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“The verdict is in: California’s experiment with energy deregulation is not just a mess; it’s a certifiable failure, according to everyone from the state governor to the very utilities that initially backed the scheme.” This is how Charles Feildman, CNN Correspondent, began his article on January 4, 2001, entitled “The California Power Quagmire”. Has this happened with any other industry? How and why did this happen in California and can it happen in other states? To understand what happened one must look at some simple and basic concepts in economics.

KEY CONCEPTS

Competition, Demand, Markets, Price, Scarcity, Supply

STUDENTS WILL

  • Identify the economic concepts involved in deregulation of California Utilities.
  • Apply the law of supply and demand to current economic events.
  • Identify the direction of price change if a good becomes scarce.
  • Understand the consequences of setting a price ceiling.
  • List and recognize the reasons that the demand curve could shift.
  • Understand the effect that government can have when it sets regulations on an industry.

INTRODUCTION

"The verdict is in: California's experiment with energy deregulation is not just a mess; it's a certifiable failure, according to everyone from the state governor to the very utilities that initially backed the scheme." This is how Charles Feildman, CNN Correspondent, began his article on January 4, 2001, entitled "The California Power Quagmire." Has this happened with any other industry? How and why did this happen in California, and can it happen in other states? To understand what happened one must look at some simple and basic concepts in economics. What really happened with deregulation and the California utilities? Did these people understand the Law of Supply and Demand? Did they understand what makes supply and demand shift? Did these people understand what happens when you place a price ceiling on a retail commodity when you can't control the wholesale price of that commodity? How could this have been prevented?

MATERIALS


PROCESS

Before studying about deregulation and other economic concepts we need to review some important economic terms. Either use your textbook or go to AmosWeb and look up the definitions for the following concepts and terms: scarcity, regulations, markets, price, law of supply and demand, competition, market failure, economic systems, monopoly, incentives and government regulation. Once you understand these terms develop a crossword puzzle to give other students in your class to see if they understand these terms. To do this use the puzzle making web site. Find "puzzlemaker online", click on the kind of puzzle you want to create, and follow the directions to develop your own puzzle.

To understand why California suffered a number of rolling blackouts since January one must look to see how Califonia got into this situation. To do this you need to go to How California's Power Crisis Works page and the California Blackout page .

1. What were the major reasons for the utilities crisis in California? [Deregulation of California Utilities, Growing power consumption, Regulated consumer prices, No new power plants, Outside companies cut supply, Lack of snow/rain]

2. Why did deregulation of California utilities play such an important part in causing the crisis? [At the time of deregulation in 1996 many felt that the utilities were a monopoly and that deregulation would make it possible to lower prices. The main problem came when the California utilities sold their power plants to a small group of electricity wholesalers.]

3. During the last five years how much has the consumption of power grown in California and what has caused this to happen? [The demand for power has increased about 30% (6 percent annual growth). One of the reasons for the growth is the increase in the number of technology companies which are headquartered in California. Another reason is the population increase due to the growing technology industry on the west coast.]

4. What basic economic law was forgotten by those that passed the deregulation law? [The Law of Supply and Demand - This is because they froze the price that the utilities could charge for their product to the consumer (Price Ceiling) but they did not place a ceiling on the price utilities had to pay for the electricity they had to buy and sell to the consumer.]

As you learn about the utilities crisis in California you might ask yourself whether your state has deregulated its utility industry or whether your state is in the process of deregulating its' utilities. To find out what is happening in your state go to the Online NewsHour Special Report and click on your state in the slide down menu.

1. How many states have deregulation laws or orders in place? [23] Is your state one of the deregulated states? [Answer varies] If yes, in what manner has deregulation taken place? If no, has your state considered deregulation at any time?

2. Compare your electricity rates to those in neighboring states and also to those in California. [Answer will vary]

[NOTE: There are a number of factors related to the causes of the California crisis. One of these is the lack of understanding the Law and Supply and Demand and what causes the demand or supply curve to shift. There are five nonprice reasons that can cause a shift in the demand curve. These are: 1) income, 2) price of related goods, 3) expectations about future prices, 4) population size, and 5) taste and preferences. As we see, the main reason that demand shifted an increase in population. Not only did the population of California increase; the technology industry also grew.]

sanfran

Likewise there are factors that can cause a shift in supply. Yet, in California's cases there was not have been a shift in supply; therefore the supply of electricity remained constant. The major reason is that during the last 10 years there were no new power plants built in California. If there was a change it was because the major utilities sold many of their power plants to electricity wholesalers in 1996, when deregulation began. With deregulation the suppliers had few incentives to increase the supply of electricity.

Finally, one needs to understand the concept of price ceiling. Price ceiling is when the price of a good or service is set by someone and sellers are not allowed to charge more than that price. In this case, the price of electricity that could be charged to the consumers was frozen by the government until 2002. The problem arose when there was not a price ceiling placed on the wholesalers. There was no expectation of the increase in the wholesale price due to an increase in demand and where supply stayed constant, causing the price to purchase electricity to increase more than the ceiling price that was set by law.

CONCLUSION

The government made many mistakes in California when it deregulated the utilities industry. The major mistake made was that of regulating the price of electricity causing the market system to fail.

ASSESSMENT ACTIVITY

What have we learned from the mistakes make in California? Can California fix the problems that it created? Only time will tell.

Now that you have looked at the effects of deregulation of the utilities in California review the articles on rent control and deregulation of the airlines industry and see if you can find some similarities and differences in the effect of these cases of deregulation.

[NOTE: Now that you have looked at the effects of deregulation of the utilities in California, review the articles on rent control and deregulation of the airlines industry and see if you can find some similarities and differences among these cases of deregulation.]

supply & demand

Price Ceiling established in 1996

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Wholesale Price of Electricity in 1996

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Wholesale Price of Electricity in 2001

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Demand Curve of Electricity 1996

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Demand Curve Shift of Electricity 2001

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The best way to understand what takes place with rent control or the deregulation of the airlines industry is to graph out what happens when price ceilings are set and there are either increase or decreases in supply and demand..

EDUCATOR REVIEWS

  • “Great review for the microeconomics unit!”

    Amber R., CA   POSTED ON February 28, 2005

  • “Great lesson! Economic education is much more effective when we learn from real life situations. In interest to fairness to those who favor deregulation, we should point out that price ceiling are regulation, so what happened in California is not deregulation but harmful regulation that was doomed to fail from the beginning.”

    Tom, ID   POSTED ON March 6, 2007

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