Video Transcript: Competition Policy: Price Regulation

Hello, welcome. We're going to discuss competition policy, price regulation first,  when we talk about price intervention, not all prices are set by the free market of supply and demand. A lot of times, government will have intervention trying to  maintain the price for consumers. If there is limited supply, but quite high  demand, can, companies will be able to set prices high, because there are no  no real market forces in competition driving the prices down. So the  government, at times, will step in and set a price cap, saying that producers of a  certain good or service can only set prices so high because there'll be an  artificial under supply, because there's not very much competition in the market.  So governments try to mitigate those unnecessary price ranges and protect  consumers purchasing power by capping prices. Good examples are rail fares,  the cost of postage stamps and water bills. So obviously, there's only so much  rail, right? Built. There's only so much water in the world, right? So it's all limited  supply. So when there's a limited supply and we can't make more of it, or it's  really difficult to make more of it, sometimes prices can inflate to very high levels where the government steps in and they put a cap on those prices to protect  consumers. So in the UK, the rail industry, some fares are unregulated, and this  allows the train operating company to set their own prices. And this may be  someplace where you may find a bigger city where there is more competition in  the rail industry, so they are being used by consumers as day to day passage  vehicles. So there's going to be a high, high demand, a high supply. So so  prices may work themselves out and find a market equilibrium, whereas some  may not. So the government steps in and they cap the prices and they regulate  them. So price capping is an alternative to rate of return regulation in which  utility businesses are allowed to achieve a given rate of profit on their capital. So utility businesses, electric companies, water companies, things like that, they  are only allowed by the government to make a certain return on their  investment, and then the government caps it, and then they have a certain rate  of return on their capital that the government will allow. Price capping in the UK  has been known as RPI X. This takes the rate of inflation and subtracts the  expected efficiency savings. So for example, if inflation is 5% and 3% is what  can be raised by the industry, right? We can then raise prices 2% so if inflation is 5% and the X is 3% then an industry can raise prices, on average by 2% so the  government sets the 3% rate right? So they come in and they say, Okay, this is  the expected inflation. This is where we see the efficiency savings for the  consumer, the 3% so now, because we want to make sure that we are  protecting the consumer with the 3% insulation from that inflation, the 2% is now what those industries can raise the prices to in the terms of price capping in the  water industry, the formula is RPI plus x, minus x plus k, where k is based on  capital investment requirements designed to improve water quality and meet EU water quality standards. So we want to make sure, and especially in the water  industry, you want to make sure that, obviously, the capital equipment that is 

cleaning the water that is making it, you know, available to drink and safe. You  want to make sure that that equipment, that technology, is the best, right? So  they're going to make an allotment for capital investment requirements, right?  So they're going to allow this water treatment company to increase their prices  based on their capital investment to ensure that the equipment standards are up to par and water quality is excellent for the consumers. And they also bring in  the rate of inflation, which is the RPI minus the x, which is the more. In for the  consumer protection, and then you're going to add in the capital investment.  Then this is typically government controlled utilities. So that's how that works.  The UK recently introduced a price cap on payday loan interest rates, which I  thought was interesting. Fact, payday loan interest rates can get out of control.  So they thought that it would be an extra protection to the consumer to put a cap on these interest rates, and they're taking advantage of the consumer, and those companies can be taking advantage of the consumer. So the government will  step in and regulate those prices around 45% of UK rail fares are subject to  regulation Since 2015 This is limited the rate of RPI inflation. All other fares are  set at a commercial rate by the train operating companies. So you can see how  UK rail fares have increased or the prices have inflated over time. In the past 11  years, they've increased from 2003 to 2014, about 50 something percent. So we can go through and see how it's gradually. The gradual rate of inflation has  taken place, and the fares for the rail have not went extremely high. It's  incrementally climbing, and you can see the relevancy of the price caps,  because prices don't have large fluctuations. Arguments for price capping.  Capping is an appropriate way to curtail the monopoly power of natural  monopolies, or dominant firms, thereby preventing them from making excess  profits at the expense of consumers. So governments want to protect the  consumer. They want to make sure that they aren't operating companies aren't  operating as a monopoly, and they're not dominating the industry solely and that they aren't charging exorbitant amount of prices and making exorbitant profits at  the expense of consumers. So the government wants to control that protect  consumers. Cuts in the real price levels are good for household and industrial  consumers, leading to an increase in consumer surplus and higher real living  standards in the long run. So this is going to help the consumer out, because  they're going to have more discretionary income to spend, and overall is going  to help the market, because people be able to spend more money on different  products, and they won't just have to spend money on these high priced goods.  And the government allows for the competition to happen. And the consumer  protection through these price through the price capping system, price capping  can help to stimulate improvements in productive efficiency, because lower unit  costs are then needed to increase a producer's profits. So if the government  doesn't cap prices to some certain extent in certain industries, raw materials and inputs into production, those costs can rise also, and an unsustainable rate of 

inflation, and then that's going to cost cause the prices in the overall market to  rise as well, because the raw material inputs to create the goods that are being  sold in the market, those prices are Going up too, because prices aren't being  capped for consumer protection. The price capping system can be a tool for  controlling consumer price inflation in the UK, although inflation has been below  the 2% target target in the UK in recent years. So governments want to control  inflation, they want to control prices. They don't want runaway inflation, where  prices go up really fast, right, or they are sustained at very high prices for a long  period of time. We want to make sure that the consumer is protected, that they  can purchase goods and services in the market at a reasonable market rate,  and we want to make sure that companies aren't bidding up the price artificially  of their products and their goods and services to make excess profits, and  therefore harm consumers and harm the overall Market. Consumers against  arguments against price capping. Price caps have led to large number of job  losses in utility industries because they aren't making the profits and their costs  are staying the same or going up due to the price caps, companies may have to  lay people off in order to break even or make a profit and not lose money.  Setting different price capping regimes for each industry distorts the working of  the price mechanism. So when you put a price cap on a good or service, you're  not really allowing the free market to determine the market price. You're.  Artificially setting the price, saying it cannot go further than this price. So if the  market is willing to pay more for the price, but the government finds that it's  unnecessary, and they price cap it, and they know that if the price gets bid up  too high, that lower level consumers won't be able to afford it, then they'll come  in and price cap it, but at the same time, it doesn't find a true market equilibrium, and based off of the supply and demand in the market, the industry regulator  may not have enough accurate information when setting the price cap for future  years. This can lead to regulatory failure. So a lot of times, the regulator won't  have the guidance to know moving forward what's going to happen in the  industry or the market. So they may come in and set a cap, but it may be the  wrong cap price. So if that happens, then you might it might result in regulatory  failure, and price discovery won't be maximized because we've got an artificial  cap, and the government has to revisit that issue and hopefully realign the cap  to make it better for the company and the consumer. Capping prices means  lower profits, which in turn can lead to reduced capital investment by the utility  businesses. Ultimately, consumers suffer if there is under investment in utility  infrastructure, because this limits supply. So this is another reason why we have  got to make sure that it's fair, equal and balanced in the price capping system.  Yes, it's necessary to not let prices get too high so that consumers can manage  the costs and afford, especially the utilities like a water company, so we need to  make sure that it's ran balanced, so that they can have enough cash to make  sure that the utility is ran properly, ran effectively, ran efficiently, in a safe 

manner, so that people can get the service that they need, and that's clean  drinking water, right? So we need to make sure that that we don't hinder the  industry so much, that we crush their cash flow, and that they're not able to  

invest in their business, and that way they can invest wisely and not under  invest, and make sure that everything continues to run smoothly, operationally  sound, let's not cap it so much that we hurt their industry. Unintended effects of  price capping Financial Conduct Authority decided to cap UK payday loans at . 08% interest a day. An unintended consequence of this is that the market supply of payday loans will fall. So no one in the market is going to come in and they  don't want to offer loans anything less than .08% per day, right? They they want  to charge .08% or more. So that means the amount of loans will fall. This means some will be vulnerable and will turn to the black market, potentially for loans,  right? And this makes the problem of sky high consumer debt even worse. So  even though it's a good idea to cap the loans, if people need the money, they're  going to go find the money elsewhere. So there's unintended consequences  with government actions as far as price regulation, price capping, high prices,  high profits. So if we look back and we think, okay, we see that the price on this  mobile internet, you can see that they've driven the price up, right, and the price  has come down considerably, but then they've capped it, so as they've capped  it, You can see that the demand has fallen as the data usage has been capped,  so companies are making less money because of the cap, because people can  use less data. Impact of price capping on the market to be effective, the cap  must be set below the normal profit maximizing price a price cap lowers the  monopoly profit made by dominant firms and the market. So we're trying to  control the price they're not these firms that have price caps imposed on them.  They won't be able to make as much money as they once did, but they're getting a price cap placed on them to protect the consumer so that they don't have sky  high prices. The price cap may stimulate attempts to improve cost efficiency. In  theory, it leads to an improvement in allocative efficiency and consumer welfare  May. Lead to the exit of some businesses from the industry, which reduces  competition. Overview of price capping on a market. So let's look at the benefits, the benefits of price capping a useful surrogate for competition, right? It's going  to increase competition and make prices more fair, because nobody can charge  more than this price holds consumer prices down, consumers gain because  things are more affordable, and therefore the overall market will improve  incentives for businesses to cut costs to maintain profits. So downside of price  capping reduces profits, less money for capital investment for firms may  dissuade new entrance into the market, which limits competition. Firms might  raise prices in other ways. So alternatives to price capping measures to reduce  the entry barriers in an industry, right? So if there's a high barrier to entry  business or into industry, and there's a price cap that's just going to make firms  less likely to try to enter into that industry, because the price cap limits their profit

margin, higher taxes on monopoly profits, a windfall tax. So if there's a  monopoly, they dominate the industry. There's a price cap, they're going to get  higher taxes through the price cap.