Foundations of Microeconomics

A society is expected to make economic choices; from what should be produced, how much should be produced, when and how these products and services are to be produced, and for whom are these products and services produced for. The theory of supply and demand more or less answers all these questions, provided of course that there's no political intervention or other vested investor intentions that affect the whole process. Nonetheless, the theory of relativity is always true; different situations call for different actions, that is, free-market pricing may be applicable to other situations or maybe controlling the price is the solution for such situations.

In the case of California's Electric Utilities (both wholesale and retail), a lot of factors must be studied and put into consideration before giving a definite solution. In this paper, we shall study then the different factors (supply and demand, household choice, government intervention, investors' investments, etc.) that will affect and will be affected by a certain decision. Let us dissect the California dilemma and investigate what should have been done to generate a win-win situation (if possible).

On Supply & Demand and Household Choice

The supply and demand curves that depict a "Goldilocks and the Three Bears" paradigm is ideal because they are represented by "normal" slopes. Normal, meaning, the following four forces exist and are satisfied:

1. When the price of a certain product goes down, consumer demands will go up

2. When demands for a certain product is high, producers will increase their supply of such

3. The market will then shift toward a balance/equilibrium wherein consumers will purchase all the produced supplies

4. When demands exceed supplies, existing resources that were in one point accustomed with a certain level of capacity, goes beyond the limits and it will become more expensive to produce them; thus, sending prices to skyrocket all of a sudden

On the first and second stages, everything seems to be a nirvana. Upon the entry to the third stage however, things started to get too hot to handle. Supposed a price shock sends the price of a certain product sharply upward, there will be an income effect wherein the consumers will all of a sudden look and feel poor (even poorer) because they will now be required to use up a larger portion of their income to buy the same amount of products in a bigger price. Sudden price changes always influence a consumer's real income, i.e. price increase decreases real income while price decrease increases it. Another adjustment is what is known as the substitution effect, wherein a consumer responds to the sudden increase of a product in relationship to other products. Meaning, as the price of a certain product goes up a consumer tends to look for a substitute, a cheaper product which can replace the now expensive product. In the onset however, these two adjustments reinforce each other when higher prices decreasing demands and lower prices increasing demands. An exception of the rule appears however for some products that will still be in demand even if prices skyrocket (e.g. luxury cars, jewelry, etc.).

Thus, in a case wherein Governor Davis of California decides to regulate the price of a certain commodity through instigating a price cap because he thinks that the consumers are paying too much for a necessity, the demands for such commodity will go high. Consumers will then increase its level of purchasing power and then suppliers will then be forced to cater the demands of the consumer/s. At this point, the equilibrium point will shift beyond the potential output. When producers start to meet higher demands, their overall production cost will sharply increase, forcing the supply curve to shift upward. Thus, when the time comes that demands and output go down, stagflation will occur, wherein production cost will stay up and will stay that way, affecting the price of such commodity when demands starts to increase again.

The impact of the aforementioned chain of events will definitely be felt by retailers, who, are in the mercy of the wholesalers. It is quite apparent however that household/consumer choice plays a big role in this situation because it is the factor that gives the essential difference between retail and wholesale competition. If household choice is to be considered, every aspect of providing products and services to the consumers will be affected. Competition effects then will be more noticeable at the retail level.

In the wholesale electric power market, the elasticity of supply and demand is highly dependent on the price factor. The degree by which the supply changes as price changes is referred to as the price elasticity of demand while the demand's sensitivity to price is called the price elasticity of supply. Since electric power has no close substitutes, hard to replace and is seen as a necessity, it characterizes an inelastic demand. This means that an increase in its price would not have the same effect (decrease) in the demands. But over a long period of time, as the competitions grows and consumers find ways to save in power usage, the elasticity of the electricity market will increase dramatically.

Conclusion

It is but obvious that free markets carry two distinct properties - market equilibrium and economic efficiency. Competition, the market's sensitivity in the rise and drop of price, supply and demand, and consumer choices all contribute to the market's movement towards equilibrium. This movement towards equilibrium is also seen as a ticket to economic efficiency. A market is efficient when it is producing just the right quantity of products and services with the intent of satisfying consumer needs and wants at a minimum cost. These ideals could have been the ticket/solution to the economic problems of California Electric Utility.