Energy price caps

Labour leader Ed Miliband has recently announced that is Labour were to be elected, there would be a 14 month cap on energy prices. Anyone with a keen eye on business or an interest in economics will no doubt be intrigued as to the underlying business and economics behind this.

The first thing which strikes me about the price caps is that energy is a fairly competitive marketplace. There is no one company with a monopoly and a number of companies compete for customers’ revenues.  One must assume that the price caps would allow companies to operate and generate profit, and if this is the case, why does one company not simply drop its prices and take the business of competing firms?  Whilst one can assume that a start-up company cannot compete in the market due to the extortionate barriers of entry, namely capital investment and the infrastructure required, one could reason that a large company, such as Centrica could afford to be dominant in terms of price due to the economies of scale which they utilise to lower the cost of production.

The next pertinent question is whether the companies actually can afford to lower their prices. Centrica made £2.5 billion profit on a £23 billion turnover last year ; an 11.5 % net profit, meaning that if revenue were to decrease by about 10 % due to price caps, and costs of factors of production were to rise , Centrica would almost certainly be making a loss. It would then be likely that mass layoffs and downsizing would be necessary , to mitigate the diseconomies of scale which raise costs and alter the Marginal Cost curve for firms, which is again untenable as more companies would need to be created to fulfil consumer demand , which they cannot do due to the aforementioned barriers to entry.

Either way, the energy price cap gives us a fascinating insight into the economics and finances of large energy corporations.