Sticky prices-(14.01.07)

The reluctance of retail gas prices to come down with the wholesale price is a classic case of 'sticky' prices. A less than perfectly competitive market, and prices will not follow costs in the short and even medium term. How long this length of period is will depend on a number of factors.

From the company point of view, there is a generally a belief that customers dislike frequent price changes. Where there is uncertainty that a reduction of costs is going to be sustained, the view is taken that the number of customers lost by an increase in price not immediately reflected by competitors is more than the number of customers gained from a reduction in price. Barriers to entry in advertising prices to new customers of other companies, customer inertia to switch, high cost of entry (again from advertising or other fixed costs); all these contribute to sticky prices being exhibited.

The competition question is, should there be a policy concern about this type of behaviour. It is clearly in the companies interests as profits and prices are higher than they need to be. It may be true that consumers dislike frequent price changes, but this does not avoid competition issues. However, the judgement needs to be made that regulation of prices would not necessarily be more effective. Prices may become sticker due to a delay in changing prices due to the need for information flow between the market, companies, regulators and back to companies. The market price itself may anticipate regulator action and therefore dampen out wholesale price changes, which would hardly be in consumer's interests. One solution would be margin regulation above the wholesale price, but again in the long run this creates another barrier to entry which may lessen the impact of desired competition in the first place. The best answer may be for customers to be immediately be able to switch between one company and another, perhaps based on a spot price website. The transaction costs may be high for this, and it assumes that customers are only interested in price rather than service. If you believe that British Gas does indeed have the highest price and the worst service then this may not solve customer inertia to switch in any case.