Monopolistic Competition in Public Utilities | Free Essay Example

Monopolistic Competition in Public Utilities

Words: 1952
Topic: Business & Economics
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Introduction

Monopolistic competition is described as an imperfect competition where a small number of producers sell differentiated products, which are not necessarily substitutes (Borenstein, Bushnell & Stoft, 2010). Werner & Kirk-Duggan (2009) provide several explanations for this imperfection. They are of the view that the imperfection is brought about by such factors as location, quality, and branding of the products or services. In a monopolistic competition scenario, a firm focuses more on the prices that rival companies are offering than on the effects of its prices on other firms’ prices. In the short- term, firms reap the benefits of a monopoly, such as the ability to utilize their market power to create more profits. However, new entrants disrupt the benefits derived from differentiation in the long- term. The disruption is brought about by increased competition in the market. In monopolistic competition, firms offer differentiated products, which “serve comparable purposes” (Bushnell, 2008: p. 34). Sellers make the consumers aware of the differences between the products, which makes it possible for them to control prices to some extent.

In the United States of America, monopolies are quite a few in number as a result of rigid government regulations (Farrell, 2012). Most of the companies, which can be described as monopolistic, are either legal or natural monopolies. Legal monopolies refer to firms whose products have been patented. In such a case, the company holds “exclusive rights of use” (Farrell, 2012: p. 33) courtesy of the invention process or production. Patents are limited because they are issued for a specified period of time, which is twenty years in most cases. Within this duration, other companies can only use the patented process or product with the direct permission of the holder. The main objective of patents is to help firms recover the costs incurred in research and development of patented technologies and products.

According to Boysen (2012), natural monopolies are significantly different from their legal counterparts. They refer to public utility companies, such as gas and electricity suppliers. Such firms invest large sums of money in the provision of services and goods. The huge investment makes it unviable to duplicate the provision of such services and products. Such companies conduct their business without competition from other firms. However, they are regulated by the government. For instance, the government prevents them from charging exorbitant fees to the public (Boysen, 2012).

Objectives of the Paper

The current paper has one major objective and one specific objective. The major objective of this paper is to analyze monopolistic competition in public utilities. The specific objective is to analyze monopolistic competition among energy companies based in California. Special focus will be given to Pacific Gas and Electric Company in California.

Literature Review

Introduction to Pacific Gas and Electric Company

Pacific Gas and Electric Company (herein referred to as PG&E) is an electricity and gas utility company, which supplies electricity and natural gas to approximately 15.5 million people in central and northern California. The core business of PG&E is the supply of energy. By the end of 2010, the company had 5.2 million accounts, which were held by its electricity customers. In addition, 4.4 million accounts were held by gas customers. PG&E operates a hydroelectric system, which provides the citizens of California with a renewable source of energy (Boysen, 2012).

Competition Models

According to Bremberger, Bremberger & Rammerstorfer (2012), the government of California has taken several initiatives since 2000 to supply people with reliable and cheap power. However, the prices of natural gas and electricity have continued to increase in spite of the deregulation measures taken by the government. The prices in California are now far much higher than those in other states in the US. In a market where a handful of companies hold power to determine sales, perfect competition is not easily attainable.

According to Bushnell (2008), there are two models that can be used to explain the competition in this industry today. The models can be applied in the case of the power utility companies in America. Bertrand and Cournot are the two models that Bushnell (2008) is talking about. According to the two models, firms engaged in competition reach equilibrium, which is the point where they optimize their profits. They work on the assumption that other firms will not change their strategies. According to the Cournot model, competing firms set targets for sales and accept the resulting market price. Going by the Bertrand model, competing firms fix prices and supply the quantity demanded by the market. In cases where the goods and services supplied are homogenous, the Cournot model of competition calls for prices that are above the competitive level. The prices set depend on on-demand elasticity. The Bertrand competition model gives rise to the competitive price that is charged in the market.

The two models have different outcomes. In most cases, the most applicable model is selected to analyze the monopolistic competition. The selection depends on market factors. For example, there are some markets in which firms set prices and produce the quantity demanded. There are also markets in which firms plan for production and then accept the resulting prices, which allow them to sell their output. In the case of electricity and natural gas, the Cournot competition model is more appropriate than the Bertrand model. The reason is that the exchange of electricity and gas clears the market, which depends on the available quantities.

Need for Regulation

PG&E Company is the largest public utility entity in California. The company filed for bankruptcy in April 2001. However, the move was taken only after the company had transferred more than 4 billion USD of its earnings to the parent company, Pacific Gas, and Electric Corporation (Bremberger et al., 2012). The energy crises in California at the time, together with the actions taken by PG&E, justify the need for increased scrutiny of public utilities in California and the US in general. The need for increased scrutiny is accentuated by the fact that utilities are moving towards market- based rates. For example, if PG&E retained the earnings mentioned earlier before filing for bankruptcy, the company would have remained stable for a long period of time. It is possible that the prolonged duration would have helped the company weather the crisis. In such a case, the government in California would not have resorted to importing energy.

For a long time, three utility companies have accounted for more than three-quarters of the sales of electricity in California. The three companies are PG&E, San Diego Gas & Electric (herein referred to as SDG&E), and Southern California Edison (herein referred to as SCE) (Farrell, 2012). Historically, competition in the country’s energy sector is regulated by the California Public Utilities Commission (herein referred to as CPUC). The commission collaborates with other local, state, and federal agencies to regulate the competition. With the deregulation of the trucking, telephone, and airline industries, it was assumed that power monopolies would also be deregulated (Farrell, 2012). The energy crisis that was experienced in 2000 led to the deregulation of public utilities in the power industry. However, no additional power plants were commissioned as envisaged. Consequently, the reduced funding of utilities ate into the power surplus.

Less than one year after deregulation, the cost of power increased tremendously. The increase was attributed to deliberate hoarding practices perpetrated by the companies. Such unethical practices discouraged potential investors. In addition to this, competition in the retail sector failed to take off. The failure was attributed to the fact that only less than 2 percent of consumers were able and willing to switch to new providers. Under normal circumstances, competition leads to a reduction in prices of goods and services. However, this is not always the case. It is noted that the case is different when basic commodities, such as gas and electricity, are exchanged in the open market. As such, utilities should be regulated by the government to protect consumers (Werner & Kirk-Duggan, 2009).

Analysis

In this section, the author will analyze the various aspects of the monopolistic competition evidenced in the country’s utilities industry. Market analysis and “five force” analysis are some of the highlights in this section.

Market Analysis

The power industry in the United States of America recorded unprecedented positive growth starting in 2004. However, the growth declined sharply in 2009. It only picked up in 2010. The industry’s total revenue is currently estimated to stand at 257 billion USD. It represents a Compound Annual Rate of Change (CARC) of -2.9 percent for the period spanning between 2006 and 2010. The Asian-Pacific and European industries recorded CARCs of 16 and 2.7 percent respectively during the same period. A comparison between the two regions reveals that American power utilities are lagging behind.

Between 2006 and 2010, the volume of consumption in the industry increased by 2.7%. The volume is expected to rise up to 2015. In general, it is expected that the industry will improve at a rate of 1.5 percent CARC in 2015. To this end, the US industry is expected to lag behind the Asian-Pacific and European power utility industries, which will experience a 10.8 and 3.2 percent growth, respectively (Boysen, 2012).

Five Force Analysis

Buyers’ Power

The power of buyers in America’s utility industry varies from one state to the other (Borenstein et al., 2010). Some states operate in liberalized markets, while others operate in markets controlled by monopolies. In states that are less liberalized, the buyers (both individual and institutional end-users) have little bargaining power because switching to other providers is quite expensive. According to Bremberger et al. (2012), the number of customers is another factor determining the bargaining power of buyers. For example, large companies are able to nullify contracts with gas retailers if they are not comfortable with the price.

Suppliers’ Power

In monopolistic markets, the power of suppliers is quite high. The situation is attributed to the fact that retailers set their prices depending on the prices set by the suppliers and the availability of gas. Nonetheless, because gas is an undifferentiated commodity, the retailers determine which supplier to purchase from depending on price (Boysen, 2012).

Threat from New Entrants

The threat from new entrants is very low. It can be attributed to the fact that the initial outlay needed to get into the power utility industry is quite high. However, for retail companies in the gas utility industry, there is always the constant threat of new entrants from other countries. Once they manage to establish themselves in the liberalized ends of the market, such foreign companies expand into the rest of the country (Farrell, 2012).

Threat from Substitutes

The threat from substitutes is low. It is low because other sources of power, such as solar and wind, are more expensive compared to electricity and gas. Additionally, the cost of switching from fossil fuel to non-fossil fuel is very high (Boysen, 2012).

Competitive Rivalry

Competitive rivalry varies from one state to the other. For instance, the markets in California and New York are liberalized, meaning that the end-users determine their gas suppliers. However, in such states as Texas, the market is protected. In such a case, local monopolies enjoy a large share of the market (Boysen, 2012).

Conclusion

In conclusion, it is noted that monopolistic competition characterizes the power utility industry in America. Market imperfections are caused by differences in the quality, location, and branding of products and services. The government regulates the activities of electricity and gas suppliers to avert the exploitation of customers. The growth of the power utilities’ industry in Asian-Pacific and European nations is far much higher than that of the industry in the US. The competition in the different American states is determined by market liberalization.

References

Borenstein, S., Bushnell, J., & Stoft, S. (2010). The competitive effects of transmission capacity in a deregulated electricity industry. RAND Journal of Economics, 31(2), 294-325.

Bremberger, C., Bremberger, F., & Rammerstorfer, M. (2012). The impact of different unbundling scenarios on wholesale prices in energy markets. Energy Journal, 33(3), 183-214.

Bushnell, J. (2008). A mixed complementarity model of hydrothermal electricity competition in the Western United States. Operations Research, 51(1), 80-82.

Farrell, K. H. (2012). Key policies and market structure. United States Power Report, 12(1), 54-68.

Boysen, Y. H. (2012). United States and the power industry. United States Power Report, 2(3), 1-91.

Werner, R., & Kirk-Duggan, M. (2009). Regulation of monopolistic methods. Journal of Marketing, 54(3), 92-95.