in distributing and transmitting electricity. This cost is increased when the rate of interest charged by the government is higher. This cost, including the padded costs is passed on to the consumers through high prices. Reduction of that interest reduces the electricity network charges and reduces the cost of electricity and in the end; the effects of cost padding will disappear. Conclusion The purpose of the government intervention into the market system is to regulate the inappropriate behavioral characteristics of monopoly. The intention is to protect the consumers the products offered. The power of monopoly in the electricity market should be minimized in order to create market efficiency by lowering the cost of exploitation by the monopolist. Therefore, state intervention is essential in restoring market equity and sanity for the partisans. Reference List Albon, Robert P. and Kirby, Michael G..1983. ‘‘Cost padding in profit-regulated firms’’, The Economic Records, vol. 59, No.1, pp.16-27. Berg, S.V. and Tschirhart.1988. 'Natural monopoly regulation: principles and practice' Cambridge University Press. Boardman, Anthony E., and Aidan R. Vining. 1989. “Ownership and Performance in Competitive Environments.” Journal of Law and Economics 32:1–34. King, Stephen. 2012. ‘‘Risks, Gold platting and over-Pricing for electricity’’, on-line resource available at: http://economics.com.au/?=9198 Kirby, Michael G., 1979. ‘‘An Economic Assessment of Australia’s Two Airline policy’’, Australian Journal of Management, Vol 4, No.2, pp.105-118. Shepherd, William G., 1982. “Causes of Increased Competition in the U.S. Economy, 1939–80.” Review of Economics and Statistics 64: 613–626. Read More