758 section 14 Market Failure and the Role of Government
profits are avoided, and overall welfare increases. Unfortunately, things are rarely that
easy in practice. The main problem is that regulators don’t always have the information
required to set the price exactly at the level at which the demand curve crosses the aver-
age total cost curve. Sometimes they set it too low, creating shortages; at other times
they set it too high, increasing inefficiency. Also, regulated monopolies, like publicly
owned firms, tend to exaggerate their costs to regulators and to provide inferior quality
to consumers.The Regulated Price of Power
Power doesn’t come cheap, and we’re not just
talking about the nearly $2 billion spent on con-
gressional races in 2010. By 2017, Georgia
Power plans to add two 1,100-megawatt nu-
clear reactors to its Vogtle Electric Generating
Plant in eastern Georgia at an estimated cost
of $14 billion. In Kentucky, Louisville Gas and
Electric will spend $1.2 billion to add a 750-
megawatt coal-fired generating unit. With high
start-up costs like these, power plants are natu-
ral monopolies. If many plants competed for
customers in the same region, none would sell
enough energy to warrant the cost of each
plant. Here we see the spreading effect from
Module 55 in action—having just one plant al-
lows the production level to be relatively high
and the average fixed cost to be tolerably low.
On October 6, 2010, U.S. Interior Secretary
Ken Salazar and representatives from CapeWind Associates signed the lease for a wind
farm off the coast of Massachusetts. The $2.5
billion project will generate 468 megawatts
of electricity. With lower output and higher
start-up costs than the coal-fired power plant,
the spreading effect is smaller, making the
average fixed cost and the average total cost
relatively high. If regulators set prices for this
natural monopoly in accordance with average
total cost, we would expect coal-fired plants
to be held to a lower price per kilowatt-hour
(kWh) than the relatively expensive wind
power plants. Indeed, Cape Wind plans to
charge 19 cents per kWh, more than twice
the 8 cents per kWh allowed for electricity
from coal-fired plants in Kentucky and
Massachusetts.
Why the interest in generating energy from
wind when energy from coal is cheaper for thefyi
consumer? The dynamics of supply and de-
mand provide one reason: as supplies of coal
decrease and energy demand increases, the
equilibrium price for coal energy will rise,
helping investments in wind energy to pay off.
Another reason relates to the external costs
discussed in Module 75: wind turbines create
no emissions. The U.S. Department of Energy
reports that if 20 percent of the nation’s en-
ergy needs were satisfied with wind, carbon
dioxide emissions would fall by 825 million
metric tons annually. Like coal-fired power
plants, wind farms do create some negative
externalities. The potential for noise and ob-
structed views elicit cries of “not in my back
yard (or even five miles off my coast)!” As
with lunches, there’s no such thing as a free
kWh, which highlights the importance of
cost-benefit analysis.Module 77 AP Review
Check Your Understanding
- Would each of the following business practices be legal under
antitrust law? Explain.
a. You have a patent for a superior fax machine and therefore
are the only person able to sell that type of fax machine. In
order to buy your fax machine, you require the purchaser to
buy a service contract from you (even though other firms
provide excellent service for your machine).
b. You have invented a new type of correction fluid that does
an amazing job covering up mistakes made on paper forms.
In order to buy your correction fluid, you require purchasers
to buy all of their office supplies from you.
c. You own a car dealership and plan to buy the dealership
across the street and merge the two companies. There are
several other car dealerships in town.
d. You and your only other competitor in the state have an
agreement that, any time a new firm tries to enter the
market, you will drop your prices for long enough to run the
new entrant out of business before returning to your
previous prices.Solutions appear at the back of the book.