Regulation of prices through price capping has been a feature of regulation of the utilities in the UK for many years – although this is now being phased out as most utility markets have become more competitive.
Price capping systems
- Price capping is an alternative to rate-of-return regulation, in which utility businesses are allowed to achieve a given rate of return (or rate of profit) on capital.
- In the UK, price capping has been known as "RPI-X". This takes the rate of inflation, measured by the Consumer Price Index and subtracts expected efficiency savings X. So for example, if inflation is 5% and X is 3% then an industry can raise their prices on average by only 2% per year
- In the water industry, the formula is "RPI - X + K", where K is based on capital investment requirements designed to improve water quality and meet EU water quality standards. This has meant increases in the real cost of water bills for millions of households in the UK.
Advantages
Capping is an appropriate way to curtail the monopoly power of “natural monopolies” – preventing them from making excessive profits at the expense of consumers.
Cuts in the real price levels are good for household and industrial consumers (leading to an increase in consumer surplus and higher real living standards in the long run).
Price capping helps to stimulate improvements in productive efficiency because lower costs are needed to increase a producer’s profits.
- The price capping system is a tool for controlling consumer price inflation in the UK.
Disadvantages
Price caps have led to large numbers of job losses in the utility industries
Setting different price capping regimes for each industry distorts the price mechanism
Notes
Data Charts
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