Is price capping an effective way to deal with monopolistic power?

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Price capping involves limiting the amount that a firm can charge for a particular good or service. In order to address this question, you should weigh up the costs and benefits of price capping and their effects on monopoly power. It may also be helpful to use contemporary examples to address the question, for example by looking at the effect that price capping would have on the 'Big Six' energy companies.

It would be useful to distinguish between different types of price capping in the introduction (RPI-X, and RPI-X+K, rate of return) and how the effects of them differ.

Advantages of price capping

Cuts in real prices help households and industrial consumers. Prices are lower, so there is greater consumer welfare, alongside lower production costs.

Improvements in productive efficiency. Firms can only increase profits by decreasing costs, so they have an incentive to try to move towards the lowest point on their AD curve. Monopolies operate where MC=MR, so this would mean a movement to a more competitive equilibrium.

Useful for controlling consumer price inflation. Inflation can arise from increased costs for firms. For example, an increase in energy prices leads to an increase in prices across the entire economy due to these higher costs. Capping the price would stop this.

Disadvantages of price capping:

Job losses. Lower prices can mean lower profits for firms, so firms may have to fire workers in order to cut costs and increase profits.

Distortion of price mechanism. Price sends signals within markets as to the balance of demand and supply. Artificially altering the price can send the wrong signals to the market.

Cementing of monopoly power/decreased competition. Lower prices can make it more difficult for new firms to challenge monopolies, as they may not have the cost advantages that large monopolies benefit from.

Difficulties of setting appropriate price cap. What level should a price cap be set at? Governments have to set it at a level where it alters the behaviour of monopolies, but doesn't stop investment, and doesn't price out smaller firms. This point is a good evaluation point in essays, as how well the price is set will have a large bearing on how effective price capping will be.

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