This oligopoly when a firm hikes prices all

This
article is about the rise in price of dual fuel in UK, the combination of
electricity and gas provided by the same energy supplier.

 

 

According to
the article in UK there are six big energy companies that dominate the market. A
market structure controlled by a small number of large firms is called
oligopoly, they could be differentiated or homogeneous depending on if the goods
or services they offer are different or equal the ones each firm in that market
provides, in this situation the market is homogeneous because provides
electricity and gas. In an oligopoly, there is a mutual interdependence, decisions
taken by a one firm affect other firms in the industry, so they depend on each other.

 

 

As the
article says, SSE has become the last one of the big six to raise its prices “dual
fuel prices will go up by 6.9% or 73£ a year for the dual fuel bills of 2.8
million standard tariff customers from the end of April.” Usually in an
oligopoly when a firm hikes prices all the other firms don’t follow it keeping
their prices still, so that firm will lose revenue because consumers will be
attracted from the lower prices of competitors, while if a firm lowers its
prices the others will follow it in order not to lose revenues, but if all the
firms of an industry drop their prices they will have the same market share as
before but less incomes, this event can be represent with a kinked demand curve.
So, in an oligopoly there the price should be inflexible.

 

 

If the
price rose up it may be due to a rise in costs of production as shown in the diagram
below

(For simplicity,
the diagram is about the gas market, but we have to consider also the
electricity one because it is the dual fuel price that increased):

 

Gas
market

                             

If the
costs rise the marginal cost, the cost added by producing one additional unit
of a good or service, would rise too changing the price. This happens because
if a firm produces at Q1, where the profit maximisation point is MC1=MR and the
price at P1, and the MC cost shifts from MC1 to MC2 the maximisation point
moves to MC2=MR bringing the price at P2, which is higher than P1.

 

 

Another
possible reason for the rise in dual fuel prices could be a collusive behave.
In an oligopoly, firms can avoid competition attempting collusion, an agreement
usually illegal between rivals, if they do so they would act like a monopoly
and achieve higher profits. Collusion could be formal, when agreements aren’t hidden,
informal, when it is secret in order to avoid detection by regulators, and
tacit, when there is a leading firm and all the others follow it.

 

 

Gas
market

             

 

 

In this situation,
the demand curve isn’t kinked because the collusion consists in acting like a
monopoly. Also here the MC shifts from MC1 to MC2 causing a change in the profit
maximisation point (MC1=MR à MC2=MR) and so the price increases.

 

 

 

The main
issue is that consumers are suffering for the high prices and the big six are
taking advantage of them. Martin Lewis, founder of MoneySavingExpert.com says: “everyone on a standard tariff from
the big six, including British Gas, is being ripped off,”

 

 

 

 

 

 

 

 

A solution proposed by
John Penrose, a former minister at the Cabinet Office and a Conservative MP, is to introduce a price
cap to the standard variable tariffs. The price cap is represented in the
diagram below:

 

Gas market

                      

Assuming that the
market produces at Q1 and P1 where MC=MR1, when the price is introduced it
becomes the new MR