The power of a Monopoly in the Energy Industry

Objective: The goal of this activity is for IB Economics students to gain an in-depth understanding of the monopoly market structure. Through the Island Energy Co. case study, students will explore the characteristics and implications of a market dominated by a single seller.

Case Study: Consider Island Energy Co., the sole provider of electricity on Isla Verde, a remote island. As a monopolist, Island Energy Co. has exclusive control over the electricity market due to high barriers to entry, including significant infrastructure costs and government regulations.

In the short run, Island Energy Co. capitalizes on its monopoly power by setting prices above the marginal cost, leading to high profits. The absence of competition allows it to be a price-maker, significantly influencing both the market price and output level of electricity.

However, in the long run, the situation is subject to change. The government, concerned about the monopolist’s power and potential exploitation of consumers, may introduce regulations. These could include price caps or mandates to increase production, influencing Island Energy Co.’s profitability and operational strategies.

Questions for Students

  1. Short-Run Market Power: Draw and explain a diagram showing Island Energy Co.’s market position in the short run as a monopolist. Indicate how it determines its price and output levels and the resulting supernormal profits.
  2. Long-Run Adjustments: Discuss potential long-run adjustments in the monopoly market. How might government intervention impact Island Energy Co.’s monopoly power and profitability?
  3. Price Elasticity of Demand: Analyze the price elasticity of demand in a monopoly and how it affects a monopolist’s pricing strategy, using Island Energy Co. as an example.
  4. Monopoly vs Perfect Competition: Contrast the efficiency and welfare outcomes in a monopoly like Island Energy Co. with those in a perfectly competitive market. Discuss the implications for consumers and society.
  5. Regulatory Policies: Evaluate the potential effects of different regulatory policies on a monopoly, considering both economic efficiency and consumer welfare. Propose a regulatory strategy for Island Energy Co.