Natural Monopoly and Pricing Strategies in the Spanish Electricity Market

In my particular case, I found it interesting to understand How in certain areas of the production of society, appears a phenomenon (due to The increasing returns on a scale) where the demand does not admit more than One company in the market without it being resent social welfare for the Increase in costs. Therefore a situation of natural monopoly is given.

On the scenario of our project, we see that we are an Electric company, (Company Victor SA), the structure of increasing returns to Scale allows us, to produce more, and be more productive, in addition, we will Attract more public, and the cost unit of the product will be less. Instead, in This scenario we will have to make a great initial investment, such as Infrastructure, this will be our entry barrier to the market.

We will operate in the Spanish geographic market, this Market has a natural monopoly structure because there is no more efficient Structure than the monopoly of a single company, it is the most efficient way Since if another company is incorporated it loses efficiency. It would not be Efficient if there were many energy operators and that each of them put their High-voltage towers and their wiring. Focusing on our particular case, the inverse demand linear Function of hours of electricity supplied is p = 22-0.02 = MU.

In addition, TC = 1200 + 0.4 * q. Where, 1200 refers to the Fixed costs.

The situation posed is the following, the directors of the Company do not know whether to set a price first-best or a second-best price, Which they know for sure that they want the company's goal to maximize social Welfare.

If they choose first-best, the price is equal to the Marginal cost. Optimal quantity, but with subsidy (basic services paid with Taxes)

Demand = MC will be the best production of the market, that Is, the most efficient point

P =MC Is replacing the market decision and setting a price That is equivalent to the one of Perfect Competition since it wants to maximize The social welfare.

PROBLEM: In markets where there are very important economies Of scale, the Average Cost is above the marginal (AC> MC). The sale price is Less than the average cost of producing one, therefore, what is between MC and AC will be losses

In order to cover losses, subsidies will be made through Taxes to cover the costs of companies, since a very low price has been set for The economy to be efficient.

SECOND-BEST: A price equal to the average cost is Established. It covers costs, but with loss of efficiency.

P = AC

B = 0 It has no losses and ensures continuity of the Company.

The service completely finances the costs of the company And, therefore, it should no longer be subsidized.

PROBLEM: There is less production therefore the price is Higher and the market is less efficient.

Solution, due to what has been set out above regarding the Company's objectives, the directors will choose to set a first-best price. Now we will put it into practice and we will obtain the Desired price and quantity of balance: SW= CS+PSSW=TU-TC

22-0,02q=MaU TC= 1200+0,4q---- MC=0,4

22-0,02q=0,4 ------- q=1080 P=22-(0,02*1080)=0,4€

In fact, our monopoly wants to set a Price of 0,4€ per hour.