ECON 7239 Economics for Management : Natural Gas Market

Introduction

The article “Gas price war erupts with discount offer” by Daniel Mercer on 8^th may 2017 presents information about a price war in Western Australia household natural gas market. The two firms in this industry, Alinta Energy, and Kleenheat have staged price war with the aim of wooing the clients to increase their market share. Alinta’s monopoly in Western Australia natural gas industry came to an end in 2013 when Kleenheat entered the marketplace. Since then, Kleenheat has been endeavoring to woo customers from Alinta and has managed to get 20% of the market share. With its 20% discount to the clients, Kleenheat has grabbed some consumers from Alinta. Alinta Energy has since responded with 25% discount to win the customers back (Mercer 2017).

The managers of these two firms are taking a keen watch on the market developments to make sure that they do not lose their clients. According to Jeff Dimery, the manager of Alinta Energy, the size of Alinta is sufficient enough to allow the company to offer consistent and competitive pricing to protect the clients from price volatility. On the other hand, the manager of Kleenheat, Mark Gadsby, says that his company is aware of the effect of competition on their profit margin. According to Mr. Gadsby, reinvesting in reduced price for consumers should be taken as an opportunity and not an issue.

Economic Analysis

Competitive Oligopoly

The oligopoly in Western Australia natural gas industry is a competitive one involving price war. In this type of market structure, the rival firms are not likely to match another enterprise’s price hike, but they are likely to match a price decline (Arnold 2013, p. 56). This scenario can explain why Alinta Energy has introduced a discount of 25% after Kleenheat’s 20% discount. The competitor businesses under oligopoly react asymmetrically to another firm’s price variation. If one company increases the price while others fail to amend their rates, then a considerable substitution effect will occur causing a relative price elastic demand. Therefore, the enterprise will lose its marketplace share to the rivals leading to a drop in its total revenue (Mankiw & Cosgrove 2014, p. 64). We anticipate the same situation to occur in Western Australia natural gas market. If Alinta increases its price, then Kleenheat will leave its prices unchanged so as to grab Alinta’s marketplace portion.

Kinked Demand Curve

The kinked demand curve model under oligopoly is based on the supposition that an enterprise is likely to encounter a dual demand curve for its products determined by potential reactions of competitor companies to shifts in prices and other relevant variables (Mankiw & Cosgrove 2014, p. 61).

On the graph below, if one firm increase its price (S1) and other companies fail to equal the addition, then the sales of the company will decline regardless of the price hike. If the venture reduces its price (S2), then the competitors will go with the drop to avoid losing their market share. This scenario is depicted by Alinta’s response to the discount offered by the Kleenheat. These companies maximize revenue at price P1 and quantity Q1 where the marginal cost matches the marginal revenue. Moreover, Kleenheat and Alinta Energy are unlikely to increase the price of gas as long as their marginal costs are within MC1 and MC2.

Graph 1: Demand curve

Strengths

These corporations are paying close attention to the actions and behaviors of each other. This situation has made these companies to adopt a highly competitive practice thus resulting in benefits like those availed by more competitive market structures. For instance, these companies are currently in price war thus helping the consumers through lower prices of natural gas. Moreover, these companies can make use of the supernormal profits they earn in research and development to provide the households with a higher quality of the gas product (Mankiw 2014, p. 63).

Weaknesses

There are only two firms in Western Australian natural gas industry. This scenario shows that these enterprises have intensified barriers to market entry thus locking out potential marketplace entrants. If more firms are in the market, then the purchasers are likely to receive greater benefits. Moreover, Kleenheat and Alinta Energy are allocative and productively inefficient.

Graph 2: Allocative and Productive inefficiencies exhibited by Kleenheat and Alinta

Quantity

0Q = Profit Maximizing Output

0A = allocative efficient output

0P = productively efficient output

Allocative efficient happens when the marginal cost equals the price (Sloman, Wride & Garratt 2015, p. 56). However, for Kleenheat and Alinta, the price outstrips the marginal cost and thus allocative inefficient. Moreover, these businesses are productively inefficient because they do not operate at minimum average cost. Hence, there is under allocation and underutilization of resources.

Recommendations

Competition in the marketplace generates enormous benefits such as reduced prices that benefit the consumers and high-quality products (Sloman, Wride & Garratt 2015, p. 59). Therefore, the government through the competition commission should put measures in place to enhance transparency in the natural gas industry. There is a need for the competition commission to provide timely, equitable and sufficient information to the producers and consumers to facilitate competition in the market. Additional, the government should be keen of possible collusive activity between Kleenheat and Alinta Energy. There are possibilities that these firms can agree to set price and output that maximizes their profits. If this behavior develops, then these companies will act as monopolies leading to consumer exploitation through poor quality, low quantity and hiked prices. Therefore, there is a need for strict implementation of antitrust laws.

Conclusion

The entrance of Kleenheat in Western Australia natural gas market in 2013 has stimulated competition in this industry. This competitive behavior is desirable as it has led to price cuts for the consumers. There is interdependence between these firms in market operation. The government should increase competition in the industry to bring the users more paybacks. Finally, strict implementation of the antitrust law can help prevent Kleenheat and Alinta from colluding.

Bibliography

Arnold, RA 2013, Economics, South-Western, Mason, Ohio.

Mankiw, NG 2014, Principles of economics, Cengage Learning, Stamford, CT.

Mankiw, NG & Cosgrove, S 2014, Principles of microeconomics, Cengage Learning, Stamford, CT.

Mercer, D 2017, Gas price war erupts with discount offer, viewed 15th May 2017, <https://thewest.com.au/news/wa/gas-price-war-erupts-with-discount-offer-ng-b88468341z>.

Sloman, J, Wride, A & Garratt, D 2015, Economics, 9th edn, Pearson, Harlow.