Question

Hong Kong Electric Joins Chorus against a Cut in Permitted Return Rate HK Electric Investments, the sole power supplier to Hong Kong Island and Lamma Island, has joined its larger rival CLP Holdings, which supplies power to 80 percent of Hong Kong's population, in opposing the Hong Kong government's proposal to cut their permitted return and bring in competition to their regional electricity supply monopolies in the long term. a. What barriers to entry exist in the electricity supply market in Hong Kong Island and Lamma Island? b. Are high power tariffs evidence of monopoly power? c. Draw a graph to illustrate the effects of introducing new competitors in the electricity supply market in Hong Kong Island and Lamma Island on the price, quantity, total surplus, and deadweight loss.

Short answer

Barriers include high capital costs and regulations. High tariffs suggest monopoly power. Adding competitors reduces prices, increases quantities, improves total surplus, and reduces deadweight loss.

Step-by-step solution

Identify the Barriers to Entry

List the main barriers to entry in the electricity supply market for Hong Kong Island and Lamma Island. Factors could include high capital costs, governmental regulations, and infrastructure control.

Assess Monopoly Power

Analyze whether high power tariffs indicate monopoly power by comparing tariffs with average costs and considering if new firms face entry barriers.

Draw a Demand and Supply Graph

Create a graph with a downward-sloping demand curve and an upward-sloping marginal cost curve. Identify the monopoly equilibrium where marginal revenue equals marginal cost.

Introduce Competitors in the Graph

Show how the introduction of new competitors shifts the supply curve to the right, lowering prices and increasing quantities.

Evaluate Surplus and Deadweight Loss

Illustrate the changes in consumer surplus, producer surplus, and deadweight loss by comparing the monopoly outcome to the competitive market outcome.

Key concepts

barriers to entry

When it comes to the electricity market in Hong Kong Island and Lamma Island, several significant barriers to entry exist. These barriers prevent new firms from easily entering the market and competing with established companies like HK Electric Investments and CLP Holdings. High capital costs are one of the most critical barriers. Setting up power plants and the necessary infrastructure requires a huge amount of investment, which is not feasible for many potential competitors. Additionally, the existing regulations play a significant role. Governmental rules and policies often create hurdles for new entrants, making the entry process complicated and expensive.
The control over the existing infrastructure by current providers further compounds the issue. Current electricity suppliers hold substantial control over the transmission and distribution networks, making it difficult for new firms to establish their own or access these facilities affordably. These barriers ensure that the current firms maintain their stronghold over the market.

monopoly power

High power tariffs in the electricity market often signify monopoly power. Monopoly power occurs when a single or a few companies dominate the market, leading to limited competition. In such situations, these firms can charge higher prices because consumers have little to no alternative.
In Hong Kong Island and Lamma Island, the high electricity tariffs charged by HK Electric Investments and CLP Holdings could be indicative of their monopoly power. Significant barriers to entry prevent other firms from entering the market and competing effectively, allowing these existing firms to maintain high prices. By comparing the tariffs to the average costs and considering the lack of competition due to entry barriers, it becomes evident that high tariffs signal monopoly power. The firms can maximize their profits at the expense of consumer choice and fair pricing.

competition impact

Introducing new competitors into the electricity supply market in Hong Kong Island and Lamma Island would have substantial effects on price, quantity, total surplus, and deadweight loss.
1. **Price:** With new competitors entering the market, the supply curve shifts to the right, indicating an increase in supply. This shift leads to a decrease in the market equilibrium price. Consumers benefit from lower electricity prices.
2. **Quantity:** The increased competition results in higher total quantities of electricity supplied to the market. This increase in supply meets the higher demand at lower prices.
3. **Total Surplus:** Total economic surplus, which includes both consumer surplus and producer surplus, sees an increase. Consumers gain more surplus because they are paying lower prices. Although producers might earn less per unit sold, the increase in the number of units sold can still keep their overall profit stable or even increase it, depending on the cost structures.
4. **Deadweight Loss:** In a monopoly, there is typically a deadweight loss, which represents the loss of economic efficiency when the equilibrium output is less than the socially optimal level. Introducing competition reduces or eliminates this deadweight loss. The market becomes more efficient, maximizing total welfare.
Overall, new competition can shift the market closer to an ideal competitive market, benefitting consumers through lower prices and higher efficiency.