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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