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Maximum	
  Prices	
  
EdExcel	
  Economics	
  1.4.1	
  
Maximum	
  Prices	
  /	
  Price	
  Caps	
  –	
  Some	
  Topical	
  Issues	
  
Housing	
  Rent	
  
Controls	
  
Energy	
  Price	
  Caps	
  
to	
  control	
  fuel	
  bills	
  
Caps	
  on	
  CEO	
  Pay	
  /
Bonuses	
  
Cap	
  on	
  Mobile	
  
Roaming	
  Charges	
  
Price	
  capping	
  for	
  
water	
  companies	
  
Cap	
  on	
  interest	
  
rates	
  charged	
  by	
  
pay-­‐day	
  lenders	
  
Cap	
  on	
  annual	
  
charges	
  to	
  
occupaDonal	
  
pension	
  plans	
  
Currency	
  peg	
  e.g.	
  
Hong	
  Kong	
  /	
  US	
  
dollar	
  
The	
  government	
  or	
  an	
  industry	
  regulator	
  can	
  set	
  a	
  maximum	
  price	
  
to	
  prevent	
  the	
  market	
  price	
  from	
  rising	
  above	
  a	
  certain	
  level	
  
Maximum	
  Price	
  Analysis	
  Diagram	
  
QuanDty	
  supplied	
  
P1	
  
Q1	
  
A	
  maximum	
  price	
  must	
  be	
  set	
  below	
  the	
  normal	
  free	
  market	
  
equilibrium	
  price	
  to	
  have	
  any	
  effect	
  on	
  price	
  and	
  output	
  
Market	
  
Demand	
  
Max	
  Price	
  
Q2	
  
Price	
  
Q3	
  
Market	
  
Supply	
  
Max	
  Price	
  (price	
  ceiling)	
  
Free	
  Market	
  
Equilibrium	
  
An	
  alternaDve	
  to	
  a	
  
maximum	
  rent	
  is	
  a	
  rent	
  
subsidy	
  for	
  housing	
  which	
  
is	
  the	
  equivalent	
  of	
  an	
  
increase	
  in	
  income	
  
Maximum	
  Price	
  Analysis	
  –	
  “Black	
  Market”	
  Prices	
  
QuanDty	
  supplied	
  
P1	
  
Q1	
  
If	
  quanDty	
  is	
  restricted	
  to	
  Q3,	
  then	
  some	
  consumers	
  will	
  be	
  
willing	
  to	
  pay	
  a	
  higher	
  “unofficial	
  price”	
  at	
  P2	
  
Producers	
  can	
  extract	
  extra	
  consumer	
  surplus	
  at	
  higher	
  price	
  
Market	
  
Demand	
  
Max	
  Price	
  
Q2	
  
Price	
  
Q3	
  
Max	
  Price	
  
P2	
  
Market	
  
Supply	
  
Extracted	
  
consumer	
  
surplus	
  above	
  
the	
  official	
  
price	
  ceiling	
  
Possible	
  unofficial	
  
price	
  above	
  the	
  ceiling	
  
Some	
  
raDoning	
  or	
  
aucDon	
  
process	
  may	
  
be	
  needed	
  if	
  
output	
  =	
  Q3	
  
Applied	
  Micro:	
  Plans	
  for	
  an	
  Energy	
  Price	
  Cap	
  
Output	
  
of	
  gas	
  
P1	
  
Q1	
  
D	
  
Max	
  
Price	
  
Price	
  
of	
  gas	
  
Q3	
  
S	
  
In	
  2013,	
  ex-­‐Labour	
  Leader	
  Ed	
  Milliband,	
  announced	
  that	
  he	
  would	
  
consider	
  capping	
  fuel	
  prices	
  if	
  elected	
  into	
  Government	
  in	
  2015	
  
•  Milliband	
  argued	
  that	
  rising	
  fuel	
  
prices	
  benefit	
  only	
  the	
  privately-­‐
owned	
  firms	
  that	
  sell	
  the	
  fuel.	
  
•  These	
  firms	
  benefit	
  unfairly	
  
because	
  there	
  is	
  limited	
  
compeDDon	
  in	
  the	
  fuel	
  
generaDon	
  and	
  retail	
  markets.	
  
•  Because	
  demand	
  for	
  fuel	
  is	
  price	
  
inelasDc,	
  an	
  increase	
  in	
  fuel	
  bills	
  
reduces	
  people’s	
  real	
  
purchasing	
  power	
  
•  The	
  main	
  case	
  for	
  the	
  energy	
  
price	
  cap	
  proposal	
  is	
  to	
  increase	
  
fairness	
  for	
  families	
  on	
  low	
  
incomes	
  
Opponents	
  of	
  a	
  price	
  
cap	
  argue	
  that	
  more	
  
compeDDon	
  is	
  a	
  
beaer	
  long-­‐term	
  
strategy	
  to	
  lower	
  
prices	
  
EvaluaGng	
  Price	
  Caps	
  in	
  Different	
  Markets	
  
A	
  maximum	
  price	
  also	
  involves	
  a	
  normaGve	
  judgement	
  on	
  behalf	
  of	
  
the	
  government	
  about	
  what	
  that	
  price	
  should	
  be	
  
Benefits	
  
•  A	
  useful	
  surrogate	
  
for	
  compeDDon	
  
•  Holds	
  prices	
  down	
  
–	
  consumer	
  
welfare	
  gains	
  
•  IncenDves	
  for	
  
businesses	
  to	
  cut	
  
costs	
  to	
  maintain	
  
profits	
  
Downsides	
  
•  Reduces	
  profits	
  –	
  
less	
  money	
  for	
  
capital	
  investment	
  
•  May	
  dissuade	
  new	
  
entrants	
  
•  Firms	
  might	
  raise	
  
prices	
  in	
  other	
  
ways	
  
AlternaGves	
  
•  Measures	
  to	
  
reduce	
  entry	
  
barriers	
  in	
  an	
  
industry	
  
•  Higher	
  taxes	
  on	
  
monopoly	
  profits	
  
e.g.	
  a	
  windfall	
  tax	
  
Maximum	
  Prices	
  
EdExcel	
  Economics	
  1.4.1	
  

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Maximum prices

  • 1. Maximum  Prices   EdExcel  Economics  1.4.1  
  • 2. Maximum  Prices  /  Price  Caps  –  Some  Topical  Issues   Housing  Rent   Controls   Energy  Price  Caps   to  control  fuel  bills   Caps  on  CEO  Pay  / Bonuses   Cap  on  Mobile   Roaming  Charges   Price  capping  for   water  companies   Cap  on  interest   rates  charged  by   pay-­‐day  lenders   Cap  on  annual   charges  to   occupaDonal   pension  plans   Currency  peg  e.g.   Hong  Kong  /  US   dollar   The  government  or  an  industry  regulator  can  set  a  maximum  price   to  prevent  the  market  price  from  rising  above  a  certain  level  
  • 3. Maximum  Price  Analysis  Diagram   QuanDty  supplied   P1   Q1   A  maximum  price  must  be  set  below  the  normal  free  market   equilibrium  price  to  have  any  effect  on  price  and  output   Market   Demand   Max  Price   Q2   Price   Q3   Market   Supply   Max  Price  (price  ceiling)   Free  Market   Equilibrium   An  alternaDve  to  a   maximum  rent  is  a  rent   subsidy  for  housing  which   is  the  equivalent  of  an   increase  in  income  
  • 4. Maximum  Price  Analysis  –  “Black  Market”  Prices   QuanDty  supplied   P1   Q1   If  quanDty  is  restricted  to  Q3,  then  some  consumers  will  be   willing  to  pay  a  higher  “unofficial  price”  at  P2   Producers  can  extract  extra  consumer  surplus  at  higher  price   Market   Demand   Max  Price   Q2   Price   Q3   Max  Price   P2   Market   Supply   Extracted   consumer   surplus  above   the  official   price  ceiling   Possible  unofficial   price  above  the  ceiling   Some   raDoning  or   aucDon   process  may   be  needed  if   output  =  Q3  
  • 5. Applied  Micro:  Plans  for  an  Energy  Price  Cap   Output   of  gas   P1   Q1   D   Max   Price   Price   of  gas   Q3   S   In  2013,  ex-­‐Labour  Leader  Ed  Milliband,  announced  that  he  would   consider  capping  fuel  prices  if  elected  into  Government  in  2015   •  Milliband  argued  that  rising  fuel   prices  benefit  only  the  privately-­‐ owned  firms  that  sell  the  fuel.   •  These  firms  benefit  unfairly   because  there  is  limited   compeDDon  in  the  fuel   generaDon  and  retail  markets.   •  Because  demand  for  fuel  is  price   inelasDc,  an  increase  in  fuel  bills   reduces  people’s  real   purchasing  power   •  The  main  case  for  the  energy   price  cap  proposal  is  to  increase   fairness  for  families  on  low   incomes   Opponents  of  a  price   cap  argue  that  more   compeDDon  is  a   beaer  long-­‐term   strategy  to  lower   prices  
  • 6. EvaluaGng  Price  Caps  in  Different  Markets   A  maximum  price  also  involves  a  normaGve  judgement  on  behalf  of   the  government  about  what  that  price  should  be   Benefits   •  A  useful  surrogate   for  compeDDon   •  Holds  prices  down   –  consumer   welfare  gains   •  IncenDves  for   businesses  to  cut   costs  to  maintain   profits   Downsides   •  Reduces  profits  –   less  money  for   capital  investment   •  May  dissuade  new   entrants   •  Firms  might  raise   prices  in  other   ways   AlternaGves   •  Measures  to   reduce  entry   barriers  in  an   industry   •  Higher  taxes  on   monopoly  profits   e.g.  a  windfall  tax  
  • 7. Maximum  Prices   EdExcel  Economics  1.4.1