Tag: price elasticity of demand

A row erupted in mid-October between Tesco, the UK’s biggest supermarket, and Unilever, the Anglo-Dutch company. Unilever is the world’s largest consumer goods manufacturer with many well-known brands, including home care products, personal care products and food and drink. Unilever, which manufactures many of its products abroad and uses many ingredients from abroad in those manufactured in the UK, wanted to charge supermarkets 10% more for its products. It blamed the 16% fall in the value of sterling since the referendum in June (see the blog Sterling’s slide).

Tesco refused to pay the increase and so Unilever halted deliveries of over 200 items. As a result, several major brands became unavailable on the Tesco website. The dispute was dubbed ‘Marmitegate’, after one of Unilever’s products.

This is a classic case of power on both sides of the market: a powerful oligopolist, Unilever, facing a powerful oligopsonist, Tesco. With rising costs for Unilever resulting from the falling pound, either Unilever had to absorb the costs, or Tesco had to be prepared to pay the higher prices demanded by Unilever, passing some or all of them onto customers, or there had to be a compromise, with the prices Tesco pays to Unilever rising, but by less than 10%. A compromise was indeed reached on 13 October, with different price increases for each of Unilever’s products depending on how much of the costs are in foreign currencies. Precise details of the deal remained secret.

An interesting dynamic in the dispute was that Tesco and Unilever were acting as ‘champions’ for retailers and suppliers respectively. Other supermarkets were also facing price rises by Unilever. Their reactions were likely to depend on what Tesco did. Similarly, other suppliers were facing rising costs because of the falling pound. Their reactions might depend on how successful Unilever was in passing on its cost increases to retailers.

This example of ‘countervailing power’, or ‘bilateral oligopoly’, helps to illustrate just how much the consumer can gain when a powerful seller is confronted by a powerful buyer. The battle was been likened to that between two ‘gorillas’ of the industry. Its ramifications throughout industry will be interesting.

Podcasts and Webcasts
Tesco-Unilever row: Can unique shop explain ‘Marmitegate’? BBC News, Dougal Shaw (13/10/16)
Tesco, Unilever in Brexit price clash Reuters, David Pollard (13/10/16)
Brexit price-rise warning to shoppers BBC News, Simon Jack (10/10/16)
Tesco in Brexit Pricing Spat With Unilever Wall Street Journal (13/10/16)
Tesco battles Unilever over prices Financial Times on YouTube (14/10/16)
Tesco vs Unilever: Who won? ITV News, Joel Hills (14/10/16)

Articles

Tesco removes Marmite and other Unilever brands in price row BBC News (13/10/16)
Marmite Brexit Shortage ‘Just The Beginning’ Of ‘Gorilla’ Grocery Battle As Pound Slumps Huffington Post, Louise Ridley (13/10/16)
Unilever sales increase despite dozens of its brands being removed from Tesco shelves Independent, Ben Chapman (13/10/16)
Tesco-Unilever price row: Why pound value slump has caused Marmite to disappear from shelves Independent, Zlata Rodionova (13/10/16)
Tesco pulls Marmite from online store amid Brexit price row with Unilever The Telegraph, Peter Dominiczak, Steven Swinford and Ashley Armstrong (13/10/16)
Tesco runs short on Marmite and household brands in price row with Unilever The Guardian, Sarah Butler (13/10/16)
Tesco pulls products over plunging pound Financial Times, Mark Vandevelde, Scheherazade Daneshkhu and Paul McClean (13/10/16)
Brexit means…higher prices The Economist, Buttonwood’s notebook (13/10/16)
Tesco, Unilever settle prices row after pound’s Brexit dive Reuters, James Davey and Martinne Geller (14/10/16)

Questions

  1. To what extent can Tesco and Unilever be seen a price leaders of their respective market segments?
  2. What would you advise other supermarkets to do over their pricing decisions when faced with increased prices from suppliers, and why?
  3. What would you advise manufacturers of other consumer goods sold in supermarkets to do in the light of the Tesco/Unilever dispute, and why?
  4. What determines the price elasticity of demand for branded products, such as Marmite, Persil, Dove soap, Hellmann’s mayonnaise, PG Tips tea and Wall’s ice cream?
  5. What factors will determine in the end just how much extra the consumer pays when supermarkets are faced with demands for higher prices from major suppliers?
  6. Give some other examples of firms in industries where there is a high degree of countervailing power.
  7. What are the macroeconomic implications of a depreciating exchange rate?
  8. If, over the long term, the pound remained 16% below its level in June 2016, would you expect the consumer prices index in the long term to be approximately 16% higher than it would have been if the pound had not depreciated? Explain why or why not.

If you want a ticket for an event, such as a match or a concert, but the tickets are sold out, what do you do? Many will go to an agency operating in the ‘secondary market’. A secondary market is where items originally purchased new, such as tickets, company shares, cars or antiques, are put up for sale at a price that the market will bear.

The equilibrium price in a secondary market is where supply equals demand and the actual price will approximate to this equilibrium. In the case of tickets, this equilibrium price can be much higher than the original price sold by the venue or its agents. The reason is that the original price is below the equilibrium.

This is illustrated in the figure (click here for a PowerPoint). Assume that the total supply of tickets is Qs. Assume also that the official box office price is Pbo and that demand is given by the demand curve D. At the box office price demand exceeds supply by QdQs. There is thus a shortage, with many fans unable to obtain a ticket at the official price. Many of you will be familiar with having to be as quick as possible to get hold of tickets where demand considerably outstrips supply. Events such as Glastonbury sell out within seconds of coming on sale.

If you buy a ticket and then find out you cannot go to the event, you can sell the ticket on the secondary market through an online site or agency. Such agencies could be seen as providing a useful service as it means that otherwise empty seats will be filled. But if the equilibrium price is well above the original ticket price, there is the potential for huge gain by the agencies, who may pay the seller considerably less than the agency then sells the ticket to someone else.

What is more, the difference between the original price and the equilibrium price in the secondary market makes ticket touting, or ticket ‘scalping’, highly profitable. This is where people buy tickets with no intention of using them themselves but in order to sell them at much higher prices on the secondary market. Such ticket touting has been illegal for football matches since 1994 and was illegal for the 2012 London Olympics, but it is legal for plays, concerts, festivals and other events.

Ticket touts are often highly organised in obtaining tickets at official prices by buying early and using multiple credit cards and multiple identities to avoid systems that restrict the number of tickets issued to a card. They often use internet bots to mass purchase tickets the moment they go on sale.

Those in favour of ticket touting argue that the high price in the secondary market is just a reflection of demand and supply (see the IEA article below). Ticket touting allows tickets to be directed to people who value them most and will get the greatest benefit from it. What is more, banning ticket touting, so the argument goes, would simply drive it underground.

Those against argue on grounds of equity. Ticket prices set below the equilibrium are designed to give greater equality of access to fans. Rationing on a first-come first-served system, either on the internet or by a queue, is seen to be fairer than one by ability/willingness to pay. A poor person may be just as keen to go to an event as a rich person and gain just as much enjoyment from it, but cannot afford the high equilibrium price. What is more, non of the profit from the higher prices reaches the event organisers or the artists or players. Yet the mark-up and hence profit made by ticket touts can be massive, as the first Observer article below shows.

Various measures are being tried to prevent ticket touting. One is the use of paperless tickets, with the number of tickets limited per person and with people having to show their ticket on their phones along with ID at the door or gate. If a person cannot attend, then the solution is a system where they can give the ticket back to the box office (perhaps electronically) which will re-sell it for them at the official price.

A government-backed investigation, the Waterson review reported in May 2016 and recommended that touts should be licensed and that there should be harsher penalties for firms that flout consumer rights law as applying to ticket sales. Whether this would be sufficient to bring secondary market prices down significantly, remains to be seen. In the meantime, organisers do seem to be trying to find ways of beating the touts through smarter means of selling.

Articles

MP Nigel Adams calls for secondary ticket marketing to be reformed Music Week, James Hanley (14/9/16)
Iron Maiden go to war with ticket touts BBC News, Mark Savage (22/9/16)
The new age of the ticket tout BBC World Tonight, Andrew Hosken (25/5/16)
Government urged to help music industry tackle ticket touts The Guardian, Rob Davies (13/9/16)
Ticket touts face licensing threat The Guardian, Rupert Jones (26/5/16)
How the ticket touts get away with bleeding fans dry The Observer, Rob Davies and Rupert Jones (15/5/16)
What sorcery is this? A £140 ticket for new Harry Potter play now costs £8,327 The Observer, Rob Davies and Laurie Chen (14/8/16)
Ticket touts made $3m from the last Mumford & Sons tour. $0 went back to the music industry. Music Business Woldwide, Adam Tudhope (6/9/16)
This is tout of order – join the Daily Mirror campaign to beat rip-off ticket resales Daily Mirror, Nada Farhoud (19/9/16)
Ticket touts: A muggle’s game The Economist (20/8/16)
Can We Fight Back Against The Robot Touts Ruining Live Music? Huffington Post, Andy Webb (6/9/16)
In defence of ticket touts Institute of Economic Affairs, Steve Davies (25/2/15)

Report

Consumer protection measures applying to ticket resale: Waterson review Department for Business, Innovation & Skills and Department for Culture, Media & Sport 26/5/16)

Guide
#Toutsout MMF & FanFair Alliance September 2016

Questions

  1. Why can ticket touts sell tickets above the equilibrium price shown in the diagram?
  2. In what ways could ticket touts be said to be distorting the market?
  3. How do ticket touts reduce consumer surplus? Could they reduce it to zero?
  4. Why may allowing ticket touting to take place result in empty seats at concerts or other events?
  5. Would it be a good idea for event organisers to charge higher prices for popular events than they do at present, but still below the equilibrium
  6. How does the price elasticity of demand influence the mark-up that ticket touts can make? Illustrate this on a diagram similar to the one above.
  7. Is it in ticket touts’ interests to adjust prices as an event draws closer, just as budget airlines adjust seat prices as the plane fills up? Could organisers sell tickets in the primary market in this way with prices rising as the event fills up?
  8. Discuss the various ways in which the secondary ticket market could be reformed? To what extent do these involve reforms in the primary ticket market?

Your Americano, Latte or Cappuccino may soon be more expensive. This is because coffee bean prices are rising. A combination of continuing growth in demand and poor coffee harvests in various parts of the world have led to a rise in both Arabica and Robusta prices, with the International Coffee Organization’s Composite Indicator price (in US dollars) having risen by over 30% since mid-January this year (see chart below: click here for a PowerPoint)

Supply has been affected by droughts in Brazil and Vietnam, two of the world’s biggest coffee producers, and by pests (the Coffee Berry Borer) in the Kilimanjaro region of Tanzania and in other East African countries. Global exports of coffee in July 2016 were 22% down on the same month in 2015.

The growing shortage and rising current (spot) prices is reflected in future prices. These are prices determined in the market now for trading at a specified future date (e.g. in three months’ time). Future prices depend on predictions of the balance of demand and supply in the future. According to the MarketWatch article below, “Analysts at Société Générale in a note predicted that prices could climb about 30% further by the end of next year”. The current (mid-September) spot price of robusta coffee beans is around $0.96 per lb. The December 2016 future price is around $1.48.

So what effect will this have on the prices in Starbucks, Costa or Caffè Nero? And what effect will it have on ground or instant coffee in supermarkets? To quote the MarketWatch article again:

A research report from the US Department of Agriculture found that, on average, a 10% increase in green-coffee-bean prices per pound would yield a 2% increase in both manufacturer prices and at the register in places like Starbucks Corp.

This is because the cost of coffee beans is just one element in the costs of coffee roasters and coffee shops. Also these companies use futures markets to smooth out the prices they pay. They hold stockpiles of coffee, which they build up when prices are low and draw on when prices are high. This helps to reduce fluctuations in retail prices.

So don’t worry too much about the price of your morning coffee – at least, not yet.

Articles

Why a surge in coffee-bean prices may not hit the Starbucks set—yet MarketWatch, Rachel Koning Beals (9/9/16)
Wired coffee prices may not slip far News Markets, David Cottle (9/9/16)
Late-harvest woes prompt Brazil coffee harvest downgrade Agrimoney (7/9/16)
Look Out, Latte Lovers: Brazil Drought Hurts Espresso Beans Bloomberg, Fabiana Batista and Marvin G. Perez (13/9/16)
Why Your Morning Coffee Is About to Become Even More Expensive Fortune (28/7/16)
Climate change brews a storm for East Africa coffee farmers Business Daily (East Africa), Paul Redfern (4/9/16)
Coffee Market Report ICO (August 2016)

Data

Commodity Prices Index Mundi
Historical Data on the Global Coffee Trade ICO
ICO’s Coffee Trade Statistics Infographic for July 2016 ICO blog (31/8/16)

Questions

  1. What determines coffee futures prices?
  2. How are the price fluctuations of coffee in coffee shops related to the price elasticities of demand and supply? What determines these elasticities?
  3. Why does a strengthening (an appreciation) of the currency of a coffee exporter affect (a) the price of coffee to producers in the country; (b) international coffee prices in dollars?
  4. Are poor coffee harvests on balance good or bad for coffee producers? How does this depend on the market price elasticity of demand? Does the answer vary from producer to producer?
  5. How does speculation affect coffee prices (both spot and future)? Is such speculation of benefit to (a) the coffee consumer; (b) the coffee grower?