In Hong Kong, the supply of electric power is monopolized by two vertically integrated companies. Hong Kong Electric supplies Hong Kong Island, while China Light and Power supplies Kowloon and the New Territories. The Hong Kong government regulates each company to a maximum 9.99% rate of return on net fixed assets. Although the two companies' networks are just a few kilometers apart, they do not interconnect.

a.Discuss vertical integration.

b.How does vertical integration differ from horizontal integration? Explain.

c.Discuss whether vertical integration of the Hong Kong electricity industry is economically efficient.

d.Given differences in the demand for electricity between Hong Kong Island and Kowloon and the New Territories, how would interconnection increase economic efficiency?

e.Why do the two electricity companies oppose interconnection?