Oh My Gawd!

Five of Britain’s biggest energy companies were facing mounting pressure to cut prices last night after figures from Ofgem, the industry regulator, showed the average profits they earned per household leapt 40 per cent this winter to the highest level in five years.

Supplier profits rise in period of rising demand.

Is there nothing those bastard economists cannot explain?

Think of it the other way around. Some resource (anything, good or service in fact). Demand rises in the face of static supply. Thus prices and profits rise. So more peeps see the high profits and think, I\’ll have me some of that. They invest in a number of things to try and capture some of those profits. Finding more of the goods or service, producing more, perhaps looking for ways to substitute for the good or service. Either supply of the scarce resource, good or service increases, bringing down prices again or demand falls, bringing down prices again.

In this case, maybe more poeple drill for gas or perhaps someone comes up with an interesting and cheap way to insulate a house (as a bloke I know is thinking about. Why is it that lofts are insulated but not the floorboards between floors?)

Excess profits are thus competed away as excess profits are the signal that there are excess profits to be had.

No, no, you\’re right. Absolutely crazy system, never take off in a million years*.

* No, really: took Homo (of various different flavours, erectus, australopithecene, sapiens etc) a good two or three million years to work it out. First recorded explanation is probably 1776, Wealth of Nations.

Guys…in the comments there you\’re forgetting this bit. \”or perhaps someone comes up with an interesting and cheap way to insulate a house\”. Even if supply is constrained by barriers to entry, demand ain\’t.

15 thoughts on “Oh My Gawd!”

  1. err … yes, except this story of excess profits spurring entry and competition is not necessarily an accurate description of how the UK energy market operates. You can tell other stories (oligopoly, barriers to entry etc.) all right out of Econ 101.

  2. Luis is right, we can hardly pop and and build a generator. Even if we could source the capital the regulatory framework – planning permission etc, political risk and attendant timescales would kill the project before it got off the fag packet.

  3. Luis Enrique & The Great Simpleton are right, the regulatory has made the market very difficult to enter.

    So instead of capping prices, why not undo the former mistake.

  4. Serf,

    you don’t need regulations to create barriers to entry and natural monopolies – you might choose to regulate a market in which such things arise.

  5. Brian, follower of Deornoth

    “mounting pressure to cut prices”

    Of course we need regulations, regulations and more regulations. If energy were an efficient market, we wouldn’t be able to show our moral superiority by making costly gestures at other people’s expense.

  6. I think the update is as confused. If a company is making excess profits through a lack of competition meaning its prices are higher than would otherwise be the case, when consumers reduce their consumption of that product it’s not fantastic news, go and stick a statute of Adam Smith up in every town. It’s welfare-reducing.

  7. I think you’ll find the preferred socialist scenario would have been:

    Here we all are on January 15th celebrating the record losses incurred by the energy companies. Ed Milliband was right about global warming, it’s a muggy 35C and aircon has been banned except in government offices.

    We’ve hung grandma out of the window and attached her to the largest radiator in the house via a superconducting cable, in the hope that she’ll reduce the temperature in here. Simon had the idea and has a degree in physics, but I keep telling him that if we get a thunderstorm we could be in deep shit…

  8. Tim,

    yes good point about higher prices and demand.

    Ian, I know you didn’t ask me but … it’s a relative term, defined as excess over normal profit

    (another way of thinking about this, is anything in excess of the minimum return to capital necessary to give somebody an incentive to provide that capital. You can adjust this for risk etc. In a competitive economy, returns would be competed down to that minimum).

  9. Ian, as Luis says. In fact Tim and Luis used the term before I did, both without sounding like ‘a twat’.

    Luis’s answer unfortunately made you look a bit of one, though.

  10. Lofts are an easy market to enter, literally, to gain access to the intervening floors means virtually demolishing the house. Modern building regs are incresingly focussing on total insulation packages. By not insulating the intervening floors of a single occupancy dwelling, the ratiator sizes for the upper floors can be reduced, in theory. Rising heat from the lower floors mean that the bedrooms, which most people prefer to be cooler, need less heat input. The matter is very different for multiple occupancy houses. I would choose to live over a rich old person who keeps the thermostat wound up high!

  11. Economists may be able to explain everything , although I doubt it , but as they occupy all positions and we don’t know which ones have the correct explanation ,they are of less use than a tea leaf reader .
    This throws you back on your commons sense and mine tells me the market is not operating here.

  12. Luis, thank you. I have said before that I am no expert on economics, and technical terms often have a meaning other than what may be expected, so every little helps.

    Matthew, I realise they did, but yours was the most recent use. You’ll note that I nowhere suggested that you were sounding like a twat, and simply hoped that you would not lapse into such. I apologise for the misunderstanding.

    Tim adds: Sorry, should have got to this sooner. Yes, we say that there’s an average risk adjusted profit rate across the economy. This is old stuff, Adam Smith. If people are making more than this it’s evidence that not enough capital is being used in that sector/industry. So peolpe hare off to capture those “excess profits” by investing in that industry. This brings the profit rate down to that average rate.

    Another way of looking at the same thing. You can only make those “excess profits” if there’s not enough people making what you do. This means customers are paying higher prices than they would do (which is what leads to your profits of course) if there was more competition. Those excess profits are a signal that there’s not enough competition and that new entrants into the market can (well, might) make good profits by making what you make. More competition leads to lower prices for consumers (a good thing!) aqnd reduces those profits.

  13. ‘after figures from Ofgem, the industry regulator, showed the average profits they earned per household leapt 40 per cent this winter to the highest level in five years’

    I must have missed the bit where the regulator told us what he was doing to claw back this money for the customers.

  14. Another way of looking at the same thing. You can only make those “excess profits”

    Or supernormal Profts if it is a quasi cartel . Tim if your demand theory is right why do people set up cartels ?

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