Description of a Sclerotic Monopoly

[Philip Copeman]

Description of a Sclerotic Monopoly with reference to ESKOM,

Municipal Distributors, IEPPs and South Africa

Philip Copeman 21 August 2016

Most students of economics learn in first year microeconomics what the effects of a pure monopoly are, namely higher prices and reduced output. For purposes of this discussion on ESKOM and South Africa, I am interested not so much in final demand but in intermediate demand. That is where customers of the output are businesses that use the electricity output as an input cost in their own businesses.

A sclerotic monopoly takes the pure monopoly analysis further and examines what happens when society encourages or allows the monopolist further powers to effect legislation that disallows competing technologies with substitute potentials from other sectors, from entering the market. There is a multiplier, choking effect on intermediary uses of the industry output that has a particularly damaging effect on aggregate output.

For the purposes of simplifying, I have drawn all supply and demand curves as straight lines. Areas and dimensions should not be taken in scale, but rather as a means of illustrating principle. Figure 1 In Figure1, three markets are examined: Competitive Market; Pure Monopoly and Sclerotic Monopoly. In the familiar Competitive Market there is a clearing process that determines a market price at the point where marginal demand equals marginal supply – Pcomp. At the price of Pcomp consumers are willing to buy a quantity Q1

In a Competitive Market there is a benefit to consumers of output, called the consumer surplus. The consumer surplus is the pink triangular area under the demand curve A- H- Pcomp. When the output is used as an intermediary good, bought buy business consumers, like electricity is used in production, consumer surplus is particularly important as it effects the cost structure of each industry that consumes electricity or any goods made with electricity. Consumers in the area would have been prepared to pay a higher price, but get the benefit of Pcomp, which is lower than what they would have been prepared to pay. Entrepreneurs thrive on using these goods and the opportunities they present. Take these opportunities away and GDP evaporates.

In a Pure Monopoly, the monopolist tries to maximize its revenue. The monopolist can only sell more product if it lowers its prices, because the demand curve for its output slopes downward. Since demand only increases with decreasing prices, the marginal revenue gained by selling one additional unit will always be less than the price of that unit because the monopolist will have to sell all of its units at the lower price. Except for the first unit, marginal revenue is always less than price. As the quantity produced increases, marginal revenue continually declines until it becomes zero, then negative. The result as shown in the middle diagram of figure 1. Under Pure Monopoly the monopolist produces until the marginal revenue equals the marginal cost. This price is always greater than the Competitive Market price. The monopolist is restricting output and ensuring a higher clearing price. The consumer pays more – Pmon and uses less - Q2. Output drops from Q1 to Q2 and prices rise from Pcomp to Pmon.

The consumer surplus is now divided up. The monopolist takes the area Pmon- D'- B'- Pcomp. The consumer gets less surplus H'- D'- Pmon. Then the area D'-A'- B' is economic waste. Business consumers that have lost because they have been excluded from the market and are unable to use the inputs at the monopolists prices and were thus forced to restrict their own output. The economic waste and the multiplier there of is the reason that most economists will recommend that societies do not allow monopolies to form, even if that monopoly is owned by the state or the citizens.

We now examine the example of the sclerotic monopoly. In a Sclerotic Monopoly, the monopolist not only has monopoly control over the output, but can also control legislation that restricts the production of substitutes. I give it the name sclerotic, because the monopolist uses legislation to intentionally choke the the production of intermediary goods, thus triggering sclerosis down all industries that use intermediaries. In the case of electricity it effects all sectors.

In the case of ESKOM, who produce fossil and nuclear generated electricity, they take a monopolistic right over the production, distribution and sale of solar electricity. This is a separate good with separate production process and a separate demand curve. Solar is much cheaper to produce, but can only cater to a market that can accept interrupted supply. Solar clears at a cheaper price. With economies of scale this should approach zero. In the case of ESKOM, in the short and medium term as a fossil fuel and nuclear producer it has an almost perfect inelastic supply function.

In the short run, ESKOM cannot change the supply of electricity. It has to take the supply and maximize the revenue. Fortunately for ESKOM at this full supply price Demand is also inelastic. Further because of power brown outs, it is better to supply less that full capacity. This causes ESKOM to supply at Q2 at a price of Pmon instead of Full Output of Q1 at a price of Pcomp. ESKOM has little need for solar in a fossil mix as it does not focus on selling to customers who accept interrupted supply. However the opportunity does exist to sell solar electricity to users at prices P3 and extend output of solar buy Q3-Q2. The sclerotic monopoly destroys F''- E''- Q3- Q2 in GDP right there.

The sclerosis is worse as it has a multiplier. Because the output of electricity is used in production, The demand for solar increases even further from H''- E'' to J''- G''. This increases the price of solar and in fact with the multiplier the area Q2-C''- G''- Q4 is lost. Ah there's is the rub! Under the Sclerotic Monopoly, ESKOM (Our company) still collects a monopoly tax of Pmon- D''- B''- Pcomp but Government (Our Government) gives up 25% tax of the lost GDP Q2- C''- G''- Q4. By freeing the solar market and placing it into a Competitive Market, ESKOM does not change its revenue downwards, so much as the Government revenue increases. (it will take a full input output analysis to calculate the exact benefit). The key understanding is that there is not a perfect substitution between solar and fossil. The interrupted supply problems exclude the majority of fossil buyers from using solar. There is also a multiplier in that solar users increasing demand on all other producers, increase further demand on solar AND fossil generated electricity.

Municipal distributors can choose whether to give up revenue or not. Supply of fossilor solar products can be charged at an absolute value (Giving up no revenue) or relative, (taking the same margin off a cheaper delivery). In making that type of decision, tax collectors rarely allow the milk of human kindness to flow. However when the multiplier effects are taken into account, even the municipalities should benefit in tax collections from the increased GDP Solar IEPPs have to date been focusing on Government sales. Given that their costs of supply are so much lower than fossil, by freeing the market and and allowing the IEPPS to refocus on the private sector, there will be a massive boom in solar production and a consequent expansion of GDP (the multiplier could be as high as three)

Introduction of an Independent Public Producers Licence would free up entrepreneurial opportunities across all sectors and create an immediate jump in GDP and employment. It would free up Government agencies to make rapid decisions on new projects. It would also allow minds immeasurably superior to ours, all around the globe to participate in the supply of free electricity in South Africa.

Hence it is the recommendation of the author that electricity supply is immediately freed of legislative sclerosis. I recommend that NERSA, ESKOM and the South Africa Government grant an Independent Public Producers Licence with immediate effect.

Philip Copeman

TurboCASH Accounting,

www.philipcopeman.com

References

Advantages of Solar

wwwcleantechnica.com http://cleantechnica.com/2016/08/17/10-solar-energy-facts-charts-ev...

Wikipedia

https://en.wikipedia.org/wiki/Monopoly

GNUGPL Public Licence

https://en.wikipedia.org/wiki/GNU_General_Public_License

Eskom Financial Statements

http://www.eskom.co.za/IR2016/Documents/Eskom_AFS_2016.pdf