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W I L L I A M S P H Y S I C S E D U CAT I O N
Price Determination in a Competitive Market - File 1 (40 marks, 2 / 4 / 9 / 25) - Question 1/1
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40 marks
Study Extracts A, B and C and then answer all parts of the question which follow. The
context is the UK gas market and the Energy Price Cap operated by the regulator
Ofgem.
Extract A - UK Energy Price Cap, typical dual-fuel household on default tariff (direct debit)
Energy Price Cap (£ per year, typical
Period
household)
October 2021 £1,277
April 2022 £1,971
October 2022 (announced
£3,549
level)
April 2023 £3,280
October 2023 £1,834
Energy Price Cap (£ per year, typical
Period
household)
April 2024 £1,690
October 2024 £1,717
Source: Ofgem default tariff cap announcements, 2021-2024. The Cap shown is the
announced level; in October 2022 the Energy Price Guarantee held actual household
bills at £2,500.
Extract B - UK day-ahead wholesale gas price (NBP), pence per therm, 2020-2024
UK day-ahead
UK day-ahead wholesale
wholesale gas
gas price
price (NBP),
(NBP), pence
pence per
per therm,
therm, 2020-2024
2020-2024
500
500
Peak: 400p
Peak: 400p (2022
(2022 Q3)
Q3)
400
400
300
300
p/therm
p/therm
200
200
100
100
Low: 13p (2020
Low: 13p (2020 Q2)
Q2)
0
0
2020
2020 2021
2021 2022
2022 2023
2023 2024
2024
Year (quarterly
Year (quarterly data)
data)
Source: Bank of England, Ofgem and ICIS Heren market data, 2024. The National
Balancing Point (NBP) is the UK wholesale price benchmark for natural gas.
Extract C - The UK gas market and the Energy Price Cap
The UK depends heavily on natural gas for heating, electricity generation and industrial
use. Around 85% of UK homes are heated by gas boilers, and gas-fired power stations
met roughly 35% of UK electricity supply in 2023. The UK produces some of its own gas
from the North Sea but imports the remainder, mainly as pipeline gas from Norway and
as liquefied natural gas (LNG) from countries including Qatar and the United States. The
rebound in economic activity after the COVID-19 lockdowns raised demand for gas
across Europe at a time when supply could not respond quickly. The full-scale Russian
invasion of Ukraine in February 2022 then disrupted European gas flows, sending
wholesale prices to record highs.
Wholesale gas is bought and sold in a competitive market with many buyers and sellers,
so prices respond rapidly to changes in demand and supply. New gas production
capacity takes years to develop, and storage in the UK is limited compared with other
European countries. In the short run, the supply of gas to the UK is therefore highly
inelastic. Demand for gas is also relatively inelastic in the short run because most
households cannot quickly switch heating systems or change consumption habits.
Concerned about the effect on household budgets, the UK government instructed
Ofgem, the energy regulator, to operate the Energy Price Cap. The Cap sets a maximum
price per unit of gas and electricity that suppliers may charge households on default
tariffs. When wholesale costs rose sharply in 2022, the Cap was lifted to £3,549 a year
for a typical household; the government then introduced the Energy Price Guarantee,
holding actual bills at £2,500 a year and using public spending to pay the difference to
suppliers. Critics argue that the policy weakened the rationing and signalling functions of
price and increased the public sector deficit. Supporters argue that, in a market where
supply is inelastic and demand is essential, allowing prices to rise without limit would
have driven millions of households into fuel poverty. Alternative policies the government
has considered include subsidies for energy efficiency improvements, a windfall tax on
gas producers and direct payments to vulnerable households.
(a) Inflation in the UK Consumer Prices Index between October 2021 and October 2022
was 11.1%. Using this information and the data in Extract A, calculate the real-terms
percentage increase in the Energy Price Cap between October 2021 and the announced
level for October 2022. Give your answer to one decimal place. [2 marks]
(b) Explain how the data in Extract B (Figure 1) show that the UK wholesale gas price has
been highly volatile between 2020 and 2024. [4 marks]
(c) Extract C states that 'in the short run, the supply of gas to the UK is therefore highly
inelastic' and that 'the rebound in economic activity after the COVID-19 lockdowns raised
demand for gas across Europe'. With the help of a diagram, explain how an increase in
demand for gas in a market with inelastic short-run supply is likely to affect the
equilibrium price and quantity. [9 marks]
(d) Extract C states that 'the Cap sets a maximum price per unit of gas and electricity
that suppliers may charge households' and refers to alternative policies including
subsidies and direct payments to vulnerable households. Using the data in the extracts
and your knowledge of economics, evaluate the view that the Energy Price Cap is the
most effective policy for protecting consumers in the UK gas market. [25 marks]
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