Unit 1: Supply & Demand for eggs in California

New changes in the egg market in California are a great resource for teaching a number of economic concepts, particularly supply and demand in action. A number of scenarios are possible as different rules in different states impact on egg producers decisions on how to produce their eggs and where to sell them.

It started back in 2008 when Californian voters approved a law that increased the minimum cage area per bird from 67 square inches to 116 square inches, a jump of 70%. That law comes into effect from the beginning of 2015 and applies to all eggs produced and / or sold in California. Therefore, existing facilities will be able to produce less eggs and there will be a clear increase in the cost of production per egg. 

The outcome predicted by supply and demand analysis would be higher prices and a lower quantity of eggs sold. Initial estimates are that there will be an increase in price in California of 20%.

But what is also interesting is the dynamics with other producers in states that don’t have the Californian restrictions. 

The largest producer of eggs is Iowa and they sell a lot of their output to California. Their first option for Iowan producers is to comply with the restrictions so that they can sell their eggs into California. This is likely to lead to a national loss of 10 million egg laying birds (3.3% of the total market). The second option is to ignore the rules and sell only to other states – having the effect of “flooding” the market and driving prices in other states down. 

The outcomes of these options are shown below.

The link to the article in The Wahington Post is found here. There are a number of issues that could be devloped which make it an eggscellent (groan) topic for a Data Response question. These include

- elasticity of demand (if estimates are correct, the 20% increase in price leading to a 3.3% decrease in national egg production would indicate a price elasticity of -0.17)

- distribution effects (will the increase in egg prices have a disproportionate effect on the poor)?

- demand for substitutes and complements of eggs

And as an extension, since the Californian law only applies to eggs still in their shells, what other outcomes could occur?

Unit 3: Market Structures in transport

I haven't posted a Unit 3 article for a while, so it was pleasing to find this excellent video made applying the theory of market structures to the world of transport in Singapore. 

This is superb as it goes through each transport mode analysing the market structure before digging into the conduct within that market. 

This will provide crucial A* level content to exams for a given market structure question. Well worth a watch.

Merry xmas everyone....happy blogging!

Unit 2 & 4: Monetary Policy, Exchange rates and Russia

All,

I really hope you have been keeping up to date with the economic crisis facing Russia at the moment. As you can read in this article, the Russian Rouble is in free fall. This has huge implications for the Russian economy. The central bank is trying to reverse this trend by raising interest rates to a massive 17% (compared to 0.5% in the UK).

This could have a devastating effect on the average Russian trying to survive the economic crisis. This article is also loaded with information.

Questions to discuss include:

Why is the Rouble depreciating?
How will raising the interest rate stop this fall?
What impact will the rise have on the other major objectives?

This is so similar to 'Black Wednesday in the UK. Read this article from the BBC. Economic policy repeating itself......did it work then? Will it work now?

I welcome your thoughts.

Unit 4: Primary Product Dependency & commodity prices

As world commodity prices plunge, who gains and who loses?

This should be a ‘favourite topic’ for determined macro students. The concept of a resource curse is well worth covering, since there are many analysis points (about how the cause of primary product dependency could lead to a variety of effects). There’s also ample scope for evaluation, examining who will be affected, by how much and to what extent it can impact on economic performance – loads of ‘it depends’ statements, in other words.

The Economist has published a handy map tool to see who are the primary product importers and exporters around the world.

The plunging oil price has sent the currencies of oil exporting economies into a dive. This is the flip side of Dutch Disease, in which demand for resources drives exchange rate movements.

Shifting terms of trade also have a big impact, especially on developing economies.

Lots of key issues for Unit 4 essay and case study questions: Please click on the links to access notes on them. (Dutch disease, terms of trade)

Unit 4: Development and capital investment

Thank you to Tom White for this excellent article on capital accumulation. It is a must read for students looking at ways to help developing economies grow........

The problem with both free-market and Keynesian economics is that they misunderstand the nature of modern investment. Both schools believe that investment is led by the private sector, either because taxes and regulations are low (in the free-market model) or because aggregate demand is high (in the Keynesian model).

In Sachs’ alternative view, private-sector investment today depends on investment by the public sector. But investment into what? What types of capital should we be accumulating?

Sachs argues that unless the public sector invests, and invests wisely, the private sector will continue to save profits or return them to shareholders in the forms of dividends.

Sachs believes that government investment needs to complement private sector investment for the best results. He describes six types of capital:

1. Business capital includes private companies’ factories, machines, transport equipment, and information systems.
2. Infrastructure includes roads, railways, power and water systems, fibre optics, pipelines, and airports and seaports.
3. Human capital is the education, skills, and health of the workforce.
4. Intellectual capital includes society’s core scientific and technological know-how.
5. Natural capital is the ecosystems and primary resources that support agriculture, health, and cities.
6. Social capital is the communal trust that makes efficient trade, finance, and governance possible.

Sachs’ point is that the different forms of capital work in a complementary way. Business investment without infrastructure and human capital cannot be profitable. Nor can financial markets work if social capital (trust) is depleted. 

Without natural capital (including a safe climate, productive soils, available water, and protection against flooding), the other kinds of capital are easily lost. And without universal access to public investments in human capital, societies will succumb to extreme inequalities of income and wealth.

Sachs says that the key to development was basic education, a network of roads and power, a functioning port, and access to world markets. 

Today, however, basic public education is no longer enough; workers need highly specialised skills that come through vocational training, advanced degrees, and apprenticeship programs that combine public and private funding. 

Transport must be smarter than mere government road building; power grids must reflect the urgent need for low-carbon electricity; and governments everywhere must invest in new kinds of intellectual capital to solve unprecedented problems of public health, climate change, environmental degradation, information systems management, and more.

Sachs goes on to worry that this just isn’t happening on the required scale. Like most observers, he is concerned that there is too much focus on the short term, and excessive cutbacks in public sector investment – which he sees as a false economy.

Unit 3: Monopsony Power

Many thanks to Newsnight for providing the material for a lesson about monopsony power - if nothing else, it makes a change from taking Tesco as the model for this topic. 

On Friday, Newsnight carried a report about Premier Foods, a conglomerate which owns many different grocery brands such as Mr Kipling, Ambrosia, Bisto and Oxo. Their allegation is that Premier Foods has been using its power as a major customer to request payments from its suppliers; if they don't pay up, they are 'delisted' from supplying the company. In other words, monopsony power.

The online report comes with a 5-minute video clip which sets up the topic nicely. Newsnight's Laura Kuenssberg interviews engineer Bob Horsely, who had a contract to supply maintenance services to Ambrosia's factory in Devon. He received a letter from Premier Foods saying that "We are aiming to work with a smaller number of strategic suppliers in the future that can better support and invest in our growth ideas. We will now require you to make an investment payment to support our growth." 

When he queried this, he received another letter: "We are looking to obtain an investment payment from our entire supply base and unfortunately those who do not participate will be nominated for de-list."

Premier Foods has been in financial trouble recently, and says that it is trying to invest in growth; it makes the point that, if it succeeds, that can only be to the benefit of its suppliers. However, there are calls for this case to be referred to the Competition and Markets Authority. 

If a supermarket behaved like this, it would be against The Groceries Code which regulates relationships between supermarkets and their suppliers (....but see below*); however, that code doesn't cover manufacturers like Premier Foods.

The article presents a good opportunity for a class exercise, leading to questions like:

- What form of market failure is demonstrated by this case?

- Can Premier Food's statement that "...our suppliers benefit from opportunities to secure a larger slice of our current business. They also stand to gain as our business grows in the future." be justified?

- Should the Groceries Code be extended to include producers as well as retailers?

- What other actions could governments take to prevent this market failure?

- What are the risks of government failure?

* Supermarkets and Suppliers - back to Tesco

There can be no doubt that in this relationship, the power is in the hands of the supermarkets: according to an online report, Britain’s top ten supermarkets owe about £15billion to suppliers for goods at any one time, giving them leverage to 'negotiate' extra payments.

However, listening to The Report on Radio 4 recently, I was really taken aback by the extent of those pressures, as they were explained by current and ex-suppliers and ex-staff of Tesco.

As much as a third of Tesco's gross profit comes, not from sales of goods and services to customers, but from payments they receive from suppliers. Some of those are called “rebates”, reported here in the FT: "Rebates are payments that Tesco receives from suppliers for hitting a certain level of sales, or for support for promotions. For example, Coca-Cola could offer a percentage discount on 2-litre bottles if 20m of them were sold in a specific period – but it will only pay this rebate if the sales target is hit. 

Tesco’s UK sales volumes have dropped as it loses market share to competitors, so there is a risk that such volume-driven rebate targets could be missed." The report in the FT is a fascinating one, very accessible to students, about the way in which such payments are pre-estimated by the retailers in order to be included in their accounts, and this practice has been largely responsible for the 'black hole' of £250mn in Tesco's accounts.

Rebates are clearly common in the industry, and a report in The Grocer implies that many suppliers see this as 'fair enough' - if Tesco can shift huge numbers of the goods, the suppliers and manufacturers benefit by selling more, producing at closer to full capacity and gaining economies of scale. 

However, there are other payments as well. There are listing or gate fees, in which the supplier pays tens or hundreds of thousands of pounds in order to get their products onto Tesco's shelves, more fees in order to get them displayed at eye level, and more recently, payments demanded in order to avoid having products delisted. 

The radio report carried several instances of small scale suppliers who simply couldn't make such payments, and so lost their contract to supply. As a sales negotiator quoted in The Grocer says, when a buyer says 'give me £4mn or I won't stock your product any more', things are getting desperate. Meanwhile, Groceries Code Adjudicator Christine Tacon has urged suppliers to come forward with “hard evidence” to allow her to investigate alleged breaches of the Code.

Unit 3: Contestable Markets - introduction notes

Introduction to contestability theory

A contestable market has no entry barriers - firms can enter or leave an industry costlessly. The threat of potential entry may be enough competition to ensure imperfectly competitive set price and output at or close to the competitive price and output.

Imperfectly competitive markets can be contestable. Contestability theory is associated with Baumol who argues the mere threat of new firms entering a market means existing firms act competitively ie lowest costs, prices and profits. The theory of contestable markets argues that what is important is not actual but potential competition.

A market is perfectly contestable when the costs of entry and exit are zero where any entry costs can be recovered on exit ie there are no sunk costs.

In a contestable market the threat of entry by potential rivals will ensure that the firm or firms in the industry will earn normal profits and deliver allocative and productive efficiency:

· Few barriers to entry into the market means potential entrants are able to enter market quickly if abnormal profits are made. This process helps ensure normal profits only, are earned in the long run;

· The size of firm is irrelevant;

· Price competition is unlikely, although it may occur for short periods;

The government has sought to create contestable markets in the rail, bus, ferry and air industries through deregulation (buses) and short franchises (trains).

However:

· Significant entry barriers may exist and incumbent firms can often scare potential entrants away from entering.

· Sunk costs refer to expenditure that cannot be recovered if a firm leaves an industry and represent a barrier to entry. If potential entrants anticipate high sunk costs contestability theory is less effective in lowering price and profits

· Short-term franchises introduce contestability into transport markets but deter long-term investment where firms feel they may lose their current franchise and experience sunk costs. For this reason, the latest franchise agreements are for longer periods eg 15 years. 15 year franchises create uncontested legal monopolies.

· Road haulage: many small one-lorry owners. Monopolistically competitive?

· Bus: after deregulation early competition mergers have created three oligopolies. Many regional bus monopolies are local monopolies. London Bus is a franchised monopoly. A national oligopoly and regional monopoly?

· Rail operators 28 TOC's are regional monopolies with a time-limited franchise. Extensive price discrimination on fares.

· Airlines: Bilateral agreements giving way to open skies resulting in an increase in the number of low cost operators and flights. Monopolistically competitive? Duopolies giving way to monopolistic competition

· Infrastructure natural monopoly argument means one regulated operator eg Railtrack and NAT's