In this assignment I will be discussing if the UK government should put a cap on retail price of electricity. Demand for electricity will be always high as we need and use electricity in everyday life e.g. charging are electrically devices overnight to using the microwave to reheat food all use electricity, this high level of electrical consumption creates high levels of demand which in turn creates competition between companies.
Competition between electricity companies allow prices to differ from each to lure people into using their electricity provider. There are to arguments to essay the positive effect of capping electricity prices versus the negative effect of caps on electricity price. Capping electricity prices could stifle competition within this sector as the incentive to switch for customers isn’t there, leading to a decline in investments with in the sector. But then, it could help families who are less able to afford the high prices of electricity them cap can it to become more affordable for them.
Through this essay I will be providing positive and negatives arguments of electricity caps and how effective these caps will be, also I will be referring to various neoclassical theories of competition.A price cap on electricity positively helps consumers especially those who are vulnerable or financial worse of.One of the biggest positives that come from electricity caps is the knowledge of consumers knowing what their electricity bill will be, a price cap on electricity would reduce consumers electricity bill being so volitaly. Being on a fixed cap reduces the shock of high bills, this knowledge could entice customers to stick to their provider as they know what their bill will be and be granted stability from the price cap.. Loyalty from customers allows electricity providers to stay competitive within the electricity sector.
Another positive would be that consumers are protected from an increase in the cost of electricity. Price caps helps prevent suppliers from swindling consumers on high cost of electricity, or charging ridiculous high prices for scarce goods or services simply because they are able to. Price caps are also are helpful for keeping the cost of living low during periods of high inflation. Inflation describes the trend of prices for goods and services to gradually increase over time.
During high inflationary periods, prices increase faster than incomes, which reduce the purchasing power, making price caps necessary for consumers to maintain their standard of living.The theory of Marginal utility is ‘that any consumer derives from successive units of a particular product diminishes as his or her total consumption of that product increases, while holding constant the consumption of all products(Lipsey + chrystal principles of economics). Electricity provides an excellent example. We all use electricity in many forms watching TV, washing clothes to even cooking on electric cookers. The consumption of electricity has become necessary in our everyday life. So we value the cost of electricity that we are willing to pay high price for it. The utility of thath much electricity becomes very high, more than the minimum that will be used, however the utility of that much electricity being used over a period of time will decrease.
If the government were to put price caps in place they will be maximising consumer’s marginal utility as with a price cap in place the consumers will be maximising the consumption of their electricity provided as the law of marginal utility states that the first ‘x’ is worth more than the second ‘x’. Price caps can be quite tricky to examine because there are conflicting ways of looking at each individual case. For example a football ticket a cap on price will allow supporters who haven’t got the money to afford to attend might be given the opportunity to attend with a price cap in place, while an advocate of price cap legislature would argue that a cap allows for the common fan to attend games, a price cap criticiser would argue at the same time that a scarcity has been created and less total fans attended the game. Both sides are correct yet one strategy must be made. This is a major example of where established political views bump heads with market economics.
In studies of the negative impacts of price caps one could claim that without letting a market naturally work its way back to equilibrium then we will never accomplish efficiencyA downside to electricity caps would be that it could destroy competition, Competition and switching electricity provides have been coexistent for ever, this being the only way to get a better energy deal. But for switching to be effective, you need a seeable flux in price to motivate consumers to switch electricity suppliers. A price cap on the price of electricity could lead to many of the cheaper deals to begin to disappear as the lower end electric firms lose their hold on the market resulting in them going out of business if the price cap is set to low then smaller companies won’t be able to compete with the larger firms. If electric firms profits fall then it can reduce the amount of money that they put into essential things like research and development.
England has been on the front of developing offshore wind technology due to a large part of investment by the larger electric companies within the country.Market structures are defined as the type of market that firms operate in. Markets differ by the amount of firms that operate within in them and what product is being produced and sold. When competition is absent, the market is said to be concentrated.
The table to the right shows a rang from perfect competition to pure monopoly. Equilibrium in perfect competition is the point where market demands will be same or equal to the market supply. A firm’s price will be set at this time. In the short run equilibrium will be assumed by demand. In the long term, both the demand and supply of a firm’s product impacted a change in the equilibrium in perfect competition. A firm would only receive a normal profit in the long term at the point of equilibriumThe competitiveness of the market is how much power individual firms have to influence market prices or the terms on which their products are sold.
The less power firms have to influence the their market in which they compete in the more competitive that sector is. Perfect market competitiveness occurs when each firm has no influence or power to control what happens within the sector. In a senorio like this firms are selling identical products and have to accept the force of market demand and market supply, the firms can sell as much as they want but have no ability to control the set price. The terms of which the firm’s product is sold is dissipated if electrical caps are in place as firms have to comply to the market rule. If the government set a price cap on electricity they will be turning the market into a perfect competitive market.
The theory of perfect competition is built on five key assumptions relating to the firm and to the market. The first assumption being ‘all firms in the industry sell an identical product (homogeneous products)’ in this case the product being sold is electricity the second being ‘customers know the nature of product being sold and the prices charged by each firm’ the customers know that product being sold is electricity and they understand the prices set the third assumption is ‘the level of output at which each firm’s long-run average total cost reaches a minimum is small relative to the industry’s total output’ assumption four ‘each firm is a price taker, meaning that each firm can change its rate of production and sales without significantly altering the market price of ist product’ this is why a firm functioning within a perfectly competitive market has no power to control or shape the market through its own actions.The fifth assumption is ‘the industry is assumed to be characterised by freedom of entry and exit’ if the government set price caps on electricity then smaller firms would become less competitive and might be more inclined to leave the market as consumers might turn to larger firms as they will be receiving the small deal.
In a perfect competition each firm’s has a demand curve that is horizontal, as changes in a firm’s outputs no seeable effect on price, this is illustrated with the figure on the left. (Image from ://cohttpsurses.lumenlearning.com/boundless-economics/chapter/perfect-competition/)So in conclusion, the amount someone is willing to pay for an item is the items price. From here we originate our basic set of supply and demand functions for our market structure. Key to the market economy is the term scarcity, demand relative to the supply. Scarcity is what determines the market for goods and services. If the government feels the need to take action in the market it can device a price cap.
The government can approach executing a price control in two different ways. Price caps are defined as when a government sets a minimum or maximum price cap for a particular good or service. In this case the good or service is electricity, a price cap on electricity can both positively and negatively affect the economy. Price caps can destroy competition within the sector pushing out the smaller firms that cannot compete with the larger firms or stay afloat with the price caps. But on the overhand price caps can stop firms from overcharging or taking advantage of vulnerable people, price caps allows customers to obtain better offers and have a sense of security when it comes to their bill.
Price caps can also insure consumers on a better standard of living.