Last year, an academic discovered that the only two firms on Amazon selling new copies of a classic biology textbook were charging well over $1 million (plus $3.99 for shipping!). Furthermore, when he checked the next day, prices had risen even further to nearly $2.8 million! Intrigued by this strange pricing behaviour, he started to investigate the prices further.
In oligopoly markets with a small number of players, firms must make strategic decisions taking into account how they expect their rivals will react. One option in today’s online market places is for firms to use computer algorithms which automatically adjust their prices according to the prices their rivals are charging. The results of his investigation suggested that this was exactly what was causing the prices for this textbook to be so high.
One of the firms appeared to adopt a pricing rule which set its price at 0.9983 times the price of the other firm. This seems to make sense – this firm wants to undercut its rival in order to be more likely to sell its copy. However, if both firms operated under this strategy, we would expect to see prices falling over time (see also). In contrast, the strategy of the other firm appeared to be to price 1.270589 above its rival’s price. Why would it want to try to make sure it was always more expensive that its rival? The academic’s plausible explanation was that:
“…they do not actually possess the book. Rather, they noticed that someone else listed a copy for sale, and so they put it up as well – relying on their better feedback record to attract buyers. But, of course, if someone actually orders the book, they have to get it – so they have to set their price significantly higher – say 1.27059 times higher – than the price they’d have to pay to get the book elsewhere.”
Put both of these pricing rules together and prices will continuously rise over time! This was exactly what the academic observed for over a week, until human intervention appears to have returned prices to a more sensible level.
As Tim Harford discusses in his recent blog post, it had been hoped that online market places would result in very low prices because the high degree of price transparency increases competition. Clearly the prices Amazon was initially charging for the textbook didn’t support this theory and even after human intervention prices would seem to be well above marginal production costs. However, as the blog post goes on to explain, we should not necessarily expect price transparency always to lead to low prices. Economic theory shows us that in oligopoly markets, when a small number of players interact repeatedly, they may be able to collude tacitly on high prices. Furthermore, a high degree of price transparency may help such collusive behaviour because it makes it easier for firms to detect cheating by a rival.
Amazon’s $23,698,655.93 Book About Flies (SCREENSHOT) The Huffington Post, Steven Hoffer (26/04/11)
Questions
- What are the key features of competition between book sellers on Amazon?
- What price setting rule would the two firms have to use for prices to continuously fall over time? Provide an illustrative example.
- What are the pros and cons for a firm of relying on a computer algorithm to set its prices?
- How might a firm program its price setting algorithm if it wanted to collude tacitly with its rivals?
- Can you think of any other explanations for the pricing strategies that the two Amazon sellers adopted?
Rail companies will be permitted to raise average regulated rail fares next year by 6.2%. Not surprisingly, this has been met with dismay and anger by rail travellers, especially long-distance commuters, who could see their annual season tickets going up by several hundred pounds.
Some fares, such as advance tickets, are unregulated. Others, such as anytime, off-peak and season tickets, are regulated by the government. The formula for working out permitted price rises for regulated fares is RPI plus 3%, where RPI is the July annual inflation rate based on the retail price index.
The RPI figure was announced by the ONS on 14 August and was a surprisingly high 3.2% – up from 2.8% in June: see Table 21 in the ONS’s CPI And RPI Reference Tables, July 2012. (Click here for a PowerPoint of the chart on the left.) Hence average fares can rise by 3.2% + 3% = 6.2%.
Rail travellers are angry on three counts:
First, the RPI measure of inflation is generally around 0.5% higher than the CPI measure (which is used for working out public-sector pay increases and the uprating of pensions and benefits). The July figure for CPI inflation was 2.6%.
Second, the extra 3% added on top of RPI means that that rail fares are going up more rapidly than other prices, and incomes too. The reason given for this is to shift the burden of funding the railways from the taxpayer to the traveller.
Third, the formula applies to average fares. Rail companies can raise particular regulated fares by up to 5 percentage points more than the formula provided they raise other fares by less than the formula. Thus some fares are set to rise by 11.2% – including some of the most expensive season tickets.
The government justified the increases by arguing that the higher fares will allow more investment by the rail companies, which could result in lower costs in the future. Nevertheless, two thirds of the revenue from the above-inflation increases will go to the government and only one third to the rail companies.
Webcasts
Inflation shock as rail fares set to soar Channel 4 News, Ciaran Jenkins (14/8/12)
Protests as rail fare price rises announced The Telegraph (14/8/12)
How do our rail fares compare with the rest of Europe? BBC News (14/8/12)
Rail fare increase will make life better, says minister BBC News (14/8/12)
Passenger Focus: Train companies ‘using dark arts’ BBC News, David Sidebottom (14/8/12)
Articles
Rail fares set to increase by 6.2% Financial Times, Mark Odell (14/8/12)
Rail fares set to rise by 6.2% in January Guardian, Gwyn Topham (14/8/12)
Rail fare hike of 6.2% sparks angry reaction BBC News (14/8/12)
Soaring rail fares will do nothing for the recovery The Telegraph (14/8/12)
Commuters plead with Osborne to prevent 10 per cent rise in rail fares Independent, Oliver Wright (15/8/12)
Rail fare rises: how to keep your ticket prices as low as possible Guardian, Mark King (14/8/12)
Documents and information
Fares Review Conclusions 2003 Strategic Rail Authority (June 2003)
Fares Office of Rail Regulation
Fares on National Rail Association of Train Operating Companies
Questions
- What are the arguments for and against the general principle of using an RPI+X formula for regulating rail fares?
- What are the arguments for and against allowing train operating companies to raise regulated rail fares by an average of RPI plus 3%, with 2 of the 3 percent above RPI inflation going to the government?
- In what ways are travellers likely to respond to the higher prices?
- Why are some travellers likely to have a much lower price elasticity of demand for rail travel than others? What determines this price elasticity of demand?
- What externalities exist in rail transport? How should this impact on the government’s rail pricing strategy?
- How is infrastructure development funded for (a) rail, (b) roads and (c) airports? Does this lead to an efficient allocation of transport investment?
- How does rail pricing in the UK compare with that in other European countries? Should other European countries follow the UK’s policy of above inflation fare increases to fund rail investment?
A campaign to introduce a tax on disposable plastic bags in England has been launched by various pressure groups, including The Campaign to Protect Rural England (CPRE), Keep Britain Tidy, the Marine Conservation Society and Surfers Against Sewage. Plastic bags, they maintain, litter streets and the countryside and pollute the seas, where they cause considerable damage to marine life.
They propose a tax of 5p per bag, which would be passed on to consumers. Such a levy has already been introduced in Wales in October 2011. As a result, plastic bag use in Wales has dropped dramatically (see also the full report from the Welsh Government). The Scottish Government and the Northern Ireland Assembly are also planning introducing similar charges.
Many other governments have introduced taxes, charges or bans on plastic bags and many more are considering introducing such measures. Ireland introduced a 15 euro cent charge on single-use plastic bags as far back as 2002 and saw a 94% reduction in plastic bag use (328 per person per year to 21). The charge was raised to 22 euro cents in 2007 after bag use rose to 30 per person.
Other countries have banned plastic bags altogether: some, such as Rwanda and Somalia have banned all plastic bags; others, such as China and South Africa have banned very thin bags; others, such as Italy, have banned non-biodegradable ones.
In the USA, various states or districts have introduced levies and in the EU, where more than four billion bags are thrown away each year, the European Commission will soon publish proposals for limiting the use of plastic bags.
So what are the arguments for limiting the use of plastic bags? Why is it not enough to leave things simply to the market? And if the use of plastic bags is to be reduced, what’s the most efficient way of doing so? Are there any problems with alternatives to plastic bags? The following articles and reports consider these questions?
Articles
England urged to pick up Wales’ plastic bag levy businessGreen, Jessica Shankleman (1/8/12)
Wales’ plastic bag charge yields massive green savings businessGreen, Jessica Shankleman (5/7/12)
Supermarkets ‘should charge £1 a bag’ BBC Today Programme, Samantha Harding and Judith Holder (2/8/12)
Environmentalists team up to push for bag tax in England Plastics News, Anthony Clark (1/8/12)
Break the Bag Habit Keep Britain Tidy (1/8/12)
Plastic bag use ‘up for second year running’ Guardian, Rebecca Smithers (5/7/12)
Plastic bag use in Wales plummets due to 5p charge, figures show Guardian, Adam Vaughan (4/7/12)
Carrier bag charge ‘effective and popular’ figures reveal ITV News (4/7/12)
What should be done about plastic bags? BBC News Magazine, Chris Summers (19/3/12)
Irish bag tax hailed success BBC News, Chris Summers (20/8/02)
The Big Fix The Math Behind Sacking Disposable Bags Atlantic Cities, Nate Berg (26/9/11)
Fremantle moves to ban plastic bags ABC News, Lucy Martin (23/7/12)
Bans Plastic Bag Ban Report, Ted Duboise (updated)
Vote With Your Dollars, and Also Vote New York Times, Gernot Wagner (30/7/12)
Reports
Evaluation Of The Introduction Of The Single-Use Carrier Bag Charge In Wales: Attitude Change And Behavioural Spillover, Wouter Poortinga, Lorraine Whitmarsh and Christine Suffolk Report to Welsh Government by Cardiff University (June 2012)
Life cycle assessment of supermarket carrierbags: a review of the bags available in 2006 Environment Agency, Joanna Marchant (25/7/11)
Stakeholder consultation on options to reduce the use of plastic carrier bags … EC Environment (19/3/12)
Questions
- Draw a diagram demonstrating the externalities involved in the use of plastic bags. Show the marginal private and social costs and benefits and the socially efficient level of consumption.
- How would you set about establishing the amount of consumer surplus from the use of plastic bags at a zero price?
- Compare the relative social efficiency of a tax on plastic bags with a ban on plastic bags.
- Would education be an effective alternative to taxing plastic bags?
- Why might it be difficult to get supermarkets and other retailers to agree to a voluntary ban on giving out free plastic bags?
- Why might it be extremely difficult in practice to establish the socially efficient price for plastic bags?
