The High Price Of Low Competition.

How competition is the only way to drive prices down.

Consumer choice will always lead to lower prices. This is basic microeconomics and in competition theory the more competitive the market, the lower the prices. This unfortunately does not appear to be apparent in several markets in the UK and it is especially true in markets where demand is derived. Derived demand is basically when you demand a good or service not for its own sake, but for the goods or service derived from it. Transport is an example where customers don’t especially want to sit (or probably stand) on a train to get work because they enjoy the journey, rather, they demand this service because they know it is vital for them to get to work. It is in these markets, transport, utilities, telecommunication networks, supermarkets and the like where there is little competition and thus high prices as a result. Consumers have very little choice but to pay the competitive rate for these services due to the market structure.

The industries mentioned resemble an oligopoly, and market structure with a few firms. It has very high barriers to entry, which means it is usually very difficult for a new entrant or entrants to enter the market because there are usually very high financing costs or even legal parameters preventing new entrants. The problem with oligopolies is that because there is such little competition as a customer you end up paying more or less the same for your goods or services, so firms usually have to rely on non-price competition in order to increase their share of the market.

The global economic crisis has led to a sharp increase in the rate of unemployment and in particular in the UK. This has in turn placed a huge burden on households up and down the country and when you consider inflation is stubbornly high in recent years which reduces spending power, the price you pay for goods and services that are essential has a huge impact on your disposable income. If you look at inflation for a moment (currently 2.2%), if the rate of inflation is higher than your pay rise then your pay has not actually increased because all goods and services around you have increased in proportion, so your nominal wage may have increased, but your real wage (inflation adjusted) has not.

Now if we look at the oligopolies again, take energy for example. There are six major suppliers in the UK. They are EDF, E.ON, N Power, British Gas, Scottish Power and SSE. An important feature of this market structure is collusion. Whether it is deliberate or tacit it does not matter because if one firm reduces its prices then others are likely to follow suit because they know they are selling the same good, so there is nothing stopping a customer from going elsewhere for a cheaper price. Collusion will occur in an oligopoly regardless of the good or service. Energy firms advice customers to shop around for the best rates, the savings will be marginal at best and they only work because majority of people pay above what they actually should, so it balances out.

Five of the six major UK energy suppliers will increase their prices

Even David Cameron weighed in on the debate, exclaiming that he would “force” energy firms to offer their customers lower rates. Ofgem later published a document demonstrated that the simplification of retail energy tariffs would be complicated. Moreover, whilst his intentions may have been good, it has proved futile; customers are going to face high prices regardless.

John Kay in Financial Times last Wednesday alluded to the fact that regulation may actually hamper business activity, not aide or regulate it. Regulation is a surrogate form of competition, it can never and will never guarantee low prices or optimal consumer choice because there is nothing a regulator can do about tacit or overt collusion in a market. If the government wanted lower prices for energy they could break down some the legal barriers preventing newer entrants into the market. If for example there were ten to fifteen energy suppliers firms are likely to lower prices in order to increase market share because consumers would usually go for a firm offering the same good or service at a lower price. As it remains however, the six major firms can effectively charge what they want because they know that consumers cannot go without heat or electricity so they are forced to pay.

  • SSE: 15 October, gas and electricity up 9%
  • British Gas: 16 November, Gas and electricity up 6%
  • Npower: 26 November, Gas up 8.8%, electricity up 9.1%
  • Scottish Power: 3 December, gas and electricity up 7%
  • EDF: 7 December, gas and electricity up 10.8%
  • E.On: No price rise before the end of 2012

The energy sector is not the only market that has squeezed incomes and thus reduced spending power; mobile phone networks are also high on the list. There was a time in which a twelve-month contract was readily available. Again, in a market where there is such little competition the realization that you are more or less going to pay the same rate is again apparent in this market. The fact that T-Mobile and Orange have merged into Everything Everywhere makes matters worse for the consumer because it has reduced its competitiveness even more.

I personally feel that the government needs to make it far easier for new entrants to break into what appears to be closed off markets. There are legal barriers preventing new firms entering transport, so the same firms dominate the market, to the detriment of the consumer. This was the whole point of privatisation, to remove state ownership and open it up to the market, but state ownership has been replaced by private ownership and it is very much closed off. This issue is especially poignant as we see the standard of living continue to fall as a result of high inflation and sluggish economic growth. The fact that essential goods are rising accordingly only squeezes more out of the pockets of those who struggle to keep up with the price increases. Moreover, more competition ensures lower prices, regardless of regulation.

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