Unit 3: Cartels and game theory - The Oil Industry

The Organization of Petroleum Exporting Countries (OPEC) is an example of an oligopoly colluding overtly to fix the price of a barrel of oil - currently there are 12 members and according to OPEC they control 81% of crude oil reserves. One of OPEC's main aims is to “ensure stable oil prices, secure fair returns to producing countries and investors in the oil industry“. 

Prices have hardly been stable of late, in fact according to the Economist "the price of Brent crude fell over 25% from $115 a barrel in mid-June to under $85 in mid-October, before recovering a little". This great article is well worth a read as it goes into the global consequences of this fascinating turn of events in such a key market. But what caught my eye, in particular as we're not far off looking at oligopolies and game theory in A2 Microeconomics, was this Bloomberg article pointing out a potential breakdown of the OPEC price fixing agreement as predicted by the prisoner's dilemma and game theory:

"China is finding oil supplies 14,000 miles away, aided by the global rout in prices that’s left producers vying for new markets. PetroChina Co. said it bought Colombian crude for a northern refinery for the first time because it was good value. The transaction underscores how the world’s second-biggest oil consumer is benefiting as producers from the Middle East to Latin America vie for customers in Asia."

Part of the reason for this price fall is the rapid increase in US production (not a member of OPEC) - see graphic left - and the Saudi response was to INCREASE production by half a percent (causing other OPEC members to follow the Saudi lead) determined to protect their market share against non-cartel rivals. 

“OPEC appears to be gearing up for a price war,” Eugen Weinberg, head of commodities research at Commersbank , wrote on Oct. 2 - another feature of Oligopoly behaviour explained by the kinked demand curve. 

The prisoner's dilemma highlights the difficulty in cartels lasting any length of time as the temptation to break the agreement and reap the rewards is simply irresistible - now the US, Latin American and others not tied to OPEC are willing to sell for cheap, are we witnessing the beginning of the end of this cartel?

Possible question:

With reference to the Extract, assess reasons for Oil producing countries’ changing behaviour. Refer
to game theory in your answer. (16 Marks)

Unit 3 & 4: Oil Prices - Collusion and Primary Product Dependency

Thank you to Safiya for another article on falling all prices (click here to read).

The article is useful for both Unit 3 (Collusion) and Unit 4 (Primary Product Dependency).

Unit 4: The Big Mac Index - Purchasing Power Parity

At some point this year we will be looking at exchange rates and the Purchasing power Parity theory....all interesting stuff, but perhaps not as interesting as the 'Big Mac Index invented by that crazy magazine, 'The Economist. Click here to read their piece.

Unit 4: Falling oil prices - Winners & Losers

This is a common question on a Unit 4 essay paper. Please take some time to read the article and check out this question. I'm not saying do it, but think about what you would say and where you would get the points from.

Click here for article

Here are some questions from relatively recent papers. Not always about a fall in oli specifically, but similar nonetheless. 

Evaluate the likely implications for the world economy of the predicted decline in

non-renewable energy resources. (30 Marks)

Evaluate the likely economic effects of a sustained rise in commodity prices on the world economy. (30 Marks)

Evaluate the likely effects on the UK economy of the decrease in price of oil from $147 per barrel in July 2008 to $56 per barrel in November 2008. (30 Marks)

Unit 3: Monopoly - Essential background reading

Dear all,

I will miss first half of the lesson today. Please click on this link to access a presentation on monopoly.

We will discuss in class later.

All units: positive economic reasons for immigration.

Immigration to the UK can have economic benefits, despite what UKIP might say. Click on the article for an informative piece, looking at the argument we rarely hear about these days.

Unit 4: Growth & Development in Ethiopia 2

All,

I see already that 8 people have viewed the previous post (good work). When the rest of you catch up, look at a Unit 4 Essay on development and try and include the piece on Ethiopia.

I guarantee that those who do, will get great marks come the summer. Foe example, here is a question from June 2010:-

NB: A 30 mark question requires 4 points and 3 evaluation (Although, I would always look at 4 & 4)

(b) Evaluate four ways in which economic growth and development might be
promoted in developing countries. (30 Marks)

Unit 4: Growth & Development in Ethiopia

Ethiopia is a fascinating country to use as a case study in economic growth and development. According to a recent editorial in the Financial Times, "Ethiopia has transformed in 20 years from a famine-ravaged nation into a destination for savvy and well-known private equity groups such as KKR."

Ethiopian economic growth compared to Sub Saharan Africa

Economic growth

• Over the last decade, Ethiopia has been one of the fastest-growing countries in the world averaging annual increases in real GDP of close to 10%.
• The pace of expansion is expected to slowdown in the near term but real GDP growth is likely to be around 7.5% in 2014-15, driven by public capital investment in critical infrastructure such as extended road and power networks, which benefit both industry and agriculture.
• Long-term economic growth potential is boosted by untapped reserves of coal, gold, oil and gas.
• The country has experienced significant foreign direct investment valued at 2% of GDP in 2014 and this is set to continue growing, through investments in agriculture and manufacturing.

Structure of GDP

• Ethiopia remains heavily dependent on farming for her economic growth
• Rain-fed agriculture (accounting for almost 50% of GDP) is the country’s main source of employment and export earnings, which results in vulnerability to weather shocks that affect farm yields, incomes, profits and domestic investment.

Inflation

• Fast growing countries often experience accelerating inflation rates and Ethiopia is no exception with consumer price inflation measured at 6% on average in 2014.
• However higher interest rates set by the Ethiopia central bank and a period of lower global commodity prices has helped to prevent inflation from surging into double-digit territory.

• A key feature of the Ethiopian economy is a persistent large current account deficit on the balance of payments combined with low foreign exchange reserves estimated to be sufficient only to cover the cost of three months worth of imports.
• The current account deficit may exceed 6% of GDP in 2015 and is structural rather than cyclical, given major capital imports for infrastructure development and low-value exports (20% of which come direct from coffee exports). Major power generation projects are under way and are set to boost exports when completed.
• At around 30% of GDP, Ethiopian external debt is relatively low as are its servicing costs. Indeed, 70% of the debt stock is public medium- and long-term debt to official creditors, both multilateral and bilateral.
• The Ethiopian government benefits from large foreign aid inflows – worth 6% of GDP in 2013 and almost 20% of government revenues. They are supported by Ethiopia’s geopolitical importance as a key Western ally in the unstable, terrorism-prone Horn of Africa.

Fiscal Position

• After increasing sharply in 2013 due to high spending on infrastructure (capital spending reached 14% of GDP in 2013), the fiscal deficit is likely to decline to 2.5%-3% of GDP in 2014-15. Public (government) debt is low, at less than 25% of GDP.

Unit 1: Elasticity of Demand

Year 12 students at Eton College were covering elasticity of demand last week and were given an assignment encouraging them to create a resource on the topic. 

Some chose a (challenging) snakes and ladders quiz, another group produced a news video, and a third group produced this fine video-scribe production covering the various elasticities of demand. 

Unit 3: Homework

Ok, so I'm trialing this and the blog to see what works for my Y13 people. I wont be in today's lesson so I want you to attempt a case study question. It will be difficult as we have not covered anywhere near enough content, but I want you to have a go anyway.

It's June 10 question 10 on the market for instant coffee. I expect it to be handed in the following lesson. So Eco 1 - that's Sunday, Eco 2 - Monday.

See Edmodo for question, but it's also in your packs.

Unit 3: Jean Triole wins the Nobel Prize for Economics

The 2014 Nobel Prize has been awarded to a microeconomist who has done a huge amount of work on the economics of large-scale businesses operating in monopolistic and oligopolistic industries. 

In the Q&A during the prize announcement, Tirole discussed some of his work on network/platform businesses such as Google.

Web search has aspects of natural monopoly - Google dominates in many different countries. And they set price well below cost -- as a customer you get a very good deal from Google, while advertisers, pay a lot. Consumer surplus is highly relevant here. 

But the cost structure of such industries has a strong tendency to lead to dominant monopoly power - Tirole argues that industry regulation needs to ensure that dynamic firms can replace complacent, rent-seeking monopolies in the long run.

Here is the press release from the Nobel Academy - it is well worth a read

"Many industries are dominated by a small number of large firms or a single monopoly. Left unregulated, such markets often produce socially undesirable results – prices higher than those motivated by costs, or unproductive firms that survive by blocking the entry of new and more productive ones.

From the mid-1980s and onwards, Jean Tirole has breathed new life into research on such market failures. His analysis of firms with market power provides a unified theory with a strong bearing on central policy questions: how should the government deal with mergers or cartels, and how should it regulate monopolies?

Before Tirole, researchers and policymakers sought general principles for all industries. They advocated simple policy rules, such as capping prices for monopolists and prohibiting cooperation between competitors, while permitting cooperation between firms with different positions in the value chain. Tirole showed theoretically that such rules may work well in certain conditions, but do more harm than good in others. Price caps can provide dominant firms with strong motives to reduce costs – a good thing for society – but may also permit excessive profits – a bad thing for society. 

Cooperation on price setting within a market is usually harmful, but cooperation regarding patent pools can benefit everyone. The merger of a firm and its supplier may encourage innovation, but may also distort competition.

The best regulation or competition policy should therefore be carefully adapted to every industry’s specific conditions. In a series of articles and books, Jean Tirole has presented a general framework for designing such policies and applied it to a number of industries, ranging from telecommunications to banking. 

Drawing on these new insights, governments can better encourage powerful firms to become more productive and, at the same time, prevent them from harming competitors and customers."

Unit 4: Ebola virus and economics!

Hi from the Maldives! It's the last day of the holidays and although it's been awesome, I have always had an eye on the news. Today I was watching Al Jazeera and they were discussing the reasons behind the outbreak of the Ebola virus in West Africa.

The hypothesis is that it is economics that has caused it (remember, bad economics kills more than any war ever will!).

In essence, the two big financial houses (both of which you will study and use for unit 4 essays), the IMF and the World Bank have been blamed for the outbreak for two differing reasons.

The IMF lends money to developing countries but with rules attached. Essentially, they cannot operate budget deficits to fund public programmes. As a result, hospitals and education have suffered as the govts have no money to spend, other than on infrastructure projects to benefit big business!

The World Bank lends money to private companies rather than public enterprises, therefore any hospitals that have been built are for the rich only!

Shocking in that it is the rich west that is killing innocent Africans, albeit indirectly. The head of the IMF suggested yesterday that their policy of not allowing budget deficits should be eased....some might say 'too little too late'.

 Click here for article

Unit 4: Income inequality - a must read!

This is an excellent article looking at all aspects of poverty and wealth.....so much evaluation for a Unit 4 question, a must read!!!!

Robert Peston has an excellent new blog to accompany a Radio 4 programme on inequality. He examines whether the ‘Great Recession’ has sharpened the debate on inequality so that the conventional wisdom has shifted. Even the International Monetary Fund are now arguing that income inequality may be a cause of slower economic growth.

There are various lines of reasoning involved.

Keynesians argue that the poor have a greater marginal propensity to consume- they are much more likely than the rich to spend the extra £1 they earn. This way, redistribution from rich to poor via progressive income tax can boost consumption and therefore aggregate demand, raising GDP. 

Peston points out that the incomes of America's poorest 20% of households fell by 8% between 2010 and 2013. He goes on to examine the link between this and sub prime lending in the lead up to the 2008 financial crash- so called NINJA loans- to those with no job, income or assets. This left those on lower income with debts they found hard to pay back, resulting in a lower level of consumption in the US.

The wealthy also have a lower marginal utility of money. That is they place less value on the next pound they earn. This way, the theory of diminishing marginal utility also applies to earnings. It might explain Mario Balotelli’s alleged trip to John Lewis and his decision to have an in-house firework display. 

It might also explain the tastes of the Mexican drug barons who had a house with various items in gold. And kept a pet cheetah...

There are also the negative externalities associated with low income- cycles of poverty: the unemployment and the poverty traps mean families can stay on low income for generations. Research also suggests those on lower income need more frequent hospital treatment. This places a longer-term burden on government spending.

On the other hand, the Neo-Classical arguments of economists such as Friedman and Lucas are that lower wages provide incentives for the poor to work harder. Wage differentials also allow the free market to attract labour to where there are shortages and to ensure vacancies are filled, boosting the supply potential of the economy. There’s a classic Milton Friedman video on why the market can solve problems of poverty here, including why the minimum wage is a bad idea.

This links to the idea of ‘trickle down’ economics, that if Roman Abramovich buys a new yacht, it creates jobs in the yacht company so that employees on lower incomes earn more. They might also get a share of the company profits too. So overall spending in the economy increases.

This argument was famously criticised by J K Galbraith, who said it was like saying “if you feed enough oats to the horse, some will pass through to feed the sparrows”…

Unit 1: Prices for sacrificial animals rise ahead of Eid Al Adha

I was sat waiting for my car to registered yesterday and I came across this article which highlights how restricting supply so farmers can react to the increased demand is a good way to increase revenue and profits.

Questions:






Draw a supply & demand diagram to show how the Eid break affects prices.

What does the article suggest about the price elasticity of demand for Sheep during Eid?

What does the article suggest about the price elasticity of supply of sheep during Eid?

I would expect students to comment on this blog.....and comment on the comments!

I look forward to hearing from you.

Mr Bentley