Traditional present similar tariffs in distinctive ways as the

Traditional
economics assumes that all consumers are rational maximisers. However, in real
life this is not always the case. Consumer biases exist, where consumers do not
act rationally according to the orthodox ideal of perfect rationality.1
This affects the consumer’s decision making as they are unable to compare
products and prices efficiently. Therefore, the RMR was introduced to provide
consumers with better information and aid their decision-making process.

 

One of the
consumer biases that is relevant to the introduction of RMR is cognitive
limitations of consumers that make comparison of products and prices more
difficult. This occurs when they have trouble in assessing a wide amount of
options and information of the goods and services offered to them. This might
be due to the limited amount of time and knowledge to evaluate the offers. It
also varies according to the level of knowledge and skills of individual
consumers. A complex range of tariffs with different components are likely to
increase the difficulties faced by consumers. Presentation of information also
matters as the same tariff maybe be explained in a simple or more complicated
way. Consumers will struggle to make comparisons when different suppliers
present similar tariffs in distinctive ways as the decision making has become
more complex.

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Piccione and
Spiegle (2010) showed that a fraction of consumers will only switch from their
current tariff if the new tariff is structured and presented in exactly the
same way.2

 

 

To asses this
problem, RMR has introduced a few simpler tariff choices proposals aiming to
make the market simpler and facilitate consumers’ ability to be aware, access,
assess and act on information available to them.3
A maximum limit on the number of core tariffs that suppliers will be able to
offer at any point in time was introduced. The policy was intended to reduce
tariff choices for consumers so that comparisons between them can be made
easier.

 

Another consumer
bias is status quo bias. It is the tendency of consumers not to change from what
they are currently doing. Consumers prefer the current option and do not search
for alternative deals from different packages or providers. This is mainly
because consumers are happy with their current supplier and express loyalty to
their current provider.

 

There is evidence that many consumers stick with
the status quo in the GB energy retail markets. A survey by Ipsos MORI, shows
that 89 per cent are aware that they can switch energy supplier, and 85 per
cent of switchers find switching fairly easy. However, approximately 60 per
cent of consumers say they have never switched supplier.4

 

RMR was introduced to reduce this status quo bias
as research for Ofgem in the Retail Market Review has shown that consumers can
make substantial savings by switching.5
Clearer information proposals were presented which consisted of new rules
designed to provide consumers with more relevant and useful information. This
will ensure that they

have information on their energy costs, their
energy tariffs and their consumption.

 

For instance, A Tariff
Comparison Rate (‘TCR’) helps consumers to compare the costs of different
energy tariffs by different suppliers. Moreover, the Tariff Information Label
(‘TIL’) creates a standard way of presenting energy tariff features to help
consumers understand all the characteristics of a tariff and compare them
across suppliers.6

 

Lastly,
loss aversion is another consumer bias relevant to the introduction of RMR. Economic
theory assumes that consumers value future losses and gains depending on how
likely they are to occur and the consumers’ appetite for risk.

 

In practice however, consumers
focus far more on losses than gains and avoid options with risks or losses. This
can affect consumers’ decisions to act or to access information in the first
place. Consumers search less when energy prices fall than when they rise. They
might even postpone decision making.

 

To conclude, the RMR was introduced due to consumer
biases that exist in real life. This includes cognitive limitation of
consumers, status quo bias and loss aversion. These biases overlap and so do
the solutions for these problems. Each proposal does not correspond to a single
consumer bias, rather it can reduce multiple consumer biases at a time. For
instance, clearer information can help consumers with cognitive limitations,
reduce status quo bias and loss aversion.

 

 

 

Question
2:

Explain
two aspects of the RMR you consider as regulating price discrimination.

 

Price discrimination is when
different group of consumers are charged different prices for identical products
that are not justified by cost differences. In the case of the energy market,
customers who are loyal or do not switch from their current tariffs pay substantially
more for their energy compared with active switchers who shop around for the
best deal. Therefore, the RMR proposals are designed to regulate price
discrimination.

 

One of the proposal is limiting
the number of tariff choices a consumer would face. This would make consumer
switching to better tariff deals easier as they are able to make better
comparisons. Consumers would be less discriminated as they will switch to
tariffs with a lower price.

 

Furthermore, the Cheapest
Tariff Messaging (‘CTM’) would also aid in regulating price discrimination as
it provides consumers with personalised information on how much they could save
by switching tariffs with their current supplier.7
This is intended to increase consumers’ awareness of how much they would save
from switching and prompt them to consider their options.

1
Et al, (2011), Consumer Behavioural Biases A Survey,
London: Office of Fair Trading

2
Piccione, M., and R. Spiegler (2010), Price
Competition under Limited Comparability, working paper

3 Ofgem,
(2013), The Retail Market Review –
Implementation of Simpler Tariff Choices and Clearer Information

 

4 Ipsos
MORI 2011, ?Customer Engagement with the Energy market – Tracking Survey?

 

5 Ofgem 2011, ?The Retail Market Review – Findings
and initial proposals?, Figure 2.9

 

6
Ofgem, (2013), The Retail Market Review –
Implementation of Simpler Tariff Choices and Clearer Information

7
Ofgem, (2013), The Retail Market Review –
Implementation of Simpler Tariff Choices and Clearer Information