Project Report on MonopolyWith Respect to WAPDA

BY

ZUBAIR AHMADSYED IRFAN ULLAH SHAH

ROLL NO. 2905ROLL NO. 2907

SUBMITTED TOSir. IMRAN KHALIL

MBA (General)

SECOND SEMESTER (EVENING)

DEPARTMENT OF MANAGERIAL SCIENCESCITY UNIVERSITY OF PESHAWAR

PESHAWAR, PAKISTANSession 2008-2009

Table of Content

1. Acknowledgment ………….………………………………………………. 03

2. Executive Summary ………………………………………...……………. 04

3. Introduction......................................................................... 05

3.1 Market Structure......................................................... 05

3.2 Market Power ............................................................. 06

3.3 Monopoly..................................................................... 06

3.4 Barriers of Monopoly ………………………………. 07

3.5 Price and Marginal Revenue…………………… 08

3.6 Price Setting……………………………………… 09

4. Problem Statement ……………………........................................... 10

5. Methodology…………………………………………………………………. 11

5.1 Price discrimination…………………………………..

6. Conclusion …………………………………………………………………… 17

7. References ……………………….…………………………………………… 18

Acknowledgment

I would like to thanks my cousin Mr. Nasir Shakoor for his enormous help in typing

the manuscript.

The work of a large number of Authors has contributed to the body of knowledge in

this script and it would be impossible to thank them individually or to provide detailed

references to their work in a concise Project. The list at the end incorporates

references and my thanks to them all.

I would also like to thank our teacher Mr. Sir Imran Khalil, for his tremendous

support and his thorough teaching that helped in the characterizing and compilation of

this report.

.

Executive Summary

Monopoly is a well defined market structure where there is only one seller who controls the entire market supply, as there are no close substitutes for his product and there are number of barriers to the entry of rival producers. Since entry is blocked, the monopolist can earn economic profits in the long run. Buyers have no alternative or choice. They have either to buy the product or go without it. A monopoly firm itself being the industry, it faces a downward-sloping demand curve for its product. That means it cannot sell more output unless the price is lowered. A monopolist is a price maker and not a price taker. In fact his price fixing power is absolute. He is in a position to fix the price for the product, as he likes. He can vary the price from buyer to buyer.

Electricity is an essential requirement for all facets of our life. It is a critical infrastructure on which the socio economic development of a country depends. The electric power sector in Pakistan is operated by the Water and Power Development Authority (WAPDA), and the Karachi Electricity Supply Corporation (KESC), with additional generation contribution from Independent (private) Power Producers (IPPs). The power sector has been plagued with problems of high transmission and distribution losses (T&D), largely due to theft of electricity and supply losses, uncollected bills, large outstanding dues to central sector companies, inadequate investment, inadequate distribution network, operational efficiency and irrational tariff structures leading to unsustainable cross subsidies, with low tariffs for agriculture and households, poor efficiency of thermal power plants, low calorific coal. The nature of competition in power sector is monopoly in nature where prices of power are being fixed by National Electric Power Regulatory Authority (NEPRA).In the concern report we are interested to get familiar with the nature of Monopoly in the shape of WAPDA.

In the first part of the report a comprehensive introduction about The Monopoly is given. An attention is paid to discuss Price Discrimination and Limits of Monopoly. In the second part a brief scenario of the WAPDA current assets, demand and supply is given. The Losses and shortage it faces is highlighted. And finally WAPDA is discussed as an example of Monopoly.

At the end of the report the Abuses of Monopoly in term of WAPDA are pointed out and respective suggestion are given in the conclusion.

Introduction

M arket structure

1. The competitive environment in the market for any product is the market

structure faced by the firm

– Is measured in terms of

• the number of the actual buyers and sellers plus potential

entrants

• Barriers to entry and exit

• Capital requirements

• Price vs. Non-price competition

– Potential entrants pose a sufficiently credible threat of entry to affect

price/output decisions of incumbents

2. Factors that Shape the Competitive Environment

• Product Differentiation

– R&D, innovation, and advertising are important in many markets.

• Production Methods

– Economies of scale can rule out small-firm size.

• Entry and Exit Conditions

– Barriers to entry and exit can shelter incumbents from potential

entrants.

• Buyer Power

– Powerful buyers can limit seller power.

Market Power

In pure competition sellers are “price takers.”o No seller [or buyer] has the ability to influence the market price.

In most markets, at least one or more of the conditions required for pure competition are violated. This gives sellers or buyers the ability to influence the market price and allocation of resources

Market power is the ability of an agent to influence the price of a good they sell or buy and to alter the allocation of resources.

Sources of market power:

· monopoly, oligopoly, monopolistic competition· Institutional structure {laws, regulations customs, mores, . . .}

Firms with market power must decide:

1. how much to produce,2. how to produce it,3. how much to demand in each input market, and4. What price to charge for their output?

Monopoly

Monopoly is a market structure in which only one producer or seller exists for a product that has no close substitutes.

Perfect competitionPerfect competition

OligopolyOligopoly

The firm in competitive marketsThe firm in competitive markets

MonopolyMonopoly

Non-perfect competitionNon-perfect competition

Monopolistic competition

Monopolistic competition

This sole seller in the market is called “monopolist”. The term monopolist is derived from the Greek word “mono”, meaning “single”, and “polist” meaning seller. Thus the monopolist may be defined as the sole seller of a product which has no close substitutes.

Examples of Monopoly

– Electricity utilities – Gas – Water– Public Transports– Telecommunications

B arriers to entry

Legal or natural constraints that protect a firm from potential competitors are called barriers to entry.Legal barriers to entry create a legal monopoly, a market in which competition and entry are restricted by the granting of a:

Public franchise Government license (like a license to practice law or medicine) Patent and copyright

Natural barriers to entry create a natural monopoly, which is an industry in which one firm can supply the entire market at a lower price than two or more firms can.In a natural monopoly, economies of scale are so powerful that they are still being achieved even when the entire market demand is met.The ATC curve is still sloping downward when it meets the demand curve.

Characteristics of Monopoly

Since entry is blocked, the monopolist can earn economic profits in the long run.

The individual supply of the monopolist coincides with the market supply

Buyers have no alternative or choice. They have either to buy the product or go without it.

A monopolist is a price maker and not a price taker. In fact his price fixing power is absolute. He is in a position to fix the price for the product, as he likes. He can vary the price from buyer to buyer. Thus in a competitive industry, there is a single ruling price, while in a monopoly, there may be differentials.

A monopoly firm itself being the industry, it faces a downward-sloping demand curve for its product. That means it cannot sell more output unless the price is lowered.

Since a monopolist has a complete control over the market supply in the absence of a close or remote substitute for his product, he can fix the price as well as quantity of be sold in the market.

Monopolists can earn losses in the short run if demand is not sufficient or if costs are too high.

Price and Marginal RevenueA monopoly is a price setter, not a price taker like a firm in perfect competition.The reason is that the demand curve for the monopoly’s output is the market demand curve.

To sell a larger output, a monopoly must set a lower price. Total revenue, TR, is the price, P, multiplied by the quantity sold, Q. Marginal revenue, MR, is the change in total revenue that results from a one-

unit increase in the quantity sold.For a single-price monopoly, marginal revenue is less than the price at each level of output. That is,

MR < P

Suppose the monopoly sets a price of $16 and sells 2 units. TR= $32Now suppose the firm cuts the price to $14 to sell 3 units. TR= $42So total revenue increases by $10, which is marginal revenue

You can see that MR < P at each quantity.

Marginal PRINCIPLE

"Increase the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.

Price Setting

The monopoly faces the same types of technology constraints as the competitive firm, but the monopoly faces a different market constraint. The monopoly selects the profit-maximizing level of output in the same manner as a competitive firm, where MR = MC.

The firm produces the output at which MR = MC and sets the price to sell that quantity.

The ATC curve tells us the average cost. Economic profit is the profit per unit multiplied by the quantity produced—the

blue rectangle. Equilibrium price for a monopoly, PM, occurs on the demand curve at the

profit-maximizing quantity. Equilibrium output for a monopoly, QM, occurs where marginal revenue

equals marginal cost, MR = MC.

Consumer surplus is the area below the demand curve and above the price. Producer surplus is the area below the price and above the marginal cost

curve. The sum of the two surpluses is maximized and the efficient quantity is

produced. Monopoly is inefficient because price exceeds marginal cost so marginal

benefit exceeds marginal cost. On all output levels for which marginal benefit exceeds marginal cost, a

deadweight loss is incurred.

Problem Statement

Pakistan's power industry, traditionally dominated by the massive monopoly

WAPDA and this report discusses the features of Monopoly in term of WAPDA.

What are the barriers around this Monopoly and what the current status of this

monopoly is? The main stress in this project is given to two aspects of WAPDA; it's

Price Discrimination and why this Gigantic Monopoly is in massive liabilities and

losses.

Monopoly is termed as "EVIL" for any society as being a solo actor, it harvest the

whole market, and in the shape of Price Discrimination its profit margin increases

two- fold, this demands that NEPRA must have a more strict watch on tariff and must

set the price into average cost level to give a relief to Pakistani public.

The massive liabilities and losses of WAPDA suggest that now it is the time for

Government of Pakistan to pay a keen attention to this Monopoly. It is clear that the

losses are their in Transmission and Distribution sector and GOP must takes measures

to invite the public sector to share T&D with WAPDA.

Methodology and Results

WAPDA's CURRENT STATUS

Electricity is an essential requirement for all facets of our life. It is a critical infrastructure on which the socio economic development of a country depends. Supply of electricity at reasonable prices is essential for Pakistan’s overall development.

The electric power sector in Pakistan is operated by the Water and Power Development Authority (WAPDA), and the Karachi Electricity Supply Corporation (KESC), with additional generation contribution from Independent (private) Power Producers (IPPs). WAPDA is responsible for supplying power to all of Pakistan, with the exception of Karachi, which is supplied by KESC. Currently, 15 IPPs operate in Pakistan. The National Electric Power Regulatory Authority (NEPRA) regulates the

power sector in Pakistan, which includes power generation, transmission and distribution. NEPRA is also responsible for determining electricity rates in Pakistan.

Power Generation Share

Public Sector 70%

Private Sector 30%

Water and Power Development Authority (WAPDA) was created in 1958.In 2008 WAPDA has supply of more than 18.9 million electricity consumers. A staff of 32,000 WAPDA officers and officials and entire operations of 177,000 WAPDA Employees. The local areas electricity distribution service was being performed by various Regions of WAPDA. The environment and structure of the power industry throughout the world is undergoing dramatic change. The power sector is moving from monopoly to privatization and from integration to disintegration. Peshawar Electric Supply Company (PESCO), located in Peshawar provides service of power distribution to over 2.0 million consumers of all civil districts of N.W.F.P.

Total Install Capacity

The total installed capacity in 1959 was 119 MW, the creation of WAPDA accelerated the pace of expansion of the electricity system and network which in 2007 had an installed capacity of 19505 MW, a 167 times increase in last 61 years, an average annual growth rate of about 11.2% over the period 1959. An additional 6,428 MW are planned to be added to this installed electricity generation capacity by the year 2010 through the IPPs, including 700 MW of Wind Power.

Consumption

Install Capacity in Country

Total Capacity 19 , 505 MW

Thermal ,

12 ,580 ,

65 %

Nuclear ,

462 , 2 %Hydel ,

6 ,463 , 33 %

WAPDA+KESCSources of Generation

Furnace Oil , 25.20%

Imports , . 30 %

Gas , 40.90%Nuclear , 2.10%

Hydro , 31.40%

Coal , 0.10%

Consumption Share of each Sector

Street lights1%

Other7%

Commercial

5%

Agriculture14%

Household43%

Industries30%

Price Discrimination

Price discrimination is the practice of selling different units of a good or service for different prices.To be able to price discriminate, a monopoly must:

Identify and separate different buyer types Sell a product that cannot be resold

Price differences that arise from cost differences are not price discrimination.Price discrimination converts consumer surplus into economic profit.

As a

single-price monopolist, this firm maximized profit by producing 8 units, where MR = MC and selling them for $1,200 each.

By price discriminating, the firm can increase its profit.

Price Discrimination by WAPDA

Pesco Tariff Rates

Tariff A- Domestic Consumers

Up to 50 units Rs. 1.40/kWh(51-100) Rs. 2.57/kWh(101-300) Rs. 3.47/kWh(301-1000) Rs. 5.75/kWhAbove 1000 units Rs. 6.9/kWhMinimum Charges of Rs. 45 for Single phase and Rs. 100 for Three Phase

Tariff A- Commercial Consumers

Up to 100 units Rs. 6.8/kWhAbove 100 Units Rs. 7.6/kWhFor peak load Rs. 7.5/kWhMinimum Charges of Rs. 150 for Single phase and Rs. 300 for Three Phase

Tariff B - Industrial Supply Tariff C - Bulk Supply

Tariff D – Agriculture

Increasing Demand and Losses

Demand and Supply Schedule:-(In Mega Watt)

Year Demand Supply          Shortage

2003 13,071 14,336           Surplus2004 13,831 15,046          Surplus2005 14,642 15,082           Surplus2006 15,483 15,072           4112007 16,548 15,091           1,4572008 17,689 15,055         2,6342009 19,080 15,055           4,0252010 20,584 15,055           5,529

An average 7 per cent increase in the GDP is expected in future is going to increase energy demand by 11 per cent annually. As government is now focusing more on manufacturing sector whose share is going to increase at an average growth rate of 12 per cent per annum, it is expected to generate more demand for energy due to its energy intensive structure. The potential of Hydel power generation is 46000MW whereas installed capacity is only 6463 MW. If this capacity is not increased in near

future, we will not be able to achieve the targets sets for growth and economic prosperity.

It is estimated that the annual financial losses of Wapda and KESC are increasing since Wapda's losses alone were estimated at 817 million dollars for financial year 2006. The system losses of the two power utilities were also very significant. During the 10 years between 1996 and 2005, Wapda's total system losses, including auxiliary consumption of generation plants, transmission and distribution losses ranged between 26 per cent while KESC's system losses ranged between 38 percent per cent

The power sector has been plagued with problems of high transmission and distribution losses (T&D), largely due to theft of electricity and supply losses, uncollected bills, large outstanding dues to central sector companies, inadequate investment, inadequate distribution network, operational efficiency and irrational tariff structures leading to unsustainable cross subsidies, with low tariffs for agriculture and households, poor efficiency of thermal power plants, low calorific coal.

It is very important to understand the consequence of the prevailing situation. Current price of furnace oil is about Rs 22,000 per ton, which amount upto Rs 22/- per kg. On an average one kg of furnace oil produces 3.8 kWh of electricity. Thus, the cost of furnace oil for generating one unit of electricity is about Rs 6. On top of this the fixed cost of a thermal plant works out to be about Rs 3 per unit. Therefore, one unit (kWh) of the electricity produced by all thermal plants using furnace oil is Rs 9 per unit. According to WAPDA/IPP agreement, the private power producers will charge WAPDA the actual fuel cost for which they have a direct contract with PSO. As we all know that WAPDA tariff charged from the consumers is about Rs 5 per unit (kWh).

The production cost of furnace oil electricity is Rs 9 per unit, add to it the transmission, distribution cost (including loses), "the total cost of such electricity works out to approximately Rs 15 per kWh. The difference between WAPDA tariff and the furnace oil electricity is Rs10 per kWh." It is estimated that the country consumes at least 25 billion units of electricity produced annually through furnace oil, which amounts to the total deficit of Rs 250 Billion. If WAPDA has to balance its books it would require a subsidy of Rs 250 Billion. This deficit is somewhat reduced due to cheap power produced through hydel energy and natural gas, but the deficit cannot change substantially, unless bulk of electricity is produced through hydel energy. Obviously, a deficit of Rs 300-350 Billion cannot be sustained, the government does not have resources to pay such a huge subsidy, it is also not feasible to increase the power tariff very much. Therefore the power crisis is far greater than what is being perceived. In the absence of extremely heavy subsidy, WAPDA is delaying payments to IPPs and also to the oil companies. The result is that IPPs are now producing much less electricity than their capacity.

Conclusion

In Pakistan, as in most of the developing world, the demand for power has far exceeded production and supply. And since power is the basis for industry, country faces massive losses every year. It means that despite the fact that wapda is a gigantic monopoly yet it is continuously sinking due to its huge losses.

The cheapest resource for electricity is Hydel and then Gas. But due to poor planning and political issues in the previous so many decades, no new installation has been done with these two resources. Although gas is to be provided for 5800 MW to various thermal plants, but in actual fact much less gas is being made available. This ultimately makes the WAPDA to depend on IPPs and OIL electricity. The deficiency is being filled through furnace oil. It can be inferred that in the recent past, only furnace oil was used as fuel for about 9000 MW generation. The OIL prices are in continuous fluctuation due to GEO_POLITICAL scenario and as soon as Prices of oil increases the NEPRA has to give readjustment to the prices to make the IPPs in profit zone. Already there is irrational tariff and price discrimination and further changes make the "60 to 70 percent low income population" in troublesome and they increases the electricity theft. So increase in prices makes a negative impact on WAPDA total revenue in the shape of T&D losses. Currently the country loses 29 billion units of electricity annually due to heavy losses in the system. All efforts must be genuinely applied to reduce the losses. If losses are reduced by even 5 percent, the saving will be over 7 Billion rupees.

To any planner, it should be obvious that the country cannot afford electricity produced through oil. Indigenous fuels like coal, gas, atomic will have to be developed and developed quickly. The final solution however lies in depending on the hydroelectric renewable energy. The government has announced that immediately 1200 MW of additional plants will be set-up. If these plants will operate on furnace oil, the deficit will further increase. At present the country has about 28 Trillion cft of recoverable gas available, the yearly consumption is about 1.2 Trillion cft, which means that even if gas consumption is increased, the existing recoverable gas will be sufficient for the next 15 years.

WAPDA has undergone widespread changes in the past decades, with the extensive development of the private sector. Of course, the economic benefits of privatization are now widely accepted; it not only works better and yields quick rewards but it makes for efficiency, higher output, increasing profitability and developing a competitive industry which serves consumers well. The problem that arises, though, is that privatization is always political; governments have aims that are non-economic. These, can be ensuring that enterprises are not forced to close down, reducing budget deficits, raising revenue and so on. There are also political obstacles to overcome, mainly the closed and conservative attitudes of state-owned management who are generally unfamiliar with the ways of the market place. Publicly-owned and operated enterprises are normally driven by political gain, and bear little relevance to production, quality or the safeguarding of the consumer. In most cases where power is still in the public sector, and certainly in Pakistan, the set-up and plant have become

highly inefficient and obsolete. The level of investment required for greater efficiency would be enormous.

References1. http://en.wikipedia.org/wiki/WAPDA

2. http://en.wikipedia.org/wiki/List_of_electric_supply_companies_in_Pakistan

3. http://en.wikipedia.org/wiki/Electricity_in_Pakistan

4. http://www.wapda.gov.pk/

5. http://www.aedb.org/re_sector.php

6. http://www.ppib.gov.pk/SupplyDemand.htm

7. http://www.pesco.gov.pk/

8. http://www.nepra.org.pk/index.htm

9. http://www.unclaw.com/chin/teaching/antitrust/monopoly.htm

10. http://webpages.marshall.edu/~agesaj/week11_250.html

11. http://courses.ttu.edu/econ3320-kdesilva/Lecture14.ppt

12.http://pakistaniat.com/2008/01/03/more-crises-in-pakistan-electricity-flour-sugar-water-sui-gas-crises-what-is-the-way-out/