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Pandemic prices: should companies be penalised?

Jake Foad Jake Foad

A rise in demand due to COVID-19 has seen the prices of essential products increase. Jake Foad explores whether regulators need to step in.

The COVID-19 situation has led to a sharp rise in prices for related essential items, such as masks, hand gel and, bizarrely, toilet roll.

Each saw unprecedented spikes in demand, and presented opportunities for suppliers to make quick profits. The question is whether competition authorities should be preventing these price rises, or does their intervention only exacerbate shortages in essential products?

As an economist, my stock answer is: let the markets correct themselves.

High prices are a by-product of increasing demand and act as a signal for new sellers to enter the market. As supply increases, we’ll end up - more or less - at an equitable equilibrium with prices falling to pre-coronavirus levels.

Is this true all of the time? For example in the COVID-19 environment when you practically had to take out a small loan to buy hand sanitiser! Well, sort of...

Demand and supply balance market prices

Independently, the issue at hand is not the high prices and excessive profits, it’s the scarcity of product.

For example, in December 2019, you could buy hand sanitiser for £1. Roll forwards four months and the same product was more expensive or, more likely, unavailable, because there wasn't enough product to serve the market.

However, roll forwards another four months and we can buy the same products for more or less the original prices. Why? Because excessive profits signalled the entry of new suppliers who competed to bring prices down to the pre-coronavirus equilibrium.

Global competition authorities are receiving complaints relating to the conduct of suppliers: how can they be allowed to abuse their market power by setting prices at such a premium during a crisis?

The Competition and Markets Authority (CMA) recently decided to close four investigations into suspected charging of excessive and unfair prices for hand sanitiser products, as the defendants “were unlikely to infringe competition law”. Looking elsewhere across the globe, we see regulators taking contrasting approaches, such as the Competition Tribunal of South Africa issuing a workwear manufacturer with a ZAR 76K fine for charging excessive prices for face masks.

Three regulatory levers to influence market prices

We should consider whether the impact of regulatory intervention will improve or worsen the situation? Broadly speaking, a regulator has three levers to influence market dynamics:

1 Price: implement a price ceiling on products, thereby limiting companies’ profits

To implement a price ceiling, we are, effectively, removing the incentive for suppliers to enter the market. If all suppliers are forced to sell at the competitive price (eg, £1 hand gel), or are fined if they are found to price above this level, there is no incentive for new suppliers to enter. Therefore, the issue of scarcity is not resolved.

2 Demand: subsidise the cost that consumers pay

Governments subsidising the cost of products would lead to a more-equitable allocation of the scarce resource – i.e., the products become more affordable. While arguably a fairer outcome, suppliers will be aware of the government aid and there's therefore no incentive to lower prices. Furthermore, this would place additional stress on an already fiscally-burdened government.

3 Supply: remove barriers to entry to allow easier access of suppliers into the market

Finally, the most-effective method, in my opinion, is for regulatory bodies to review barriers to entry in the market, either through a relaxation of regulation, or subsidising new entry through the utilisation of the European Commission's £50 billion state aid package (or an equivalent subsidy package that may be agreed by the government following Brexit), providing "support for the production of products relevant to tackle the coronavirus outbreak". This would ensure that new suppliers can enter and begin production as soon as possible.

The introduction of competitors will reduce the timeframe in which producers can make excessive profits and would drive prices down to pre-coronavirus levels.

Intervention may be counterproductive

In my view, high prices and profits should not be seen as a de facto abuse of market power. In the short term, consumers will feel aggrieved at paying extortionate prices for essential goods. However, if barriers to entry are low, the high prices will signal the entry of new suppliers into the market, naturally bringing the prices down as competition increases.

Strict intervention in these markets may be counterproductive and lead to a further decline in the supply of products, which at the height of the coronavirus situation, should be the least-preferential outcome.

To continue the conversation, get in touch with Craig Reed or Jake Foad.

 

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