The UK energy industry (electricity and gas) is an oligopoly. There are six large suppliers: the ‘Big Six’. These are British Gas (Centrica, UK), EDF Energy (EDF, France), E.ON UK (E.ON, Germany), npower (RWE, Germany), Scottish Power (Iberdrola, Spain) and SSE (SSE Group, UK). The Big Six supply around 73% of the total UK market and around 90% of the domestic market.
Energy suppliers buy wholesale gas and electricity and sell it to customers. The industry has a considerable degree of vertical integration, with the energy suppliers also being involved in both generation and local distribution (long-distance distribution through the familiar pylons is by National Grid). There is also considerable horizontal integration, with energy suppliers supplying both electricity and gas and offering ‘dual-fuel’ deals, whereby customers get a discount by buying both fuels from the same supplier.
Smaller suppliers have complained about substantial barriers to entry in the industry. In particular, they normally have to buy wholesale from one of the Big Six. Lack of transparency concerning their costs and internal transfer prices by the Big Six has led to suspicions that they are charging more to independent suppliers than to themselves.
Under new regulations announced by Ofgem, the industry regulator, the Big Six will have to post the prices at which they will trade wholesale power two years in advance and must trade fairly with independent suppliers or face financial penalties. In addition, ‘a range of measures will make the annual statements of the large companies more robust, useful and accessible.’ According to the Ofgem Press Release:
From 31 March new rules come into force meaning the six largest suppliers and the largest independent generators will have to trade fairly with independent suppliers in the wholesale market, or face financial penalties. The six largest suppliers will also have to publish the price at which they will trade wholesale power up to two years in advance. These prices must be published daily in two one-hour windows, giving independent suppliers and generators the opportunity and products they need to trade and compete effectively.
But will these measures be enough to break down the barriers to entry in the industry and make the market genuinely competitive? The following articles look at the issue.
The energy market is complex and is a prime example of an oligopoly: a few dominant firms in the market and interdependence between the suppliers. Over 95% of the market is supplied by the so-called ‘big six’ and collectively they generate 80% of the country’s electricity. There are two further large generators (Drax Power Limited and GDF Suez Energy UK), meaning the electricity generation is also an oligopoly.
This sector has seen media attention for some years, with criticisms about the high profits made by suppliers, the high prices they charge and the lack of competition. Numerous investigations have taken place by Ofgem, the energy market regulator, and the latest development builds on a simple concept that has been a known problem for decades: barriers to entry. It is very difficult for new firms to enter this market, in particular because of the vertically integrated nature of the big six. Not only are they the suppliers of the energy, but they are also the energy generators. It is therefore very difficult for new suppliers to enter the market and access the energy that is generated.
Ofgem’s new plans will aim to reduce the barriers to entry in the market and thus make it easier for new firms to enter and act as effective competitors. The big six energy generators are vertically integrated companies and thus effectively sell their energy to themselves, whereas other suppliers have to purchase their energy before they can sell it. The regulator’s plans aim to improve transparency by ensuring that wholesale power prices are published two years in advance, thus making it easier for smaller companies to buy energy and then re-sell it. Andrew Wright, the Chief Executive of Ofgem, said:
These reforms give independent suppliers, generators and new entrants to the market, both the visibility of prices, and [the] opportunities to trade, [that] they need to compete with the largest energy suppliers…Almost two million customers are with independent suppliers, and we expect these reforms to help these suppliers and any new entrants to grow.
Although such reforms will reduce the barriers to entry in the market and thus should aim to increase competition and hence benefit consumers, many argue that the reforms don’t go far enough and will have only minor effects on the competitiveness in the market. There are still calls for further reforms in the market and a more in-depth investigation to ensure that consumers are really getting the best deal. The following articles consider this ongoing saga and this highly complex market.
Microsoft’s Office suite is the market leader in the multi-billion dollar office software market. Although an oligopoly, thanks to strong network economies Microsoft has a virtual monopoly in many parts of the market. Network economies occur when it saves money and/or time for people to use the same product (software, in this case), especially within an organisation, such as a company or a government.
Despite the rise of open-source software, such as Apache’s OpenOffice and Google Docs, Microsoft’s Office products, such as Word, Excel and PowerPoint, still dominate the market. But are things about to change?
The UK government has announced that it will seek to abandon reliance on Microsoft Office in the public sector. Provided there are common standards within and across departments, it will encourage departments to use a range of software products, using free or low-cost alternatives to Microsoft products where possible. This should save hundreds of millions of pounds.
Will other governments around the world and other organisations follow suit? There is a lot of money to be saved on software costs. But will switching to alternatives impose costs of its own and will these outweigh the costs saved?
Why has Microsoft retained a virtual monopoly of the office software market? How relevant are network economies to the decision of organisations and individuals not to switch?
Identify other examples of network economies and how they impact on competition.
How do competitors to Microsoft attempt to overcome the resistance of people to switching to their office software?
What methods does Microsoft use to try to retain its position of market dominance?
How does Apple compete with Microsoft in the office software market?
What factors are likely to determine the success of Google Docs in capturing significant market share from Microsoft Office?
In December 2013, Uruguay passed a law permitting the growing, distribution and consumption of marijuana. The legislation comes into effect in April 2014. The state will regulate the industry to ensure good quality strains of the crop are grown and sold. It will also tax the industry.
Uruguay is the first country to legalise cannabis, but in July 2012, Colorado and Washington states in the USA passed laws permitting the sale and possession of small amounts of the drug for recreational use. (It was already legal to possess the drug for medical use.) The laws took effect a few months later. It is heavily taxed, however, especially in Washington, where it is taxed at a rate of 25% three times over: when it is sold to the processor; when the processor sells it to the retailer; and when the retailer sells it to the consumer. In Massachusetts, Nevada and Oregon, medical cannabis shops will be permitted to open this year. In the Netherlands, although the sale of cannabis is still illegal, ‘coffee shops’ are permitted to sell people up to 5 grams per day.
So should cannabis be legalised? People have very strong views on the subject and this can make a calm assessment of the issue more difficult. The economist’s approach to legalising cannabis involves seeking to identify and measure the costs and benefits of doing so. If the benefits exceed the costs, then it should be legalised; if not, it should remain illegal (or made illegal). The problem is that the size of the costs and benefits are not easy calculate as they involve estimates of things such as consumption levels, tax revenues, crime reduction, the effects on the consumption of other drugs, including legal drugs such as alcohol and tobacco.
Nevertheless, various estimates of these costs and benefits have been made and provide a basis for discussion.
Possible benefits of cannabis legalisation include: increased tax revenues for the government; reduction in crime, and hence reduction in law enforcement and prison costs; encouraging people with addiction problems to seek help, as they would not fear arrest; reduction in the price, benefiting users; regulating quality of the drug; reducing the consumption of alcohol and more dangerous drugs if these are substitutes for cannabis; moral arguments concerning freedom of individuals to choose their lifestyle.
Possible costs include: increased consumption of cannabis, with attendant health and social side effects; increased consumption of other drugs if they are complements, or if cannabis is an ‘entry level’ drug to harder drugs; moral objections to drug taking.
Clearly some of these costs and benefits are easier to measure than others. Moral arguments are almost impossible to assess quantitatively, even when various underlying moral standpoints are agreed.
The following articles look at recent events and at the arguments, both economic and non-economic.
If a country legalises cannabis, what is likely to happen to the price of cannabis? Use a demand and supply diagram to illustrate your argument, considering the effects on both demand and supply. How are the price elasticities of demand and supply relevant to your answer?
What externalities are there from drug use?
What externalities are there from making cannabis illegal?
Distinguish between complementary and substitute goods for cannabis? How is the demand for these likely to be affected by legalising cannabis?
Go through each of the benefits and costs of legalising cannabis and identify difficulties that might be experienced in quantifying these costs and benefits?
If cannabis were legalised, how would you set about determining the optimum rate of tax on cannabis production, processing, distribution and sale?
Consider the arguments for and against legalising cannabis from the perspective of (a) a free-market liberal and (b) a social democrat who sees government intervention as an important means of achieving various social goals.
Most football fans will probably never have heard of an organisation called FIFPro but, if it is successful, the labour market for football players could change quite radically.
FIFPro represents over 65,000 players from around the world. It is effectively an international trade union whose main objective is to promote the interests and defend the rights of professional football players. Its president, Philippe Piat, has recently announced that the organisation will challenge the way the current transfer system operates and is prepared to take its case to the European Commission and the European Court of Justice.
FIFPro’s argument is that players are being exploited under the current system. This may seem difficult to believe in the week when Luis Suarez signed a new four-and-a-half-year contract at Liverpool with earnings of £200,000 per week. However, referring to the transfer system, Piat stated that:
These legal and monetary shackles binding footballers to their current clubs can no longer be accepted and upheld. Football players are workers and only when they are able to enjoy the rights enshrined in law and enjoyed by all other workers, will Fifpro be satisfied.
In order to understand this argument, it is important to understand how the transfer system has evolved and how it now operates.
When the Football Association (FA) first accepted professionalism in 1885 it introduced a registration system. Before this reform it was possible for players to play for different teams each week. The new system meant that players had to register with a club at the beginning of each season. If a player was not registered with a team he was not allowed to play. He could only change team mid-season if his current club and the FA agreed to the transfer of his registration details to a different team. However, a player was free at the beginning of each season to register with a different team. Therefore there were no constraints on his mobility between teams from one season to another.
Significant changes were made to the system in 1893 when the retain-and-transfer system was first introduced. The new scheme allowed teams to keep retaining players they had initially registered for another year. This effectively meant that when a player was signed by a team he was tied to that team for as long as they wanted him. The mobility between clubs from one season to another had been removed. This gave the clubs significant monopsony power in the labour market. If a player wanted to change teams, he had to make a transfer request but the team was under no obligation to put him on the transfer list and allow him to move. Teams could decide to put players on a transfer list and would only allow them to leave if an agreeable level of compensation (a transfer fee) was offered by another team. A maximum wage of £4 per week was also introduced in 1901.
The system was periodically challenged and a number of minor changes were made. In particular, the conditions under which a player could be retained by a club were gradually altered. Originally a player could be retained by a club even if his contract was not renewed. Effectively a team could stop a player moving to another club by holding onto his registration without having to pay him. This was changed so that a minimum wage had to be paid to a player if he was to be retained by the team that held his registration.
The first major change to the system came in 1963 from a player called George Eastham. In 1959 he failed to sign a new contract with Newcastle United and made a transfer request which the club promptly rejected. Although they did eventually allow him to leave and join Arsenal, he still took his case to the High Court and the judge concluded that the retain-and-transfer system was an unreasonable restraint of trade. Following this judgment the system was amended so that, in order to retain a player, a club would have to offer the player a new contract with terms and conditions which were at least as good as the previous one. If this was done, then a player could be retained by a club and his registration would only be released if an acceptable transfer fee was offered by another team.
Perhaps the biggest change to the system was made in 2001 following the famous Bosman ruling. Jean-Marc Bosman had wanted to move to the French side Dunkirk, but FC Liege, the club that held his registration, demanded a transfer fee that Dunkirk were unwilling to pay. Bosman took his case to the European Court of Justice and in 1995 a decision was made that the system was in breach of European Union law on the free movement of people. Following this ruling, an informal agreement was reached between the European Commission, FIFA and UEFA. From 2001 players over the age of 23 were free to leave their clubs once their contracts had expired. Transfer fees no longer needed to be paid for players who had reached the end of their contracts.
In September 2013, Mesut Özil joined Arsenal from Real Madrid on the deadline day of the transfer period for a reported fee of £42.5 million.
Although the ease with which players can change teams has significantly improved over the past 50 years, they still face constraints on their labour mobility that are unusual for employees. Most workers simply have to give a period of notice in order to change employer. These vary between jobs but are not usually longer than 3 months. FIFPro’s argument is that professional football players should have these same rights. This would allow Luis Suarez to leave Liverpool at any point in the next four and a half years without any transfer fee having to be agreed. He would simply have a serve out a short period
of notice and then he would be free to join any other club. Under the current system he would have to wait four and a half years until the
end of his contract before he could leave without a transfer fee having
to be paid.
Whenever the transfer system has been challenged the football authorities have always used the same defence – sport is different from other industries because of the importance of maintaining an appropriate level of competitive balance. It is argued that the ease with which players can change clubs needs to be restricted in order for this level to be maintained. Ultimately a judgment will have to be made between this argument and the principle of freedom of movement.
Explain why the marginal revenue product of footballers is so much higher than it is for people in most other jobs. What impact do you think technology has had on the marginal revenue product of footballers over the past 20 years?
Draw a diagram to illustrate how the wage rate for footballers would be determined if the labour market was perfectly competitive.
What is monopsony? Explain how the retain-and-transfer system could give football clubs monopsony power in the labour market.
Draw a diagram to illustrate the impact of monopsony on wages and employment in the labour market for professional footballers.
Explain how limiting the mobility of players might help to maintain the level of competitive balance in a league.
If the proposals by FIFPro were accepted, what impact do you think it will have on players’ wages?
The UK energy industry (electricity and gas) is an oligopoly. There are six large suppliers: the ‘Big Six’. These are British Gas (Centrica, UK), EDF Energy (EDF, France), E.ON UK (E.ON, Germany), npower (RWE, Germany), Scottish Power (Iberdrola, Spain) and SSE (SSE Group, UK). The Big Six supply around 73% of the total UK market and around 90% of the domestic market.
Under new regulations announced by Ofgem, the industry regulator, the Big Six will have to post the prices at which they will trade wholesale power two years in advance and must trade fairly with independent suppliers or face financial penalties. In addition, ‘a range of measures will make the annual statements of the large companies more robust, useful and accessible.’ According to the Ofgem Press Release:
Energy firms told to trade fairly with smaller rivals BBC News, Rachel Fletcher (26/2/14)
