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Why can’t other competitors enter the market?

The lines surrounding choice for consumers become fuzzy when they involve the utilities sector. Utilities are commonly referred to as natural monopolies, meaning consumers having choice may not be a good thing; for two reasons:
1) increasing economies of scale
2) high barriers to entry

Ausgrid can provide power at a fraction of the cost additional firms could provide, called increasing economies of scale (compare this to most firms who eventually have rising costs).

Increasing economies of scale only applies to Ausgrid. A single firm spreading its massive infrastructure costs across all of Sydney results in lower average costs than if 50 firms were to enter and each incur the same fixed costs independently.

These initial infrastructure costs are what we call a barrier to entry, and in this case they are very high.

Ausgrid is shielded from competitors entering the market because they won’t have increasing economies of scale, and will have to pay extremely high startup costs.

Ausgrid remains untouched by competitors.

Therefore, with this monopoly power, Ausgrid is regulated by the Australian Energy Regulator.

Without this regulation, Ausgrid would price goods at the profit maximisation point, a very high price; far above the cost to produce, with some consumers being driven out of the market, so it wouldn’t be a socially optimal quantity. That would create a deadweight loss.

The Result: A Regulated Monopoly

Government: “What Quantity & Price Will We Set?”

The government could split this company in half, then each half would produce half the amount, but this would be at a higher price than what one firm could achieve.

Or, the government could regulate the market, and have the firms produce at the cheapest amount possible. However, the firm would suffer losses as this is below the average cost curve. The government could potentially do this with a subsidy, so essentially pick up the losses, however paying for subsidies requires taxation, which itself generates deadweight losses.

Alternatively, the government could set the price and quantity where average cost equals price, so zero economic profit is made, but no losses are realised. This is the best regulatory outcome; whilst a deadweight loss is created, the firm isn’t producing at a loss.

This sounds good in theory, but determining a level of output and price is difficult with political pressures, time constraints, and limited information. It’s harder than just pointing at a graph!

No reference list as this is a summary of this article.