The Wider Economy And The Energy Industry

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  • Created on: 07-04-15 14:13

Text book theory: 4.3.1b: Do Markets Always Work?

What Market Failure Means:

  • Market failure refers to situations where free market forces have lead to an inefficient allocation of resources.
  • Reasons for market failure: public and merit goods, when the externalities associated with production or consumption are high, imperfect competition (e.g. monopolies), inequality.

Public Goods: 

  • Cannot be provided for effciently by the private sector
  • Once provided, they are available to all
  • No one can be excluded from enjoying the benefits
  • Businesses have no incentive to provide for them
  • Can only charged for via taxing
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4.3.1b: Do Markets Always Work?

Demerit Goods:

  • Seen to be socailly undesirable but are over-consumed if left to the free market.
  • Potential customers often over pay for the good because the private benefits outways the cost.
  • e.g. tobacco, drugs.

Merit Goods:

  • Seen to be socially desirable but they are likely to be under-produced is left to the market to provide.
  • Potential consumers may be unablr or unwilling to pay the prices being charged by firms
  • Provided by state because the market would exclude those most in need of it
  • e.g. education, healthcare, energy.
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4.3.1b: Do Markets Always Work?


  • Involves fairness or the distribution of income and wealth.
  • This does not necessarily mean that income is distributed equally between all.
  • Inequality is an aspect of market failure because poverty entails social costs.
    -> Poverty can be addressed through income redistribution (using tax system/merit goods). 

What Are Externalities?

  • Externalities are external benefits and external costs. They occur when consumption or a production affects a third party.
  • External costs reflect the side effects of a firm or individual using a product: negative effect on a third party not the consumer or producer (PC+EC=SC).
  • External benefits reflect the positive side effects of a firm or individual using goods and services that they have paid for (PB+EB=SB).
  • If the social costs exceed the private costs-> negative externality andvice versa with benefits.
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4.3.1b: Do Markets Always Work?

To What Extent Are Externalities Acceptable?

  • Marginal social benefit (MSB): the amount the society as a whole gains from the consumption of one more item
  • Marginal social cost (MSC): the cost to society as a whole of the consumption of one more item.
  • As MSC exceeds the MSB, there is over production and output should be cut
    • (
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4.3.1b: Do Markets Always Work?

Cost-Benefit Analysis:

  • Involves investigationg all the private and external costs and benefits associated with a possible project.
  • When they can be qualified in money terms, long term returns can be calculated, so decisions can be made.
  • Difficult to evaluate externalities.
  • Social costs and benefits that cannot be qualified will be valued differently so becomes political.

Externalities And Government Policy:

  • Regulation can reduce costs. Governments probhibit excessive levels of pollution and can fine.
  • Environmental charges are government imposed fees for using natural resources.
  • Tradeable permits seek to combine market incenties with command and control measures. 
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4.3.2b: Should Markets Be Regulated?

Why Regulation Is Needed:

  • Protection of consumers: businesses with enough control can distort the process of competiton. They have less incentive to to be productively efficient, so customers pay more for products than they really should
  • Market power: affects the allocation of resources, there is market failure
  • Collusion: means agreeing with competing producers to avoid any action that would make the competition stiffer.
  • Cartel: an agreement not to compete with producers. They agree on prices, production, division of market.
  • Collude by: restricting output, market sharing, price fixing
  • Impact of competition on consumers: market power can mean businesses change more, so consumer incomes will buy less. Competition helps raise purchasing power. In the absence of competition, some firms will manage less economically and waste resources, so consumers aren't getting best possible prices
  • Impact of competition on businesses: firms with lots of competion domestically often succeed globally. Makes businesses more efficient, innovative and versatile. Reduces profits. 
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4.3.2b: Should Markets Be Regulated?

What The Government Does:

  • The office of fair trading:set up to gather information about the competitveness of markets, to respond to complaints made about anti-competitive practices and to ensure compliance with competition law. Regulates the behaviour of businesses and protects consumer interest.
  • The competition market authority (CMA): An independent public body that investigates markets where one or more firms have become dominant, or where there are restrictive practices in operation, or illegal collusion.
  • EU Competition Law: The power to act when a firms chases a monopoly pwer in order the disort trade between member states.
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4.3.2b: Should Markets Be Regulated?

The Effectiveness Of These Policies And The Implications For Business:


  • International trade has allowed competition from imports ensuring prices of traded good and services are kept low. Businesses are able to expand through export markets.
  • Businesses seek export markets as they cannot expand in the UK.

Government Failure:

  • Occurs when government intervention makes the situation worse rather than better. One source of market imperfection is dealt with, but another one is created at the same time.

Implications for business:

  • Uncertainty during investigation and any legal issues creates compliance costs.
  • Protects businesses from unfair competition. 
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4.3.4b: Should The Government Intervene In Society

Why The Government Redistributes Wealth:


  • Leads to poverty.
  • Many in the UK suffer relative poverty, but not absolute.
  • Relative poverty occurs when income in insufficient to allow people to fully participate in society.
  • Can occur because of low incomes or unemployment, and impacts childeren, families and society.

The impact of inequality and poverty on business and the economy:

  • Income distribution has a impact on the pattern of goods and services people demand.
  • When more even, demand for luxuries will be limited.
  • Wide disparities associated with low wages.
  • Low levels of education and trainong in foreign markets.
  • Existence of extreme poverty can create social costs.
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4.3.4b: Should The Government Intervene In Society

The impact of redistribution on business and economic welfare:

  • Businesses want to be able to hire the people best suited for the job, and will pass the rate that motivates and attracts people they want, must provide sufficient incentive to encourage employees to meet objectives.
  • Redistribution alters incentive structure, reduces extent to which high earners can benefit.
  • Redistribution reduces social costs of poverty.
  • National minimum wage reduces inequality but increases costs for businesses.
  • Reduces demand for inferior goods.
  • May reduce demand for luxury goods.

How And Why Does The Government Intervene?

  • Regulation and legal constraint, programs financed by government funds, incentives/subsidies.
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Introduction To The Energy Industry

What Is The UK Energy Industry?

  • The energy industry refers to the domestic demand and industrial supply of electricity and gas.
  • Concern about greenhouse gas emissions encapsulates the burning fossil fuels. Apart from its strategic importance, the energy industry has a number of distinctive characteristics.

The Supply Chain:

  • Energy supply is extremely important in all advanced economies. Schools, offices and factorieis have to close if the electricity supply is disrupted for any length of time. Gas supplies are also essential for cooking and heating. Maintaining security of supply is therefore essential- and the winter of 2014-2015 is looking difficult with spare capacity down from 5% t0 4%. This inhibits growth which is why the government is investing.
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Introduction To The Energy Industry

Greenhouse Gas (GHG) Emissions:

  • The burning of fossil fuels-gas,oil and coal- currently forms a crucial past of the energy industry. This must change, if the UK government is to meet its GHG reduction target of 80% by 2050 (not meeting this would be bad for investment). The main greenhouse gas is CO2, associated with global warming and climate change.

Difficulty Of Storing Electricty:

  • It is costly to store electricity, so the vast majority of it is generated on demand. A result of this is that there has to be enough capacity to cope with demand peaks- where upon much capacity will be lying idle for much of the time. In light of the capital-intensive nature of the industry's productive capacity, this then becomes very expensive. Combined with inelastic demand, prices and profitss tends to be unstable. (because of vairents in demand).
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Introduction To The Energy Industry

Capital Intensity:

  • The industry is capital-intensive at most points along the supply chain. This feature leads to substaintial economies of scale,where upon most companies in the industry as very large. (wouldnt be efficient for small companies)

Natural Monopolies:

  • Electricity and gas are disributed through cable and pipe networks, classic examples of natural monopolies. Their price and quality must, therefore, by regulated by government agencies, in this case by Ofgem. The pressures arising from a competitivr free market do not apply to energy distribution.

Monopoly Power:

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Introduction To The Energy Industry

Fuel Povety:

  • Those who find difficulty paying for it products such as heating or gas. For example, deaths rise sharply during spells of cold weather and this is in part caused by the inability of many to heat their homes properly. Energy providers cannot, therefore just cease supplying people who do not pay thir bills in the same way as most other commerical enterprises would. (elderly and young childeren especially)

The Supply Chain Of The Electricity Industry:

Primary Producers:

  • The extractive producers/companies who mine and drill for gas, oil and coal. With the exception of British Gas, most primary producers do not own generating capacity.
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Introduction To The Energy Industry

Power Generators:

  • These businesses own power stations which generate electricity, which are purchased from the primary producers. The generate their own electricity from renewable or nuclear sources. 71% of the UK power generation is provided by the Big Six.


  • These are the retailers who have supply contracts with virtually every firm and household. The 'big six' are vertically integrated businesses, own their own powerstations, thus generating most of their electricity themeselves. Also buy from wholesale markets. Also pay for pipes.

Transmission And Distribution:

  • The delivery of electricity takes place through a network of cables. A single natural monopoly,  the national grid, runs the nationwide network. (inefficient to have more than one supplier).
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Introduction To The Energy Industry

The Supply Chain Of The Gas Industry:

  • This has a strong overlap witht the electricity industry. All retail suppliers will sell you both gas and electricity, while the national grid owns both distribution networks. The national grid owns 4 of the 8 regional monopolies distributing the product from themselves to the consumer. (Gov Regulation?)

Product, Storage And Security Of Supply For Gas:

  • In the UK, 40% of our gas suppliers come from North Sea gas platforms, although its set to decline in the future.
  • Much of Europe relies on gas pipes from Russia to central and western europe. In colder central Europe, Russia has used gas supply and prices as a diplomatic weapon, as a means of putting pressure on its neighbours.
  • Gas can also be transported and stored in liquid from (LNG). Costly but gas takes up 600 times less space than its gaseous equivalent. Very expensive though.
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Issues In Energy Supply: (1) Carbon Reduction And

Nuclear Saftey & Costs:

  • Generating electricity from nuclear power is a controversial topic: it carries a very low risk of catastrophic failure; but possible negatives can be drastic.
  • Nuclear power generation has high fixed costs of construction followed by low running costs- and then very high decommissioning costs at the end of the plant's life. Thus it is possible to run a nuclear power station profitably for many decades and then close it, leaving it to tax payers to pick up the final bill.

Nuclear Power In Britian:

  • Nuclear power has provided 20% of Britain's electricity needs in 2013. In October 2014, EU approved EDF to build a £16 billion nuclear power startion in Somerset. In return, the government will for electricity at a fixed price for 35 years. Double the amount Finland are paying Russian company Rosatom. (Gov failure. Environment over economy).
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Issues In Energy Supply: (2) Carbon Reduction And

Commitments Arising From the 2008 Climate Change Act:

  • Commited Britian to reducing GHG emissions by 80% by 2050 from the 1990 base line. 60% was proposed but bumped to 80% as all main political parties sought to establish their green credentials.
  • 80% target is extremely demanding because heating of almost all UK buildings is currently fuelled by gas and most transport uses petrol and diesel. Probable that almost all electricty will have to be generated from renewable sources. By 2013 GHG emissions had been cut by 25%.

Reducing Demand For Energy Through Energy-Saving Measures:

  • Subsidised new boilers, and subsidised wall insulation, subsidised double glazing.
  • Higher energy-efficiency standards in new homes, from 2016 all new houses will have to be 'zero carbon' in the UK. 
  • 'Smart meters' by 2020 will enable both households and suppliers to record supply on a half-hourly basis. Consumers will be charged more during peak times, which should reduce demand at these times.
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Issues In Energy Supply: (2) Carbon Reduction And

Switchung To Low Carbon Technologies:

  • In 2006 the government committed to all new homes being 'zero hour' by 2016, through a combination of energy-saving measures and low-carbon provision of heating. This could be provided by solar panels, whose owners have the legal right to sell surplus solar-generated electricity back to the national grid. 
  • Electricity generation itself has to become carbon neutral too. This is being achieved via EMR. It is to guarentee prices for the producers of renewable electricity from renewable way above the current electricity price. 
  • Many of these technologies have fundamental problems attached, which make them have very little commercial interest. Solar power generates most of its output in summer, while peak demand takes place in the winter. Wind power generates output only when it is windy. Onshore wind turbines are cheaperr than offshore ones. But create their own environmental damage in terms of visual degradation.
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Issues In Energy Supply: (3) Should We Scrap The 8

  • The target was passed in 2008 with near-ananimous support. Since then, the political consensus behind this target has started to unravel. Therer are two main reasons behind this.

The Target Only Ever Made Sense If Other Countries Followed Suit:

  • The EU accounts for just 10% of global CO2 emissions. There would be little point in the EU cutting CO2 emissions by 80% if everyone else emitted more and more, a classic 'free rider' problem. If the EU were to fail, the UK left with expensive program aimed at reducing the 1% of global emissiob it produces. Put the UK at a economic disadvantage.

Every Renewable Energy Souces Are Much More Expensive:

  • The cheapest energy source-nuclear-80% more expensive than current price. Also only financially viable because the tax-payer assumes risk of a nuclear accident. The 80% target based on 20% increasing to 60% with the other 40% coming from wind (wind turbines still needs backup).
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Issues In Energy Supply: (3) Should We Scrap The 8

On What Basis Should We Decide a CO2 Emissions Target:

  • Cost-benefit analysis is the traditional tool for deciding upon major public infrastructure projects like this. The last minute switch from 80% from 60% suggests that the figure is driven by politics rather than analysis and evidence. On the plus side, actions could 'set an example' for others to followe. On the minus side, other countries may calculate they have little gain from reducing if the EU is doing it anyway. The EU has very little leverasge over BRICd, USA and Indoesia (main polluters).

The Current Political Position:

  • Hitting the 80% target would likely double electricity costs get rid of energy-intensive industries. Such considerations have led UKIP to oppose all subsidised wind farms although other parties still support it. It is said that 2050 target would cost £1,300 billion-roughly size of national debt.
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Issues In Energy Supply: (4) The Market Structure

  • The big issues here include potential market failures of a non-competitve market structure and fuel poverty.

The UK Electricity Retail Market:

  • The UK market is dominated by 'the big six': 2 British, 2 Germans, 1 French, 1 Spanish. (Wind farm subsidies going abroad). Most of the big six formed through a series of mergers over the post 25 years to benefit from preceived economies of scale.
  • Key question is whether the retail market opperates efficiently and whether it operates competively. The Big Six have to histroy in this ascept. Many been fined for aggressive and unethical doorstep sales techniques will all of been accused of taking advantage of moving fees. Allegations being looked at by CMA whose report is due in 2015.
  • However, the big six are losing market share to a new breed of smalll companies such as first utility. They buy supplies on the open market and sell on directly to the final customs. Between 2009 and 2014,the big six market share dropped from 99.8% to 92.4%. The big six have now tried to compete on non price related things, which benefits the consumer.
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Issues In Energy Supply: (4) The Market Structure

The UK Electricity Wholesale Markets:

  • The big six supplies of UK energy also own 71% of the electricity generating capacity, confirming their status as dominant, verically-intergrated companies. (own stages of supply chain-able to restrict supply to smaller firms). 10 firms account for concentration ratio of 86%. Remaining 14% is accounted for by a 'long tail' of small companies, dominated by wind farms, none of which could survive without public subsidies that account for over half their incomes. Obvious suspicion that Big Six may have been able to prevent effective competition. Possibly by managing up until recently to freeze out small retailers.
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Issues In Energy Supply: (5) The Role Of Ofgem


  • Ofgem, the office gas and electricity markets describes its mission as protecting the interests of current and future electricity and gas consumers. It's poor point plan is to: 1)promote value for money, competition issues, 2)ensure security of supply, 3)promote sustainability, 4)implement government regulations.

Value For Money:

  • In 2013-14, Ofgem sought to improve value for consumers in a variety of appoachs. 
  • 1)Dealing with information failure. Ofgem reduced the number of tarriffs companies could offer.
  • 2)Anything that makes it easier to switch supplies will make the market more competitve.
  • 3)Enforcement action in the form of fines; mostly the money goes to people facing fuel poverty.
  • 4)Transparency of costs, prices and profits. The big six have to publish reports on activities.
  • 5)Price controls. Suppliers are told the prices they are allowed to chargw by Ofgem.
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Issues In Energy Supply: (5) The Role Of Ofgem

Security Of Supply:

  • Ofgem cannot compel generators to invest in new capacity and the free markets does not always prevent electricity blackouts. Building extra capacity for peak demand is not cost efficient, because the extra capacity will be lying idle most of the time. Ofgem's role in energy security is a limited one. On the one hand it makes forecasts about demand. But it also allows the network operators to increase their prices to pay for additional capacity. 


  • By 'Sustainability' , Ofgen means both reducing demand as well as switching away from fossil fuels. The current strategy for reducing demand is the introduction of 'smart meters'. 
  • They will reduce demand in two ways, firstly they will provide consumers with an exact record of how much electricity they are using minute-by-minute. Should help consumers reduce bills. Secondly, it will reduced peak demand by enabling energy companies to charge more during peak periods of demand.
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Issues In Energy Supply: (5) The Role Of Ofgem

Implementing Government Regulations:

  • These regulations are built around the enormously ambitions targets to reducing the UK's carbon emissions by 80% , includes: The renewables obligation, the feed-in tariffs system. energy companies obligation (ECO), the warm house discount scheme, whereby eight major suppliers give discounts worth £300 million a year to households facing fuel poverty.

Ofgem: An Assessment:

  • There remains the question of how effective Ofgem have been in generating value for money for consumers. If the CMA report due out in 2015 identifies significant weaknesses in the way competition is working, then the question will be raised as to whether Ofgem have been effective. The CMA claim "Ofgem may have unwittingly contributed to the problem of weak competition and high prices."
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Issues In Energy Supply: (6) The 2014-2015 CMA Inv

  • The CMA began by outlining possible reasons as to why competition in energy markets might not function effectively: 
    1.Vertical integration of electricity generation and retail supply among the 'big six' might squeeze out independent retail suppliers.
    2.Dominance by the 'big six' leads to higher energy prices, for example caused by tacit collusion.
    3.Unwillingness of customers to switch supplies might lead to weak incentives on the part if suppliers to compete on price and quality of service. Equally, government regulation to hit climate change targets and/or reduce fuel poverty might have the same effect.

Submissions Made To The CMA So Far:

  • An allegation that price comparison websites conceal the best deals for consmers.
  • Ofgem have already weighted the market in favour of new, small suppliers by exempting them from 'paying certain costs'.
  • Each supplier can only offer 4 tariffs. Purpose is to reduce information failure.
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Issues In Energy Supply: (7) Fuel Poverty

  • One of the features of the industry is the vital nature of the product it sells. Means that every household in a potential customer but price increases are a sensitive issue, not paying can lead to being cut off from suppliers.
  • Fuel poverty is defined as: a household is now offically in fuel poverty if it spends more than the national average on fuel and, were it to spend that average, would be left with an income below the poverty line.
  • Estimated that 10.4% of English households (2.28 million) are currently in fuel poverty.
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Linking The Energy Industry: 4.3.1b Do Markets Alw

What Market Failure Means:

  • Less than optimum allocation of resources: In a world of scarcity, any economy has to produce an enormous variety of goods and services. When the inputs of land, labour and capital are distributed between the various industries to achieve the maximum benefit. Within the energy industry itself, we need just the right amount gas relative to the amount of electricity. In those cases where the free market does not achieve this outcome, the 'market failure' has occured
  • Public goods:goods which a free market would not produce at all. Gas and electricity are not public goods since access to them can be effectively controlled. Only if you pay for them do you get to use them.
  • Merit goods:goods there is a private benefit to the cosumer and also an external benefit. Gas and electricity are not merit goods, as there is no third party benefit from their consumption, and we are unlikely to underestimate the benefits of staying warm as these benefits arrive instantaneously when we turn on heating. However, the do attract a lower than normal rate of VAT at just 5%. This is not because they are merit good but because they are necessities.
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What Externalities Are And How They Affect An Econ

Social Costs And Benefits:

  • The social cost of any product is the sum of the private costs and the external costs which fall on other people. In the case of energy consumption, the private cost would be the cost of generating the delivering the gas or electricity. The external cost would include the cost of climate change caused by the GHG emissions created by the production process.
  • Externalities leasd to market failure. In the case of energy, we might expect the externality of the industry, if left to its own devices, to be too large. The external cost of climate change would not be taken into account.

Examples Of Externalties, Economic, Environmental And Social:




External Costs

Tourism suffers in areas blighted by wind farms

Less willingness to leave a warm home to take part in social activities

More global warming

External Benefits

Positive multiplier and accelerator effects on GDP

More entertainment possible as more houses have electricity

Fewer winter deaths attributable to cold weather

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What Externalities Are And How They Affect An Econ

Difficulties In Measuring Externalities:

  • Private costs and benefits are easy to measure for a person. But externalities are spread out over a much wider population so attempts to express their cash value have to be treated with caution.
  • This is relevant where trying to measure the cost of GHG emissions. They depend on so many unknowns- such as how much CO2 will cause a one degree increase in global temperatures, precisely the timescale over which these effects will occur and the marginal costs of temperature rise.

Impact of Externalities In Short Versus Long Term:

  • In the case of power generation, the long-term external cost is global warming. A short-term external cost is that of the loss of amenity and landscape value caused by the erection of wind turbines. These short-term costs are often easier to measure. (e.g. local house values changes following a nearby installation of wind turbine plant.
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To What Extent Are Externalities Acceptable

The assumption behind this question is that we are dealing with external costs, rather than external benefits. The fact that a good or service generates an external cost in either its production or consumption is not a reason to prohibit the good altogether. This is true is the case of gas and electricity; essential for the operation of an advanced economy. The whole point of taxing demerit goods is not to reduce their consumption to zero. Rather, it is to reduce their consumption to the allocatively efficient level while bearing in mind that they produce many external benefits.

Social Benefit And Social Cost:

  • The existence of externalities in any industry leads to a situation where the private decisions of households and firms cannot be relied upon to produce an industry of the opitmal size, the size that will generate most net benefit. One way of looking at these merit and demerit goods is for the government to try and decide what the optimal level of production is- and then use the powers at its disposal to 'tweak' the size of the industry in question.
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To What Extent Are Externalities Acceptable

Cost-benefit Analysis-Its Limitations And Usefulness In Decision Making:

  • Such cost-benefit analysis should lie behind major decisions in energy policy, such as the decision to subsiduse carbon-free generation and- crucially- the setting of the 2050 GHG emissions target in 2008. In this latter case it is doubtbul how much such analysis ever took place, rather than setting a target based on the broad public feeling at the time the GHG emissions needed to be drastically curtailed.
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What Can The Government Do About It?

Control Of Externalities By Legislation, Regulation:

  • The government has used its powers to promote carbon-reduction in a number of contexts:
    1.Legislation to make all new homes carbon neutral by 2016 through the use of high levels of insulation and all-electric heating generated from zero carbon sources.
    2.The 80% GHG emission target is supported by a 40% reduction target by 2030.

Control Of Externalties By Taxation And Subsidy:

Another way of increasing the consumption of merit goods is simply by offering a subsidy. Thid shifts the supply curve outwards, increasing the equilibrium quantity at the same time as reducing the equilibrium price. Equally, an indirect tax like VAT has the opposite effect.  e.g. loft insultation, double-glazing and more efficient gas boilers.

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What Can The Government Do About It?

Effectiveness Of Various Policies To Control Externalities:

It is hard to measure the effectiveness of legislation, taxation and subsidies in taking account of the external benefits generated by carbon neutral energy generation, and the external costs of burning fossil fuels? It is extremely difficult to do so, because so much depends on a reasonably accurate estimate of what these external costs and benefits might be. The time lag between reducing GHG emissions now and reducing global warming is a matter of decades. We cannot yet form a judgement on the magnitude or the costs of global warming, nor which policies will prove to be the most effective.

Control Of Externalities By Tradable Permits:

The underlying idea of tradeable permits is to limit access to a common resource, the government set the overall level of access permitted and then distributes these access rights, by sale or by donation to existing users. The new owners of these access rights may then keep them, or sell them on as and when they wish. 

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What Can The Government Do About It?

Every major industrial emitter of CO2 is given an allowance at the beginning of each year. At the end of the year, operators who are have used more than their allowance have to buy an additional allowance from any other operators who have some spare. The current phase of the scheme runs out from 2013-2020.

Essentially, tradable permits use regulation rather than taxation to control the absolute quantity of external cost generated-but does so in a way that seeks to ensure a level playing field between companies. Regardless of how the issused permits are allocated initially, they should flow to the most effcient companies.

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Why Regulation Is Needed

Protection Of Consumers:

Linked to monopolies raising price above competitive levels. This results in a less-than-optimum size of industry, just as in the case of merit goods. In this case, the market failure is caused by the fact that the increased price means that some units of output that could be produced at a profit are not produced, so that the monopolist can make even greater profits on the remaining units. Also, the increase in price directly transfers resources from the consumer to the producer. Since consumers tend to be poorer to start with, such monopoly pricing increases inequality. 

Consumers also find it difficult to switch providers easily, as it is such a hassle.

Cartels, Collusion, Restrictive Practices:

There is a strong incentive for competitors in a market to band together and act like a monopoly i.e. restrict their output, raise their prices and stop competing with each other. Includes any practice which limits output of an industry.

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Why Regulation Is Needed

Effects Of Restrictive Trade Practices On Prices And Competition:

Restrictive trade practices are designed to limit competition, and so drive up prices. Ofgem has not found any examples of collusion in the UK energy market, although the complexity of many energy tariffs and the difficulties of switching suppliers may well have the side-effect of reducing competiton.

Issue Of Natural Monoploies:

When a company can always produce goods more cheaply than a smaller rival. Natural monopolies have high fixed costs. (The National Grid) Ofgem controls the prices it may charge to gas and electricity suppliers who need to use its delivery network, and also enforces quality standards on the enterprise.  

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What The Government Does

Role And Uses Of The Office Of Fair Trading (OFT):

In the case of energy, the work of protecting consumers and making referrals to the CMA was not carried out by the OFT but by the industry regulator Ofgem.

Role And Use Of The EU Competition Comission :

Focuses on the behaviour of companies. EC treaty prohibits agreements between two or more firms which restrict competition, such as cartels. Prohibits firms in a dominant position from abusing that dominance.

Use Of Regulatory Bodies=> Ofgem:

Job is to act as the OFT, but specifically in relation to gas and electricity markets.Has fined EDF £3 million for poor complaints handling and told SSE that new undersea cable is £174 million too expensive.

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What The Government Does

Provision Of Legal Framework And Consumer Protection:

Since gas and electricity are homogenous goods, some of these concerns do not apply to the energy market. However, security of supply and the procedures that have to be gone through before a household can have its source of energy cut off are live issuses. 

Consequences For Businesses:

The intervention of government in defence of the public interest has profound consequences for business. Unethical businesses will find their opportunites reduced assuming the law is properly enforced. 

However, government regulation is not all bas for energy companies and certainly not for small start-ups . In an attempt to reduce the preceived market power of the big six providers, the smallest companies with under 250,000 customers are extempt from ECO, which has increased the number of start-ups in the industry.

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Is Regulation Needed In The UK Energy Market?

Competition And The Consumer:

Competition is always benefical to consumers. It increases choice and encourages firms to charge lower prices. When customers think they are not getting good value for money, the will go to a different supplier. If more of this happens, less competitive businesses will have to leave the market.

Market Dominance:

  • The main 6 energy providers to the UK market are examples of big businesses that distort the process of competition. Big companies with market power have less incentive to be productively efficient. This means that customers may be paying more for energy than they really should. The quantities consumed may be restricted too. They can make it difficult for genuine competitors.
  • Should not assume that big is bad. This cost-cutting, productivity-raising process has been at the heart of economic development and the relief of poverty over a long period. Also big profits can be used to fund research into innovation s or better production methods.
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Is Regulation Needed In The UK Energy Market?

  • UK customers have not really benefited from economies of scale as prices are still really high.
  • UK energy companies could be spending more on developing better ways of producing renewable energy.

Where There Is Market Power There Is Market Failure-As In The Energy Market:

In an oligopoly, there are several producers each with a significant market share. They will be interdependent- their strategies will result from close observation of each other and tactical decision making. e.g. if one firm cuts prices, others are likely to do the same due to fear of losing their market share.

Strategies For Dominating:

Some businesses acquire their market power by virtue of their market share. Jusy growing bigger and bigger gives them some control over their markets. Within oligopolies, firms will often try to enhance their market power by using pricing and marketing strategies that offer advantages.

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Is Regulation Needed In The UK Energy Market?


  • Means agreeing with competing producers to avoid any action that would make competition stiffer. 
  • Price wars are generally avoided in an oligopoly as they can lead to damaging losses for the businesses involved, they tend to return to non-price competition. It cna lead to tacit collusion.

How Cartels Collude?

  • Restricting output
  • Market sharing agreements
  • Bid rigging
  • Price Fixing
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Inequality And Poverty

Lorenz Curve:

  • Plots cumulative % income against cumulative % population.
  • The 45 degree line represents line of perfect equality. 
  • The further out teh lorenz curve lies, the higher the inequality.
  • Hard to compare between countries.


The Gini coefficient quantifies the amount of income inequality in a society. The value will always be between 0 and 1. Higher the value the greater the inequality. [=A/(A+B)]

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Inequality And Poverty

Why Income Inequality Exists In The UK:

  • Higher earning inequality in different jobs and industries: Innovation has advanced more quickly than workers' ability to embody the new skills. Demand for skilled workers has expanded quicker than supply, raising skilled wages.
  • Falling relative incomes for those dependent on state welfare benefits: Who's value arises each year in line with prices rather than incomes.
  • Structural/ long term unemployment.
  • Polarisation between 2 earner and 0 earner households.
  • A long term shift towards part-time service sector employment: Often relatively low paid work with little or no trade union protection.
  • Less progressive tax system.
  • Inequalities in wealth also create income inequalities.: e.g. interest from saving, dividends from shares, inheritance.
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Inequality And Poverty

Why Different People Earn Different Amounts:

  • Different skill levels.
  • Compensating differential-> favouritsm towards similarities.
  • Discrimination.
  • Regional Differences.
  • Differnences in revenue generating ability of some individuals.
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Cost Benefit Analysis (Normally 30 mark question)

Mark Scheme Criteria:

  • Question needs 2 definitions (K)
  • Question needs at least 3 'quotes' from the case study (AP)
  • Provide a logical chain of reasoning (AN)
  • Provide judgement about the importance of your analyis (E)

Spec Guidance:

For evaluation, difficulties in placing accurate marketing values on costs and benefits.


  • CBA is a technique used for assessinh the (monetary) social costs and benefits of an investment project or a government spending decision over a given time period. e.g wind turbines
  • Evaluation: CBA in not an exact process is more estimates than judgement.
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Cost Benefit Analysis (Normally 30 mark question)


1) Define Investment Criteria
Most frequently cited investment criterion of CBA is the maximum of society's net benefit.

  • Analysis: Pareto Criterion: Net benefit exists where one person is made better off without making anyone else worse off.
    *This is a limited criteria as it does not take into account any decisions that attempts to redistribute income. e.g. better cleaner energy(wind farm), but higher taxes.
  • Analysis: Waldor-Hicks Criterion: A net benefit occurs when the sum of the benefits exceeds the sum of the costs, whether or not those benefits are used to compensate this who bear the costs.
    *Again potentially useful but major flaw is that it does not address the issues of savers compensating the losers. e.g. lot of cost, money going out of UK (to France), How do UK citizens benefit?
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Cost Benefit Analysis (Normally 30 mark question)

  • Analysis: Cost/benefit ration(CBR): This states that only those projects with a CBR of over 1 should be considered. Gives a way of comparing projects.
    *Different people put different values on things due to opinions and judgements as some may not have monetary costs therfore completely subjective. Also, does not consider long term costs and benefits, only present value. (most are long term projects)
  • Analysis: Invest or not invest
    *Short term/long term

2. Calculate Direct and Indirect costs

  • Analysis:-some are easy to value
    -other costs are more difficult
    -costs are subject to change

3. Indentify Options

  • This provides a good opportunity to apply knowledge of case study
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Cost Benefit Analysis (Normally 30 mark question)

4. Regulatory Capture
Who will be making the decisions about putting a value on the costs and benefits?
*Government committed to GHG emissions goal-> generous on benefit.
*Do they have a reason to distort figures

5. Consider The Constraints

  • The aim of CBA is to maximise social net benefits, but there are various constraits:
    -Technological (How to store energy in wind farms)
    -Distributional (Localised in certain areas for wind farm location.)

Used properly CBA can be used to address market failure and improve social efficiency. However there are likely to have many opponents and likely to be hijacked by private interests.
'Add Value' to conclusion by giving opinions

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Pollution Permits

A 'Cap And Trade' System:

  • Each year, the EC allocates a set number of permits to national governments.
  • These are divided among industries and there firms.
  • This 'caps' the amount of emissions for the year.

Government Allowance:

  • Most permits are given to industry for free.
  • Governments keep up to 10% to give to new market entrants (if not enough kept, lead to government failure)
  • Incentive to invest in green energy, so reduce carbon emissions in the long run.
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Pollution Permits


  • Price mechanism is used to internalise the external cost (polluters pay more).
  • Pollution permit can be reduced over time.
  • National governments can raise funds, the revenue can be used to clean up the environment.
  • Firms have an incentive in clean technology.
  • The EB may act as a foundation for a global-wide scheme.
  • Firms are able to bank their excess permits for future use.


  • Too many permits may be issued, so the incentive is little to reduce pollution.
  • Too few permits could be issued, so production costs become too great.
  • Disputes have risen over allocations of permits.
  • Cost of purchasing permits may be passed on to customers.
  • Major pollutiing firms can buy excess from elsewhere as they are tradable.
  • Fluctuations of the permits, uncertainty is created reducing the incentive to invest in green tech.
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Pollution Permits

  • The EU is just one corner of the globe, all countries need to adopt similar policies.
  • There is a cost to the government of monitoring pollution emissions
  • EU firms may avoid investing in cheaper countries e.g. Africa (no benefit to EU).
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What Is Government Regulation

  • Regulation includes set by government that control the operations of firms.
  • Regulation is designed to correct market failure.
  • Regulators act as 'surrogate competitor' - make the market more competitive.

1. Protect Public Interest.
2. Promote competition, economic efficiency and social welfare.

1. Can lead to government failure.
2. Costs and benefits involved in regulating market.

Methods: Price Caps (RPI-X)

  • The regulator permits the business to increase prices by the rate of inflation, minus X.
  • The 'X' refers to the cost savings of efficiency gains the regulator believes the business should be aiming for.
  • The the great the value of X, the more scope the regulator believes there is for efficiency gains.
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What Is Government Regulation

  • Can be +k, capital investments i.e. renewable energy, wind farms etc.

Evaluating RPI-X Regulation In Theory:

  • In order to make profit, businesses need to cut costs. This should increase productive and allocative efficiency.
  • It could lead to lower prices and higher consumer surplus
    -> (+C) which means prices are not really decreasing so this doesnt happen.
    -> (+C) is smaller as government is paying for it directly rather than the consumer.
    -> if prices decrease, consumer surplus increases as does consumer welfare.
  • Could lead to lower profits, lower dividends for shareholders and possibly job losses.
  • How to set X? Too low and business remains inefficient. Too high and business will have insufficent funds for investment (gov failure).
  • How long should price caps be in place (hinders market growth).
  • Regulatory capture.
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Fuel Poverty

Fuel Poverty: when you spend at least 10% of your total income on gas and electricity.

Reasons For Poverty In The UK

  • Costs of living, job insecurity, increased rents, childcare, zero hour contracts, food prices.
    *EV: poverty more than just finances, also to do with access to choices and society. Government intervention tends to help everyone, even the rich. Doesn't focus solely on helping people in poverty.

Government Intervention On Poverty:

  • Food banks: places to get free food
    - helped to feed 8,000 people last year
    - demand has tripled since 2012
    - people could be 'cheating the system'
    -does not solve solution, only cover it up
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Fuel Poverty

What Does Fuel Poverty Do:

  • People 'go cold'
  • Health and social problems-> negative mindset
  • NHS cost of £1.3 billion due to illness
    * depend upon energy inefficiency of home, fuel prices and household incomes
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The Poverty Trap

  • Where low income households have disincentives to earn extra income because of the tax and benefit system.
  • Means bested benefits are taken away as exta income is earned.
  • Employees become liable to pay income tax, national insurance contribution etc.
    * Short term loss, long term gain.
    * People do not want this

Why Does Inequality And Poverty Matter:
1. Inequality: a failure of the market to achieve vertical equity. Gains of growth are not evenly distributed.
2. Inequality threatens social cohesion of a country: pressure on welfare system.
3. Poverty damages incentives (loss of long run potential output for the country).

Absolute Poverty:

  • An income insufficient to allow a basic standard of living. *Subjective
  • An income too low to allow social participation.
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The Poverty Trap

Relative Poverty: (everywhere has relative poverty)

  • Measures the intensity of low income compound to others.
  • Households living on less than 60% of average income.
  • 9.4 million people in household on < half average income.
  • 3.9 million of UK childeren living in 'relative poverty'
    *Depends on Location
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