3.6.2 The impact of government intervention

Question 1

What are the advantages of an energy price cap?

Answer 1

1. Cap protects consumers from over-charging due to the power of dominant suppliers who make high profits
2. High fuel bills hurt lower-income families who are at greater risk of fuel poverty – relatively poorer families
   spend a higher percentage of their disposable income on energy bills.
3. Price cap will encourage energy suppliers to increase productive efficiency (lower LRAC) to improve profits
4. The cap can be temporary & lifted if competition improves

Question 2

What are the disadvantages of an energy price cap?

Answer 2

1. Price cap might hurt competition by reducing profits and therefore lowering the incentive for new challenger
   firms to enter industry
2. Price tend to gravitate towards the cap so average prices for customers might actually increase rather than
   fall
3. Fall in profit will mean less investment in renewables – operating profit of energy suppliers is only 5%
4. Better long-run strategy is to focus on nationwide housing insulation programme to improve energy efficiency

Question 3

List the indicators and the questions that might be used to judge the effectiveness of industry regulation.

Answer 3

1. Real prices for consumers – are prices falling in real terms (i.e. after inflation) so that consumers find a product
   more affordable. A good example to use might be reductions in the real interest rates on pay day loans
   following direct intervention by the UK competition authorities
2. Jobs – to what extent is regulatory intervention leading to gains in employment?
3. Research spending – to what extent is the regulatory environment helping to sustain a high level of research
   and development spending to speed up the rate of product and process innovation?
4. Investment in new capacity to meet future demand – is the regulatory environment providing sufficiently
   strong incentives for the investment needed to cope with growing populations and rising real incomes?
   Telecoms, transport and power are three industries with notably high levels of required investment.

Question 4

What are the limits to government failure?

Answer 4