Question

In 2011, New Orleans, Louisiana experienced an aggressive recession as compared to the rest of country. With unemployment rates topping 15%, the city was faced with many challenges financially, economically, and socially.

In addition to the financial challenges, the city was also experiencing political instability and corruption. Various major city officials were being investigated for fraud, bribery, and other criminal charges.

Spark Electric, operating as a natural monopoly, was the only company in the area providing electric services to New Orleans households. Like many other companies, it was experiencing financial difficulties and could no longer continue without some intervention. This was mainly due to high operating costs, foreclosures in the area, and the fact that many households were not paying their bills.

As a result, Spark Electric came to a standstill in the latter part of 2011. Frank Goldberg, Spark Electric CEO, gathered the Board of Directors and determined that the company would need to take some sort of action in order to remain in business.

CEO Goldberg outlined four proposals and urged each board member to vote accordingly, providing justification for their chosen proposal.

The following are the four proposals made by CEO Goldberg:

Proposal 1	Ask the government for a bailout of $30 million in order to allow Spark Electric to continue operation. Payback will be at 15% within 5 years.
Proposal 2	Allow two outside electric companies to join the industry and supply electric to the people of New Orleans. These companies would be competing against one another, and households would have a choice as to which electric company they would purchase services from.
Proposal 3	Increase electric rates in the short term for all users. Once the economy rebounds, electric rates will return to normal.
Proposal 4	Create private “virtual” accounts managed by Spark Electric for all households. These accounts would allow households who fall behind on their payments to “credit” their account with a 2% fee after 6 months of not making payments.

1.      Choose which of the four proposals you would consider to be the most efficient and best choice for the people of New Orleans. Explain why you believe this would be the best proposal and why the other proposals would not be as effective.

2.      Is competition needed in this situation? How does competition alter the dynamics of the city? How does competition alter the dynamics of the household?

3.      Taking into account that Spark Electric is operating as a natural monopoly, what should be its goal? How should it determine its price?

4.      How should you forecast the outcome for Spark Electric?

5.      What are the different types of risk involved in your proposal choice?

6.      What types of costs should be considered for your proposal?

7.      Did a principle agent problem occur in this situation? How can it be avoided moving forward?

Answer 1

Answer 1.     

       According to me, what I fill is that proposal 2 is beneficial to the New Orleans household. Because if competition increases they start competing among them and rates of electricity supply will be decreased. In other proposals the Spark Electric will enjoy the natural monopoly and may be exploit the household

Answer 2.        

    Yes, competition is needed in this situation. It can change or alters the dynamics of the city. If competition increases the new firms will enter into the market and starts operating, it will provide competition to the existing firms as well as employment to local household. It also changes the dynamics of the households, and now they are having employment as well as more choices for electricity provider.

Answer 3.       

     If we consider that Spark Electric is enjoying the natural monopoly, then them having the goal of only profit maximization, whatever is situation unemployment or challenges of financial, political or social instability. They were fixing the prices on the basis of marginal cost equals to marginal revenue conditions.

Answer 4.       

     Condition 1. (Based on 2­­^nd on second paragraph) If firm is in the trouble of finance then intervention will be happened by government. And government start selling the own electric supply or may give chance to the other firms to enter in this market.

Condition 2. (Based on answer 3) Because of prices are fixed on the basis of marginal cost and marginal revenue the output of the Spark Electric is optimum, costs are less and profit is maximized.

Answer 5.        

    Yes, there is risk involved as I chosen the proposal 2. Suppose there are 2 new firms entering into market, first they compete against among them, after some time they have mutual understanding regarding the competition and if they form a cartel or create artificial monopoly, then households of New Orleans can be exploited. So the proposal is good if they compete, but, if they make collusive oligopoly and form a cartel then there is uncertainty.

Answer 6.     

       Here is the biggest cost is uncertainty about the proposal 2 is that if they form cartel or work in like artificial monopoly, it will be harmful to the household of New Orleans.

Answer 7.     

       In this problem there is no issue arises regarding principal agent problem. This model purely advocates the market structures like Monopoly, Oligopoly, Perfect Competition and etc.