Microeconomics Essay The price of electricity has increased substantially in the last three years, as a result of that; there have been apparent changes in the demand for electricity for the consumers and it has affected the producers supply market. In the following essay, we are going to look at the effect of the increase in the price of electricity in South Africa, using the supply and demand framework. The reason for the increase of the price of electricity is to balance out the supply and demand of electricity.
The National Energy Regulators of South Africa (NERSA) has approved a 25% increase of the price of electricity for 3years starting from 2010 (Roodt, 2012). Supply and demand are fundamental principles of economics, it is what determines the price of goods in a competitive market. When NERSA approved of the increase in the electricity price, the price of electricity increased and the quantity of demanded for electricity by households decreased, we know this because the law of demand states that while other things remain the same, higher prices will lead to a lower quantity demanded (Parkin, 2010).
Diagram A illustrates the immediate effect of the increase of price of electricity on the quantity demanded by households, i. e. the short run. In Diagram A and Diagram B, we are assuming that Eskom sets a single fixed price for all consumers of electricity, this assumptions implies that Eskom is able to supply an unlimited amount of electricity at a fixed price, and hence the horizontal supply curve. Diagram A clearly shows that before the increase of the price of electricity, the market was at equilibrium at E1 with a price of P1 and quantity of Q1, but when the price increased from P1 to P2.
The supply curve shifted upwards from S1 to S2, causing an decrease in the quantity demanded for electricity, quantity demanded moves from Q1 to Q2, and reaching a new equilibrium at E2 with a higher price, but a lower quantity demanded. Because electricity is a necessity, in any household, the demand for electricity is relatively inelastic, meaning an increase in the price of electricity by one, will decrease the demand of electricity by less than one, which means that even though there was a big increase in the price of electricity, the demand for electricity by the households will only decrease by a little.
Another effect of the price elasticity of demand is that, when it is relatively inelastic, (like in this case), an increase in the price of the product will increase in the total revenue, therefore in this case, when Eskom increased the price, even though the quantity demanded decreased, Eskom’s 1 total revenue increased. There’ll always be a demand for electricity, and when the price goes up, the consumers would not have enough time to save sufficiently, so they would try to consume less, i. . the small decrease of demand. Diagram B illustrates how the households respond over time to the increase in the price of electricity. The long term effects of the price increasing from P1 to P2, is that the Demand curve will become more elastic, therefore the short run demand curve will curve more horizontally, becoming the long run demand curve. In the long run, the quantity demanded for electricity will decrease even more, from Q2 to Q3, and therefore forming a new equilibrium at E3.
The change of the SRD to the LRD is because households now have time to adjust to the increase in the price and is making more effective means of saving electricity, and have switched to relatively cheaper substitutes. The change in the demand is caused by the substitution effect, which states that as opportunity cost of a good rises, people will buy less of that good and more of its substitutes. The difference between Diagram A and Diagram B is that in Diagram B, people have sufficient time to adjust to the change in the price of electricity. 2
The increase in price of electricity also have a major effect in the mining industry, as in mining, one needs a lot of electric power. It is not possible to save electricity without decreasing the production of the mining factory, because of the vast amount of energy that is used in the production process. The increase in the price of electricity is equivalent to an increase in the cost of production. The law of supply states that an increase in the cost of production will cause a decrease in the supply, provided everything else stays constant (Parkin, 2010).
We can clearly see this in diagram C, when the price increased from P1 to P2, the supply curve shifts from S1 to S2, therefore decreasing the quantity supplied from Q1 to Q2. The equilibrium also shifts from E1 to E2. As time passes the mining industry will have enough time to adjust to the increase in the price of the electricity, which increased the cost of production. The supply curve of the mining industry will become more inelastic, this is because in the long run, the suppliers will find other more sufficient methods to produce gold with less energy.
So when the price does increase again, the change in the quantity demanded will be affect much less. This is shown in Diagram C, when the S2 becomes S3, we can see that the supply curve is becoming more vertical, indicating that the supply curve is more inelastic. And in the long run, the only thing that changes is the elasticity of the supply curve, the quantity supplied and the equilibrium remains the same. 3 We can conclude the essay by stating that as the price increases for electricity, the demand for the electricity by the households will decrease by a little in the short run, as the demand curve is relatively inelastic.
But in the long run the demand curve for electricity by the households will become more elastic resulting in a larger decrease in the quantity demanded. In the mining industries, an increase of the price of electricity will increase in the cost of production, therefore in the short run, the supply curve will decrease, resulting in less quantity supplied, and in the long run, the increased supply curve will become relatively more inelastic, to reduce the effects of further increase in cost of production. 4