Assess how the regulation of energy suppliers’ profits is likely to affect consumers and suppliers in the energy market

Edexcel A-Level Economics Paper 1 June 2018 Extract

With reference to Extract B, assess how the regulation of energy suppliers’ profits is likely to affect consumers and suppliers in the energy market. (10 marks)

1. A profit cap is likely to increase consumer surplus.
2. A profit cap limits how much profit firms can make as a proportion of their total revenue.
3. Extract B mentions a recommended profit cap of 1.25% of total revenue.
4. This means that firms who were previously making high levels of supernormal profit might be forced to reduce their prices to avoid a fine from OFGEM.
5. As a result, consumers can benefit from more consumer surplus, as there is a greater difference between the prices consumers were willing and able to pay, and the price they actually end up paying.

1. However, instead of reducing prices, firms might become less incentivised to control costs.
2. Firms can start to show signs of X-inefficiency when they don't produce on the lowest possible average cost for any given level of output.
3. This means that there is more wastage, and consumers still have to pay higher prices.

1. Energy producers are likely to re-invest less.
2. If firms can retain less profits consistently, they have less money left to re-invest.
3. Scottish Power said that the profit cap would 'reduce investment' across the energy industry.
4. This means that they will find it more difficult to consistently innovate their services.
5. This means that the market will experience a fall in dynamic efficiency, and customers also suffer from poorer quality services.

1. However, if firms know that they can only keep so much of their revenue as profit, it might actually incentivise them to increase the amount they spend on factors of production like capital.
2. This actually means that they might re-invest more during each financial year.

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