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
