Analytical assignment-4

Who Turned Out the Lights in California?

Case Summary
The California legislature set a retail price ceiling of 10 cents per kilowatt-hour in 1996
to make the electricity cheap. Price ceiling is the minimum price, a seller is allowed to
charge for a product or service. The situation of crisis of electricity in California made the
california utilities to buy electricity on the spot market (it is one in which the price
elasticity is determined by supply and demand conditions each hour). In the summer of
2001 the demand for electricity soared due to the use of air conditioner whereas its
supply was decreasing due to increase in naturak gas prices as well as low snowpacks and
drought in the Pacific Northwest. The increase in demand and decrease in supply lead to
shortage of electricity and disequilibrium market.

The California utilities had to buy electricity on the spot market that amounted them ten
times more that the normal levels. Investigation by Federal Energy Regulatory
Commission (FERC) reported evidence such as the Enron (one of the power companies)
developed stratigies to drive up prices thus, creating an artificial shortage.
Analyze The Issue
Draw a graph illustrating California's electricity crisis. Put the label "Price of electricity
(cents per kilowatt hour)" on the vertical axis and "Quantity of electricity (megawatt per
hour)" on the horizontal axis. as explained in Chapter 4, draw the changes in demand
and supply for electricity in California described above. [Hint: Begin the graph in
equilibrium below the price ceiling.]

Ans:
The market situation before the change in demand and supply, when the price ceiling was
implemented as a result of California's electricity crisis can be described by the following
graph:
Y

Price of electricity
(cents per kilowatt
D hour)
S'

Shortage
P E

Price Ceiling
10

S D'
Y

O X
P Q1 Q Q2

Quantity of electricity
(megawatts per hour)
Fig1: Graph of California's electricity crisis before
change in demand and supply

DD' is the downward sloping demand curve and SS' is the upward sloping supply curve. E
is the point of equilibrium. The P and Q are the equilibrium price and quantity. The
California legislature setting a retail price ceiling of 10 cents per kilowatt hour a situation
of shortage has been created as demand excess supply as the quantity supplied has
decreased from Q to Q1 and quantity demand has increased form Q to Q2.

The summer of 2000 made the consumer to turn on their air conditioners increased the
demand for electricity whereas increase in natural gas price and the drought in the Pacific
Northwest which reduced the capacity of hydroelectricity dams of thhat region decreased
the actual supply of the electricity . This increase of demand and decrease of supply in the
presence of the retail price ceiling led to excessive shortage of electricity.
This can be shown by the figure as:

S2
Price of electricity
(cents per kilowatt hour)
S1
INDEX
E2
Shortage

E1

Price Ceiling
10

D2
D1
O X
Quantity of electricity
(megawatts per hour)

Fig2: Graph of California's electricity crisis after

change in demand and supply

In the figure, we can see that the supply cure has shifted leftwards from S1 to S2 due to
decrease in supply of electricity and the demand curve has shifted rightwards due to
increase in consumers demand ffor electricity for using air conditioners where the price
ceiling is the same as 10 cents per kilowatt hour. Due to the shift in demand and supply
curve the market equilibrium has changed form E1 to E2 increasing gthe shortage for
electricity as compared in figure 1 and figure 2 given above.

Thus, the changes in demand and supply for electricity in California resulted to increase in
the existing shortage of electricity as described above.