business economic

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Article 1: UK Energy market: Gas and electricity The UK market in gas and electricity is currently subject to a lot of public criticism. Ofgem (the UK government’s
regulator) reported that that competition is being stifled by “a combination of tariff complexity, poor supplier behaviour, and lack of transparency”. The market is
dominated by six large suppliers, and there are strong barriers to entry. Most wholesale gas is imported into the UK from Norway and Qatar, and is priced in US
dollars. A large proportion of electricity is also generated using imported gas in gas-fired power stations. Thus, import prices are important in this market.
According to Ofgem, “there is evidence that the Big Six have adjusted prices in response to rising costs [of wholesale gas] more quickly than they reduced them when
costs fell”. Chief Executive Alistair Buchanan said: “Energy companies have failed to play it straight with consumers and so Ofgem is proposing to break the
stranglehold the Big Six have over the electricity market by making them auction up to 20 per cent of their generation output. This would increase price transparency
and make it easier for new players to enter the retail market. “Consumers have told us that energy suppliers’ prices are too complicated. It is no surprise that they
are bamboozled when tariff complexity has increased from 180 to more than 300 [different prices] since 2008. That is why we are planning to sweep away this complexity
so suppliers’ prices are fully exposed to allow easy price comparisons. “We are also backing these reforms with a tough approach to enforcement. Consumers must have
confidence that energy companies are playing fair at a time when they are being asked to foot the £200 billion bill to pay for the investment Britain needs to ensure
secure and sustainable energy supplies”. Energy prices have become a big political issue, especially since the UK voted to leave the European Union (EU) on 23 June
2016 which led to a significant fall in the exchange rate (pound against the US dollar).

 

Source: adapted from the Ofgem website (2013 & 2017)

Article 2: An energy price cap – a sensible response to a market imperfection
Following concerns about the market power of the Big Six energy suppliers in the UK and high prices for gas and electricity, the industry regulator, Ofgem, referred
the industry to the Competition and Markets Authority (CMA) in June 2014. The CMA published its final report in June 2016. This argued that while there was sufficient
potential for competition, consumers nevertheless needed further encouragement to switch suppliers. This would strengthen competition in the market.
To encourage switching, the CMA proposed the creation of a database that would include the details of customers who have been on a supplier’s core price or standard
variable tariff (SVT) for three or more years. The SVT is the main price that a company sells energy at and could be used to show how a frim determines its
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price for most of its customers as 66% of customers are on this tariff (price plan). Companies price discriminate and do offer different prices to the other 34% of
customers, such as higher prices to customers on pre-payment meters or lower prices to attract price sensitive customers from rival companies with deals for ‘new
customers only’. Competitor energy suppliers would have access to this database to offer better deals for these customers.
There had already been calls for price caps to be imposed on suppliers. For example, in the run-up to the 2015 general election, the then Labour leader, Ed Miliband,
proposed imposing a price freeze. This was criticised by the Conservatives for being too anti-market, that it would encourage energy companies to raise prices prior to
the freeze and that it would be of no benefit in times of falling wholesale energy prices (which was the position in 2015).
Indeed, in its 2016 report, the CMA recommended price caps only for the 16% of people on prepayment meters. But in the run-up to the 2017 election, the Conservatives
announced that if they win the June 2017 election they would, introduce a price cap on SVTs – 66% of customers are on such tariffs. It would be set by Ofgem and
reviewed every six months to reflect changes in the wholesale cost of energy.
Source: Adapted from J. Sloman, The Sloman Economics News Site, 2017

 

Questions: Answer ALL 5 questions below.

(The mark awarded indicates how much work you must do for a specific question. Diagrams can be drawn by hand or using software, but they must not be scanned from books
etc.)

 

1. (a) What are the four main types of market structure? (b) Outline the main features of each one. (c) Find the market share of the big six energy companies. (d) How
would you classify the market structure for the energy industry? (20% of marks) 2. Draw a diagram (that is, use relevant economic theory) to show the determination of
the profit-maximising price and output of one gas company. Explain the diagram, including how abnormal profits may be made by the company. (Note: the standard variable
tariff is the price) (20% of marks)

3. Why are people often reluctant to switch energy supplier and how could they be encouraged to switch supplier? (10% of marks)
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4. The current Conservative Government announced that if they win the June 2017 election they will introduce a price cap on energy. Using a supply and demand diagram,
show the impact of a price cap in the energy market and identify the potential advantages and disadvantages. (20% of marks)

 

5. (a) On a chart, show what has happened to the UK pound (sterling) against the US dollar between 1st June 2016 and 1st May 2017.

(b) Using a supply and demand diagram explain this change in the pound’s exchange rate, ensuring possible reasons are analysed.

(c) How might this change in the pound’s exchange rate affect the price of energy in the UK, and using relevant economic theory (diagrams) explain the impact of this
change in energy prices on the whole UK economy. (30% of marks)