Unit 3 Micro: Efficiency and Price Intervention in | tutor2u Economics

Unit 3 Micro: Efficiency and Price Intervention in Markets

In recent times the European Union Competition Commission introduced maximum prices for the roaming charges made by mobile phone service providers. These are the rates charged by one operator to another to enable its customers to make calls while visiting another country.

Evaluate the view that a policy of price capping for European Union mobile phone operators will lead to an improvement in consumer and producer welfare (25 marks)

Price capping is a form of government intervention in a market. In this case the EU competition authorities have opted for a maximum price on the roaming charges that mobile phone service providers charge to customers throughout the twenty-seven nations that form the EU single market.

This was in response to growing criticisms of the hefty roaming fees charged - with claims that the oligopolistic service providers were exploiting their monopoly power and achieving super-normal profits at the expense of customer welfare.

Setting maximum prices has a number of aims:

# Creating incentives for businesses to reduce their unit costs by being more productively efficient and innovative - if phone companies can reduce their costs they can still achieve higher profits even when a price cap is in place

# Improve consumer welfare by keeping prices lower - for example the huge bills facing lower income families on holiday in Europe during the summer - before the cap, charges for using a mobile phone when overseas remained on average four times more expensive than domestic mobile phone calls - a clear case of market failure?

# Price controls can help keep inflation down

# Lower prices for telecoms can be seen as a supply-side policy that encourages mobile phone usage for businesses and consumers e.g.data downloads and sending SMS messages - helping the competitiveness of EU producers in global markets and encouraging tourism within the EU

An analysis diagram could help to support this answer

Supernormal profits of phone service providers higher when demand is price inelastic. Roaming charges well above the marginal cost to the phone companies - causing a loss of allocative efficiency and a reduction in consumer surplus + deadweight loss of economic welfare

*With a price cap, demand ought to expand
*Profit margins are lower but mobile phone companies can still make profits providing price > average costs
*Net gain in consumer surplus (loss of producer surplus)

Evaluating price capping as a policy

Evaluation can come in all sorts of guises.

# Is this an effective policy in making it more affordable for consumers to use their phones overseas? After EU intervention, the cap for a “roaming” text fell to 11 euro cents (10p) from about 29 cents - the market will expand if the price elasticity of demand is high

# Does price capping lead to an improvement in producer efficiency?

# Does setting a maximum price lead to unintended consequences and possible government failure? Consumers will see the benefits in the short term but are there some negative effects in the medium term? Industry groups said the changes could mean higher charges for other services - for example a reduction in the cross subsidy offered to consumers on new handsets, or perhaps a lengthening of minimum contract times for consumers (locking them into a particular service).

# Lower profit margins for mobile phone providers might lead to fewer funds available for re-investment in networks - constraining improvements in speed and network reliability / capacity

# Price capping is not the only option available to the competition authorities. Evaluation might flag up some of the alternatives.

For example:

1/ Rate of return regulation (setting a target rate of return on capital - i.e. a satisfactory rate of profit)

2/ Lowering the statuory entry barriers in the market to allow more non-EU mobile phone companies to compete with existing providers

3/ Tough monitoring of and penalties for infringements of competition law e.g. investigations of whether mobile phone service providers might be engaged in implicit price collusion when setting roaming and other charges

More information on this issue is available here

Look to conclude with a reasoned argument at the end, perhaps focusing on what you regard as your main point - or bringing some wider context into the discussion. Also remember to make effective use of the stimulus material if this type of question appears in a data response exam.

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