Questions for Analysis and Responses
Our approach to this case is built on the information that California electricity producers behave as price takers. This statement implies that the electricity market is perfectly competitive. Before answering the questions given, we briefly describe industry supply, marginal costs, and profits for perfectly competitive markets.
First, the industry supply curve is a sum of supply curves for individual producers. In turn, each firm's individual supply curve is the quantity supplied, from zero capacity to maximum capacity, at a price equal to marginal cost. Marginal cost is determined by taking the derivative of the cost function with respect to quantity. The cost function C(Q) for each firm is the sum of variable costs VC(Q) and fixed costs FC. Because VC(Q) in this case is VC*Q, the derivative of the cost function is VC. Therefore, for each firm, the marginal cost MC is equal to the total variable cost TVC (See Appendix A) and is constant.
In the short run, firms will generate profits if marginal costs exceed average costs. Substituting marginal costs for prices (see above), this means that if market prices are greater than average costs, suppliers will earn economic profits. Conversely, if market prices are less than average costs, some firms will choose to exit the market since they are not making enough money to cover fixed costs. In relation to this case, we will assume that prices are greater than average costs, and therefore each firm's supply curve is represented by its MC.
In the appendix, we provide the relevant calculations of industry supply and marginal costs for individual producers. The individual firm's data is sorted based on marginal cost (from low to high) and a column is added fo ...