Assume that the 2 companies are charging High Price. This gives an estimated profit of £10 million to each company. However, one company will receive an estimated profit of £15 million if it charges at a Low Price and the other continues charging at a High Price. This gives an incentive to the customers to deviate for a lower price. At this point, the other company will be running at a loss of £5 million as most customers would switch to the other company charging lower prices. This gives the other firm an incentive to lower its prices as well.

This gives an estimated profit of £5 million to each company as the customers in the market are now equally distributed between the suppliers assuming that everything else is equal. However, both firms receive a lesser profit of £5 million each by charging lower prices, giving them an incentive to cooperate and charge high prices to receive a profit of £10 million each. Therefore, the companies increase their prices either simultaneously or one after the other.

This framework implies tacit collusion among the Big Six as they all have risen prices either simultaneously or after the other in order to achieve higher profits. One of the problems being faced by the energy sector leading to market failure is that of the price of the energy bills as explained through the game theory model above. The price of the energy provided by the Big Six companies has faced an annual average increase in energy bills of around £97. Recent events such as the shutdown of Forties Pipeline System which caused the closure of the British North Sea Elgin-Franklin and Britannia gas fields resulted in the UK’s gas system being undersupplied by 27.

8m cubic metres. This decrease in supply has resulted in an increase in prices due to shortage. Prices for gas supply due in January 2018 have also increased nearly by a fifth due to an explosion at Austria’s main import hub which might result in a decrease in import of supplies. Another major problem in the energy sector is that of vertical integration and barriers to entry for new firms. This is because the Big Six have dominated the energy industry for a long time which has resulted in fewer customers for the other active suppliers making it harder for new firms to enter. The entry deterrence of the new firms can be better explained through the following model. In this model, assume that the Big Six energy companies dominating the oligopoly are the incumbent firms, all together.

They are Player 2 in the model, facing the threat of a possible entry of a competitor – Player 1. The entrant must decide whether it wants to Enter (E) the energy market or Not Enter (N) the energy market with the conditions that if N is chosen, the game ends or if E is chosen, player 1 must decide whether to Fight (F) or Acquiesce (A). Following this choice, the game ends. The entrant (Player 1) chooses a strategy a_1 ?A_1, with A1 being the set of available actions for Player 1. Player 2 takes into account the Player 1’s behaviour and then chooses a strategy a_2 ?A_2 (a_1 ) with A2 being the set of available actions for Player 2.

A2(a1) shows that the set of possible actions taken by Player 2 may be affected by the action a_1 chosen by Player 1 as Player 2 has to take into account the entrant’s actions to make their own decision. These strategies imply – ?- A?_1={N,E},?- A?_2 (N)= ? ?- A?_2 (E)={F,A}We use the information above to construct a game tree to help us identify the Nash Equilibrium of the game.