The concept of economies of scale refers to the ability of
an enterprise to lower its average cost per unit through expansionary
measures. Quite simply, a company becomes more efficient at producing goods when
done on a large scale. When a business is able to buy product in bulk, they’re
able to reduce their overhead costs. For example, if a factory needs 1000 units
of a product, they’re often able to purchase at a significantly lower per-unit
cost than were they to only order 50. The saying “go big or go home” is
certainly valid in business as the big players can reduce overhead, allowing
them to be more competitive in the market or increase profit, depending on the
characteristics of the market.
Another basic economic concept is the natural monopoly. This
refers to markets where a monopoly occurs due to the characteristics which
result in favouring a single firm, minimizing the ability of firms to compete.
One primary example of such a market are utilities such as water and
electricity. For a firm to start a utility such as one which creates and sells
electricity, significant capital investment and planning is required. More so, significant co-ordination is required to build a successful transmission network that multiple firms would have difficulty achieving successfully. The
requirements for large sums of capital investment as well as the nature of the
market limits the amount of competition that the market can maintain, naturally
creating monopolistic-type conditions.
Nova Scotia Power maintains a monopoly on providing
electricity to a majority of Nova Scotians, with the provincial government
regulating technicalities and profit margins. A recently requested increase in
rates by Nova Scotia Power has led to a significant public outcry, with some
calling on the government to end NS Power's monopoly.
It should be addressed that simply ending Nova Scotia
Power's monopoly would not result in a decrease in rates, as it is unlikely
competition would increase. As mentioned, the barriers to entry into the market
are remarkably high requiring significant capital investment to get started. If
the aforementioned policy were enacted, what would need to be considered by the
government is whether or not new competitors would be able to utilize the
currently established electrical distribution network (the lines). Would they
be able to freely distribute electricity across the established infrastructure,
rent the lines from NSPI, or construct their own independently?
Of course, if a company was required to erect its own electrical
lines the costs would be astronomical. Were it to rent the lines from NSPI, it
would need to make up the increased expenditure in efficiencies elsewhere in
order to compete as this rent would be a fixed cost that NSPI would not need to
contend with.
In most markets, there is a degree of product
differentiation that a firm can engage in to make their product more attractive
to consumers, even if the good is priced the same or slightly higher than the
competition. An example of this can be seen with smart phones, where many will
have the same specs, the design and interface will vary in an attempt to garner
a wider market share.
The electricity market is one which suffers from a near
complete inability for producers to differentiate their product. This means
that demand for a product is derived solely from the price of the good. Some
are suggesting that the government simply removing NS Power's monopoly in Nova
Scotia will lead to lower prices due to increased competition in the province.
Yet, they fail to appreciate the characteristics of such a market, along with
the significant economies of scale that accompany it. While advocates of such a
policy have been sparing on details, it should be clear to all: simply removing
NS Power's monopoly will not bring increased competition and lower prices.
