Efficiency Analysis Of Telecommunication Services In The Maldives

Discussion

The Maldives is an island with 370 thousand inhabitants (O’Neill, 2021). Recent economic growth is attracting tourists and investors to this place. At the present time, there are two giant businesses namely, Dhiraagu and Wataniya Telecom competing in the telecommunication industry of Maldives. However, before 2006 (entry of Wataniya), Dhiraagu was the only player in this industry or it can be said that Dhiraagu firm was the industry itself. This firm (before 2006) is a perfect example of a monopolist. A monopolist is a firm that serves the entire market demand and hence enjoys some degree of market power. This type of market structure arises when there is only one firm serving a typical commodity or service that no other firm does plus if the firm has an exclusive right (government license or permit) to serve a particular market or to provide a particular commodity or service or when the firm has extensive economies of scale and thus can create barriers fo the new entrants (Osborne, & Rubinstein, 2020). Although in this case, the prime reason for Dhiraagu operating as a monopolist is the government license which was provided to only Dhiraagu and not the others till 2006. 

This paper aims to analyze the efficiency of telecommunication services in the Maldives. It will discuss the market structure of the telecommunication industry and how the prices and output are determined in this industry before the entry of Wataniya and how the market structure and the determination process of price and output changed after the same. The impact of this kind of market structure on society as a whole will be discussed in this report. 

The output and pricing decisions of Dhiraagu before 2006 were just like a monopolist. According to Browning, & Zupan (2020), a profit-maximizing monopolist fixes its profit-maximizing output such that the marginal cost (MC) of producing that level of output is equal to the marginal revenue (MR) of producing the same. Unlike perfectly competitive firms, the monopolists enjoy market power as it is the only provider of that particular product or service and hence set a price (higher than MR) which is equal to the consumers’ maximum willingness to pay to buy the profit-maximizing level of output. Thus, a monopolist captures the whole consumers’ surplus (the difference between the price paid and the maximum willingness to pay). It can be seen in the graph below that, Em is the point where the monopolists set the output (Qm) and then take the maximum willingness to pay from the demand curve to determine the price (pm). 

Fig 1: Monopoly and price determination

Source: Author’s calculation

The MR curve in the case of a monopolist is a downward sloping curve (not a horizontal straight line like in the perfectly competitive market) and for any level of output, the MR of the firm is not equal to the price. The reason behind these lies in the relationship between the MR and the price elasticity of demand and the market power of the monopolist. The price elasticity of demand is the percentage change in demand that resulted from a one percent change in the price. The relation between MR and price elasticity of demand (e) can be represented by the following expression: 

MR= P*{1-(1/|e|} 

In the case of perfect competition, the price elasticity of demand is zero, and thus MR=P. However, in this case, |e|>1 (as the monopolists always operate on the elastic part of the demand curve), and thus MR<P in the case of a monopolist. The MR is falling because the demand for any product falls as the price rises and the monopolist sets a different price for a different level of output.

It can be noted that, in the perfectly competitive market structure, the industry output is set at Qc (by following the rule: price=marginal cost) and the equilibrium price is Pc. Thus, the total surplus in the case of perfect competition was an area CEcD’ (according to Nguyen, & Wait, 2015), consumers surplus is area D’EcPc plus Producers surplus is PcEcC). In a monopoly market structure, the market surplus is area D’REmC (Consumer surplus area D’PmR plus producers’ surplus PmREmC). The deadweight loss is area REcEm and hence it can be understood that the telecommunication market in the Maldives was not efficient even before 2006. It can be seen in the annual reports of Dhiraagu (2006), that even in the 2006, it used to enjoy gross profit of worth 1073357. 

In 2006, Watania was given the license to serve the market as a telecommunication provider the structure of this industry changed to a duopoly market. According to Pindyck et al (2018), a duopoly market structure occurs when two large firms serve the entire demand in the market for the same product or service. In this case, these firms also enjoy some degree of market power. However, as the number of firms rises from one to two, the market share of each firm falls (given the total market demand). The same events happen with Dhiraagu and Watania. To gain greater market share and retain customers they had to engage in vigorous competition. In this case, the firms engage in quantity competition by following the Cournot model. 

 

Fig 2: Duopoly output determination

Source: Author’s calculation

In the above diagram, Q1, Q2, and RF1, RF2 are the respective quantities and reaction functions of firms 1 and 2. The reaction curve of firm 1 (or 2) shows all the profit-maximizing output levels that can be produced by firm 1 (or 2) given the output decisions of firm 2 (or 1). Thus, the meeting point (Nash equilibrium) of these two reaction functions gives the optimal quantity supplied by the two firms (q1 and q1). The determination of price in the case of the Cournot model is the same as the monopolist. After determining the quantity, according to the market share (that is from the Cournot Nash equilibrium), the price is set by each firm according to the customers’ maximum willingness to pay for the services of the respective firm (Cosandier, 2018).

In recent times, the firms do not compete in any kind of price competition (that is attracting people by reducing price levels to gain a larger market share) rather keep similar price levels for similar services. This is a good policy considering the fact that price competition between the firms reduces the profit margin. However, these firms have a chance to increase their joint profit level by forming a cartel between themselves. Although according to OECD (n.d.), forming a cartel is illegal and hence is considered a criminal offense. Cartels cause potential harm to the consumers as forming a cartel provides the firms a major degree of market power which is used to extract the consumers’ surplus and create inefficiency in society. However, the firms can form a price-fixing cartel informally where they agree to set similar prices for similar services. The price and output determination process in the case of a price-fixing cartel can be understood from the graph below: 

 

Fig: Price-fixing in cartels

Source: Author’s Calculation

The left-hand panel in the above figure shows the firm-level marginal cost and average cost curves and the right-hand panel shows the industry level of the same. The price is the same (denoted by P (cartel)) for the firms and determined from the industry demand and supply but the quantity supplied by a single firm is decided according to its market share in the total industry demand. 

The overall efficiency of the telecommunication industry after 2006 can be explained with the help of the following diagram.  

Fig: Profit and deadweight loss in the case of cartel

Source: Author’s calculation

Here, Qc is the competitive market output and Q is the output in the telecommunication industry in the presence of the price-fixing cartel (this graph is similar to the graph in the right hand panel of the previous diagram). In this case, the industry profit is area PmRST (T shows the average cost level for producing Qm output). By forming cartels, the firms can maximize their joint profit or the industry profit (in the case of a monopolist the whole area goes to the monopolist only).This market is also inefficient as the operation of duopoly firms creates deadweight loss of area REcEm just like the monopoly market. Thus, Dhiragu still enjoys ahigh growth in profit and revenue in recent years (Dhiraagu, 2021). However, such cartel is not likely to sustain in the long run as a firm has incentive to earn more profit and market share by reducing price level (Levenstein, & Suslow, 2016). 

Conclusion

The aim of this report was to analyze the efficiency of the telecommunication market in the Maldives. From the above discussion, it can be understood that the monopoly or duopoly practice in the telecommunication industry of the Maldives does not provide an efficient market structure as there is a loss of market surplus in each case (before and after 2006). The only difference is that after 2006, the consumers’ surplus is being captured by two firms instead of one. However, the customers are not getting the quality service for which they have paid a high price. There is not much effort on part of Dhiraagu or Watania to improve the quality of the service as the customers can’t shift their demand to any other firms (or substitutes). Increasing competition within the industry is helpful to reduce the inefficiency in the market. Thus, it can be concluded that the telecommunication industry in the Maldives is not efficient and government intervention to increase the competitiveness in this industry is highly recommended.  

Reference

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Cosandier, C. L. (2018). Essays in applied microeconomic theory (Doctoral dissertation, University of Iowa).

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Dhiraagu. (2022). Annual Reports. Dhiraagu.com.mv. Retrieved 31 March 2022, from

https://www.dhiraagu.com.mv/clients/Dhiraagu_CA2BB809-3A22-485B-A518-DA6B6DE653A5/contentms/img/document/ar-report/Dhiraagu_Annual-Report_2020.pdf.

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Nguyen, B., & Wait, A. (2015). Essentials of microeconomics. Routledge.

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https://www.oecd.org/competition/cartels/.

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Osborne, M. J., & Rubinstein, A. (2020). Models in Microeconomic Theory (‘He’Edition) (p. 362). Open Book Publishers.

Pindyck, R. S., Rubinfeld, D. L., Rabasco, E., Toharia, L., José María, O. K., & Flores, M. A. C. (2018). Microeconomia. Madrid: Pearson Educación.