Natural Monopolies and Cap and Trade

Note: this post is intended as discussion of economic theory. The use of certain analytical tools should not be construed as approval or said tools, nor should assertions and arguments be construed as advocacy. This is simply an exercise in economic analysis.

Taking the mainstream definition of natural monopolies, and assuming that the human-produced carbon dioxide that inevitably results when producing electricity does contribute to global warming, I think it’s safe to say that cap-and-trade schemes are superfluous.

In the first place, note that natural monopolies are generally defined are markets that have high entrance costs with minimal variation in products. Landline telephone service would be an example of this, as the infrastructure necessary for building a market is extremely expensive, while the product available generally doesn’t vary (i.e. you get to call people). In contrast, mass-market retail (think: Walmart or Meijer) is not a natural monopoly because the costs of market entry are not necessarily high—insofar as they can be localized—and there can be quite a variation in products available. For purposes of analysis, electricity is considered a natural monopoly since market entrance costs are high and the product is uniform.

In the second place, note that one common assertion made by mainstream economists is that natural monopolies are anti-market (or, more accurately, anti-consumer) because they impose what is assumed to be artificially high prices on consumers, which in turn requires consumers to lower electricity usage or reduce other forms of spending to afford their electrical bills. As such, the argument is that the government needs to interfere in this market so as to make sure that consumers do not have to make difficult decisions about economic tradeoffs. In doing so, the government lowers the price of electricity, and increases the amount of electricity consumed.

In the third place, producing electricity exacerbates global warming. Most electricity in the US is produced from fossil fuels (i.e. coal, crude oil, and natural gas). Fossil fuel refinement and usage releases carbon dioxide into the atmosphere, which traps heat.

In the fourth place, there is a proposed solution for carbon-dioxide-based global warming: cap-and-trade. This seeks to discourage the use and refinement of fossil fuels by imposing a tax on carbon usage and production.

Now, here’s where things get confounding: if natural monopolies could simply exist and charge consumers higher prices for electricity, then there would be no need for cap-and-trade since the market would solve that problem naturally by the price mechanism. Not only that, this would also help to ensure the long-term stability of carbon-based energy prices, as this would further ensure that demand is not pulled too far forward (which is what happens when the government artificially lowers prices). Of course, allowing natural monopolies to do this means that money goes to businessmen instead of politicians, so the real reason for cap-and-trade is to a) correct for a government-caused market inefficiency and b) enrich politicians. Isn’t it amazing how all that works out?

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