South-Western EconNews

Peak PowerPrices

Subject

Natural Monopoly

Topic

Market Failure, Regulation, And Public Choice

Key Words

Power Suppliers, Markets, Demand, Price Restrictions, Price, Competition

News Story

The Federal Energy Regulatory Commission (FERC) has determined that three wholesale electric power suppliers - American Electric Power Co. based in Columbus, Ohio, Southern Company in Atlanta, and Entergy Corp. in New Orleans - wield too much influence on electricity markets in their home regions because their power is essential to meet consumer demand peaks. As a result, they will face new price restrictions.

The rationale is to avoid the electricity price spikes that hit California in 2000. FERC wishes to make wholesale power markets more orderly, but also maintain competition. It promises to take similar action against another power generator or marketer if its electricity is "pivotal" during peak demand, such that the company "is in a position to demand a price above competitive levels".

The affected companies are studying the ruling. One is considering legal action.

(Updated January 15, 2002)

Questions

1.	Explain how peaks in electricity demand can make the three companies monopolies in their regions.
2.	Assume that the electricity generators are natural monopolies. a) What allows them to be natural monopolies? b) What are the implications for their long run average cost curves?
3.	Draw a diagram of a natural monopoly including the demand and marginal revenue curves and the long-run average and marginal cost curves. Show the free-market equilibrium price and output. a) Illustrate what happens to the equilibrium when demand peaks and price is unregulated. b) When price controls are introduced, what happens to price and output? c) If a price ceiling were set at a perfectly competitive level, what would happen to profit? d) Why might the power generators be willing to take legal action?

Source

Associated Press, "Price controls imposed on energy," St. Petersburg Times, November 22, 2001.