Question

Energy Economics

Question (1):

ANDE, an integrated public electricity monopoly in Paraguay, can produce electricity at constant average and MC = 5.[1] The firm faces a market demand curve given by: Q=53-P

a. Calculate the profit-maximizing price-quantity combination for ANDE

b. Calculate the monopolist’s profits

c. What output level would be produced by this industry under perfect competition?

d. Calculate the CS obtained by consumers in case (B). Show that this exceeds the sum of the monopolist’s profits and the consumer surplus received in case (A).           

e. What is the value of the “deadweight loss” from monopolization?

[1] ANDE controls Paraguay’s entire electricity market, including generation, transmission and distribution. ANDE is responsible for Paraguay’s share of Itaipú and Yacyretá bi-national hydroelectric facilities.

Answer 1

Demand function: Q = 53-P

AC = MC = 5

A)

Total Revenue(TR) = P*Q = P*(53-P) = 53P - P²

Marginal Revenue (MR) =

MC = 5

At equilibrium, Monopolist equates MR with MC.

53-2P = 5

P = 24

Put P = 24 in the demand function we have,

Q = 53-24

Q = 29

B) Profits = TR - TC

TR = P*Q = 24*29 = 696

TC = AC*Q = 5*29 = 145

Profit = 696-145 = 551

C)

Under perfect competition the firm sets price equal to Marginal cost. Hence P = MC

Thus we have P = 5

Put P=5 in the demand function we have:

Q = 53-5

Q = 48

D)

Consumer surplus is the area above the price line and below the demand curve.

CS in case of perfect competition equals the area ACF

Area of ACF = 1/2*(53-5)*(48-0) = 1152

Now,

the monopolist profit as we calculated equals 551. Alternatively, it can be calculated as the area of rectangle BCED. Area of BCED = (24-5)*(29*0) = 551

CS in case of monopoly equals the area of ABD. Area of triangle ABD equals = 1/2*(53-24)*(29-0) = 420.5

Sum of monopolist profit and CS = 551+420.5 = 971.5

Thus CS in case of perfect competition exceeds the sum of the monopolist’s profits and the consumer surplus.

E)

Deadweight loss is the area is inefficiency created by monopoly. It equals the area DEF.

Area of DEF = 1/2*(48-29)*(24-5) = 180.5

Alternatively, it can be calculated as the difference between the CS in case of perfect competition exceeds the sum of the monopolist’s profits and the consumer surplus.

Thus,

1152 - 971.5

= 180.5

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