When building supply and demand models, the assumption is usually made that both producers and consumers act in a ‘rational’ way to achieve the best possible outcomes. As far as producers are concerned, this would mean attempting to maximise profit. As far as consumers are concerned, it would mean attempting to achieve the highest satisfaction (utility) from their limited budget. This involves a cost–benefit calculation, where people weigh up the costs and benefits of allocating their money between different goods and services.
For consumers to act rationally, the following assumptions are made:
- Consumer choices are made independently. Their individual choices and preferences are not influenced by other people’s, nor do their choices and preferences impact on other people’s choices.
- The consumer’s preferences are consistent and fixed.
- Consumers have full information about the products available and alternatives to them.
- Given the information they have and the preferences they hold, consumers will then make an optimal choice.
Black Friday can be seen as a perfect occasion for consumers to get their hands on a bargain. It is an opportunity to fulfil a rational need, for example if you were needing to replace a household appliance but were waiting until there was a good deal before committing to a purchase.
The assumption that people act rationally has been at the forefront of economic theory for decades. However, this has been questioned by the rise in behavioural economics. Rather than assuming that all individuals are ‘rational maximisers’ and conduct a cost–benefit analysis for every decision, behavioural economists mix psychology with economics by focusing on the human. As humans, we do not always behave rationally but, instead, we act under bounded rationality.
As economic agents, we make different decisions depending on our emotional state that differ from the ‘rational choice’ assumption. We are also influenced by our social networks and often make choices that provide us with immediate gratification. Given this, Black Friday can also be viewed as a great opportunity to fall prey to irrational and emotional shopping behaviours.
Black Friday originated in the USA and is the day after Thanksgiving. During this annual shopping holiday, retailers typically offer steep discounts to kick off the holiday season. The Black Friday shopping phenomenon is less than a decade old in the UK but it’s now an established part of the pre-Christmas retail calendar. Between 2010 and 2013, Black Friday gradually built up momentum in the UK. In 2014, Black Friday became the peak pre-Christmas online sales day and many online retailers haven’t looked back.
Arguably, from a behavioural economist’s perspective, the big problem with Black Friday is that all the reasons consumers possibly have to partake can be largely illusory. Consumers are bombarded with the promise of one-off deals, large discounts, scarce products, and an opportunity to get their holiday shopping done all at once. However, on Black Friday, our rational decision-making faculties are tested, just as stores are trying their hardest to maximise consumers’ mistakes.
There are many ‘behavioural traps’ that consumers often fall into. The following two are most likely to occur on Black Friday:
- Scarcity and loss aversion. Shoppers may fear that they will miss out on the best sales deals available if they don’t buy it now. Retailers commonly spark consumers’ interest by highlighting limited stocks available for a limited time only, which raises the perceived value of these goods. This sense of scarcity can further trigger the need to buy now, increasing the ‘Fear of Missing Out’. Consumers therefore need to ask themselves if they are really missing out if they don’t buy it now? And is the discount worth spending the money today, or is there something else I should be spending it on or saving for?
- Sunk cost fallacy. Once consumers have started to invest, they often struggle to close out investments that prove unprofitable. On Black Friday, customers have already made the initial investment of getting up early, driving to the shops, finding parking and waiting in a queue, before they have purchased anything. Therefore, they will be inclined to buy more than they initially went for. It is important therefore to think about each purchase in isolation.
This year, however, there is also the added complication of the rising cost of living. Whilst this may deter some consumers from unnecessary, impulse purchases, some consumers are using Black Friday as an opportunity to stock up on expected future purchases, hedging against likely price rises over the coming months.
It is thought that more consumers will be looking for a combination of high quality but low price to make sure their purchases are affordable and can last for a long time. According to PwC, many consumers have closely monitored their favourite brands in anticipation that big-ticket electronics, more pricey winter wear or Christmas stocking fillers will be discounted. Consumers are also in search of bargains more than ever given rising inflation. This would suggest a shift in attitude, meaning consumers will be more aware of what they cannot afford rather than giving in to emotional temptation brought on by Black Friday.
Retailers are fully aware of the cognitive biases that surround Black Friday and take full advantage of them. ‘Cyber Monday’ follows right after Black Friday, giving retailers an extra opportunity for them to keep those ‘urgent’ or ‘unmissable’ sales going and increase their revenues.
Black Friday is one of the biggest shopping days of the year. However, the way retailers approach it is growing increasingly mixed. Stores such as Amazon, Argos, Currys and John Lewis have started offering Black Friday deals much earlier in the month, leading some to refer to the event as ‘Black November’. Other stores, such as M&S and Next, didn’t take part at all this year.
Ultimately, Consumers can use insights from behavioural economics to empower them to make more rational decisions in such circumstances: ones that better align with their individual budgets. Nevertheless, the Black Friday sales mania can trigger our deepest emotional and cognitive responses that lead to unnecessary spending.
Articles
Video
Questions
- Discuss what is meant by the term ‘rational consumer’. Is it a useful generalisation about the way consumers behave?
- Discuss what is meant by the term ‘rational producer’. Is it a useful generalisation about the way firms behave?
- What is cost–benefit analysis? What is the procedure used in conducting a cost–benefit analysis?
- In addition to scarcity and loss aversion and the sunk cost fallacy, are there any other reasons why consumers may not always act rationally?
- Are people likely to be more ‘rational’ about online Black Friday purchases than in-store ones? Explain.
On 15 March 2019, the ‘Organ Donation (Deemed Consent) Bill’ was passed into law. (See the blog, Organ donations – Changing the default option vs active choice.) The government has just announced that this will come into force on 20 May this year. Under the scheme, ‘adults in England will be considered potential donors unless they chose to opt out or are excluded. The act is known as Max and Keira’s law in honour of a boy who received a heart transplant and the girl who donated it.’
This change from an ‘opt-in’ to an ‘opt-out’ system follows a similar a move in Wales in 2015. Since then, Wales has seen a significant increase in potential donors, with the consent rate rising from 58% to 77%. A similar move in Scotland will come into force in the autumn of this year. The government expects there to be an additional 700 transplant operations per year available for transplant by 2023.
These moves from an opt-in to an opt-out system are consistent with ‘nudge theory’. This maintains that positive reinforcement or making a decision easy for people can persuade them to make a particular choice. They are ‘nudged’ into so doing.
Opting out and nudge theory
In the case of having to opt in to a scheme such as organ donation, people have to make the decision to take part. Many, as a result, do not, partly because they never seem to find the time to do so, even though they might quite like to. With the busy lives people lead, it’s too easy to think, ‘Yes, I’ll do that some time’, but never actually get round to doing it: i.e. they have present bias and hence behave in a time-inconsistent manner.
With an opt-out system, people are automatically signed up to the scheme, but can freely choose to opt out. In the case of the new organ donor schemes in the UK, it is/will be assumed that organs from people killed in an accident who had not opted out could be used for transplants. If you do not want your organs to be used, you have to notify that you are opting out.
It could be the same with charitable giving. Some firms add a small charitable contribution to the price of their products (e.g. airline tickets or utility bills), unless people opt out.
Similarly, under UK pension arrangements introduced from 2012, firms automatically deduct pension contributions from employees’ wages unless they opt out of the scheme. Opt-out pension schemes like this retain between 90 and 95 per cent of employees. Opt-in pension schemes, by contrast, have much lower participation rates of around 60 per cent, even though they are otherwise identical.
This type of ‘nudging’ can improve the welfare of those who make systematic mistakes (i.e. operate in a time-inconsistent manner), while imposing very limited harm on those who act in a time-consistent manner. If it is in the interests of someone to opt out of the scheme, they can easily do so. Policies such as these are an example of what behavioural economists call ‘soft paternalism’.
Articles
- New opt-out model for organ donation to come into force in May
Pulse, Helen Quinn (25/2/20)
- Max and Keira’s law: New ‘opt-out’ organ donor system to be introduced on 20 May, government plans
Sky News, Greg Heffer (25/2/20)
- Adults to be automatically enrolled as organ donors under new law
Independent, Peter Stubley (26/2/20)
- Max and Keira’s law: New ‘opt-out’ organ donor system that presumes all adults agree to donate when they die will be introduced in May
Mail Online, Ben Spencer (25/2/20)
- Opt-out organ donation law: Your questions answered
New Scientist, Clare Wilson (27/2/20)
- Should organ donors be paid? The heavy toll of US kidney shortage
BBC News, US and Canada, Henri Astier (18/2/20)
- What Spain can teach Scotland about organ donation
BBC News, Scotland, Susie Forrest (18/10/19)
- A little nudge goes a long way in increasing organ donor registrations
The Conversation, Nicole Robitaille (2/5/19)
- How nudge theory is ageing well
Financial Times, Julian Baggini (19/4/19)
- Richard Thaler: ‘If you want people to do something, make it easy’
Financial Times, Tim Harford (2/8/19)
- Why a nudge from the state beats a slap
The Observer, Richard Reeves (30/7/08)
Official Information
Questions
- Why do opt-out schemes have a higher take up than opt-in ones? Would this apply if people behaved in a time-consistent manner?
- What is present bias? How does it differ from simple impatience? Explain how present bias might help to explain the impact of changing the default option.
- What are the arguments for and against nudging people to make decisions that benefit them or are in the social interest?
- Give some example of nudges that are used in public policy or would be a good idea to use. Consider how effective they are likely to be. (You might refer to the work of the Behavioural Insights Team.)
- What are the possible drawbacks of presumed consent in organ donation?
- What are the arguments for and against paying live people to donate organs, such as a kidney?
- How might people be encouraged to behave in the right way during an epidemic, such as corona virus?
- To what extent was nudge theory used during the Brexit referendum campaign and in the two subsequent general elections?
Elections are times of peak deception. Political parties have several ways in which they can use data to persuade people to vote for them. At one extreme, they can simply make up ‘facts’ – in other words, they can lie. There have been various examples of such lies in the run-up to the UK general election of 12 December 2019. The linked article below gives some examples. But data can be used in other deceptive ways, short of downright lies.
Politicians can use data in two ways. First, statistics can be used to describe, explain and interpret the past. Second, they can be used as the basis of forecasts of the future effects of policies.
In terms of past data, one of the biggest means of deception is the selective use of data. If you are the party currently in power, you highlight the good news and ignore the bad. You do the reverse if you are currently in opposition. The data may be correct, but selective use of data can give a totally false impression of events.
In terms of forecast data, you highlight those forecasts, or elements of them, that are favourable to you and ignore those that are not.
Politicians rely on people’s willingness to look selectively at data. People want to see ‘evidence’ that reinforces their political views and prejudices. News media know this and happily do the same as politicians, selectively using data favourable to their political leanings. And it’s not just newspapers that do this. There are many online news sites that feed their readers with data supportive of their position. And there are many social media platforms, where people can communicate with people in their political ‘bubble’.
Genuine fact-checking sites can help, as can independent forecasters, such as the Institute for Fiscal Studies. But too many voters would rather only look at evidence, genuine or not, that supports their political point of view.
This can make life hard for economists who seek to explain the world with an open mind, based on a non-biased use of evidence – and hard for economic forecasters, who want to use full and accurate data in their models and to make realistic assumptions, emphasising that their forecasts are only the most likely outcome, not a certainty. As the article states:
Economic forecasts are flawed and their limitations should be acknowledged. But they should not be blindly dismissed as fake facts. And as far as political debate and discourse is concerned, in the long run, the truth may will out.
Article
Questions
- Give some specific examples of ways in which politicians misuse data.
- Give some specific examples of ways in which politicians misuse the analysis of economists.
- Distinguish between positive and normative statements? Should economists make policy recommendations? If so, in what context?
- Why are economic forecasts flawed, but why should they not be dismissed as ‘fake facts’?
- Examine the manifestos of two political parties and provide a critique of their economic analysis.
Do you want to get drunk this festive season in the most tax efficient way: i.e. minimise the amount of tax you pay for the volume of alcohol that you drink? Do tax rates vary or are all alcoholic drinks taxed in the same or similar way?
The UK government imposes two different types of tax on alcohol. One is a specific or fixed tax per unit, referred to as excise duty or excise tax. This varies depending on the type of alcohol and is the focus of this blog. The other is VAT, which is 20% of the price for all alcoholic drinks. The price on which VAT is based includes the impact of the excise tax.
How does the implementation of excise tax differ between alcoholic drinks? Both the tax rate itself and the unit of output on which it is based vary: i.e. the volume of liquid vs the volume of pure alcohol within the liquid.
For example, with lager, beer and spirits the excise tax depends on the units of alcohol in the drink rather than the number of litres. The tax works in the following way. It is based on the alcohol by volume or ABV of the lager, beer or spirit. This is often displayed on the bottle or can. ABV is the percentage of the drink that is pure alcohol. Therefore, if a one-litre bottle of lager has an ABV of 1%, then 10ml of the bottle contains pure alcohol. Ten millilitres of pure alcohol is one unit of alcohol. If a one litre bottle of lager had an ABV of 5% it contains 5 units of alcohol.
Excise duties on spirits are the simplest of all the alcohol taxes. The rate for 2017/18 is 28.74p for each percentage of ABV or unit of alcohol in a one-litre bottle. Most spirits have an ABV of 40%. This means that there are 40 units of alcohol in a litre bottle and the excise tax payable on that bottle is £11.50 (40 × 28.74p). If a litre bottle had an ABV of 57%, such as Woods Navy Rum, then the excise tax would be or £16.38 (57 × 28.74p). Although the volume of liquid is the same in each case, the excise tax has increased by £4.88 because the alcohol content has increased.
For cider and wine the system is quite different. Within certain bands of alcoholic strength, the excise duty is based on the volume of the drink rather than by its ABV. For example, the excise tax on a litre of cider with an ABV of between 1.2% and 7.5% is 40.38p. This has the effect of reducing the tax rate per unit of alcohol as the alcoholic content of the cider increases (up to a limit of 7.5%). For example, the rate of excise tax per unit of alcohol for a litre bottle of cider with an ABV of 2% is 20.19p (40.38/2) whereas for a litre bottle of cider with an ABV of 7.5% it is just 5.39p (40.38/7.5). Wine is taxed in a similar way. A litre of wine with an ABV of between 5.5% and 15% is taxed at 288.65p per litre.
The excise tax rates per unit of alcohol for different drinks are illustrated below.
|
Drink
|
ABV
|
Excise tax per
unit of alcohol
|
| Beer/lager |
5%
|
19.08p
|
| Beer/lager |
8%
|
24.77p
|
| Spirits |
1-100%
|
28.74p
|
| Wine |
12.5%
|
21.90p
|
| Wine |
15%
|
19.24p
|
| Cider |
5%
|
8.08p
|
| Cider |
7.5%
|
5.39p
|
The table clearly shows that cider with an ABV of 7.5 per cent is by far the most tax effective way of consuming alcohol.
Although this blog is a rather light-hearted look at excise tax, it does help to illustrate the strange anomalies of the system used in the UK. Research by the Institute for Fiscal Studies (IFS) has indicated that heavier drinkers are more likely to switch between different alcoholic products in response to price changes. They also tend to drink products with more units of alcohol in them: i.e. spirits such as whisky and gin. For these reasons, the IFS has suggested that the excise tax rates on cider and spirits should be increased.
In the November budget, the Chancellor announced plans to introduce a new excise tax rate on still cider with an ABV of between 6.9% and 7.5%.
The excise taxes on cider and wine are based on the volume of liquid because of the European Community Directive 92/84/EEC. It will be interesting to see if the government changes this system to one based on alcohol content once the UK had left the European Union.
Articles
Budget 2017 – Why is white cider being taxed more? BBC News (22/11/17)
Is it time for a flat tax on alcohol – health campaigners can drink to that The Telegraph, Christopher Snowdon (15/2/17)
Traditional cider makers say tax on strong brands will hurt their business The Guardian, Rob Davies (22/11/17)
Minimum price would increase cost of 70% of alcohol BBC News (15/12/17)
Designing alcohol taxes IFS, Kate Smith (24/4/17) .
Questions
- Explain the difference between an ad valorem tax and a specific tax.
- Illustrate the impact of an ad valorem tax and a specific tax on a demand and supply diagram.
- What is the excise tax rate per unit of alcohol on a litre bottle of cider with an ABV of 6%?
- What is the economic rationale for imposing excise tax on alcohol?
- How will the external costs of consuming alcohol differ from those of smoking cigarettes? Draw a marginal external cost of consumption curve for both products to illustrate the difference.
- Compare the impact of increasing excise tax rates on cider and spirits with introducing a minimum unit price for alcohol.
- In April 2012 the government in England and Wales imposed a ban on ‘below cost’ pricing of alcohol. Explain how this policy works and what impact you think it has had.
We all know that our spending changes during the Christmas period: namely we spend a lot more than during the rest of the year. This applies across the board – we buy more clothes, food and drink, even though each day, we can generally only wear, eat and drink the same amount as usual! This has some interesting points from a behavioural economics stance, but here I’m going to think about the impact of this on some key retailers.
Marks & Spencer have previously made headlines for the wrong reasons: poor sales on clothes and the need for serious restructuring of its stores, target audience and marketing in order for this long-standing retailer to remain current and competitive. Although sales were expected to rise in the Christmas period, they did significantly better than expected, with sales growth of 2.3%, above the expected 0.5%. More encouragingly, this growth was not just in food, but in clothing and homeware as well.
One of the key reasons given for this above-expected improvement in sales was the conveniently timed Christmas, falling on a Sunday and hence giving extra shopping days. M&S have said that this certainly helped with their Christmas trading. Although this was good for Q4 trading, the timing will not play ball for Easter and they are expecting a negative effective during that trading period. Some analysts have said that despite the growth being boosted by the timing of Christmas, there were still signs of a change in fortunes. Bryan Roberts from TCC Global said:
“It might be the sign of some green shoots in that part of the business.”
This is consistent with the Chief Executive, Steve Rowe’s comments that despite the timing of Christmas adding around 1.5% to clothing and home sales growth, the recovery was also due to “better ranges, better availability and better prices”.
It appears as though many other retailers have experienced positive growth in Christmas sales, with the John Lewis Partnership seeing like-for-like sales growth of 2.7%, with Waitrose at a 2.8% rise.
The other interesting area is supermarkets. Waitrose and M&S are certainly competitors in the food industry, but at the higher end. If we consider the mid-range supermarkets (Asda, Morrisons, Sainsbury’s and Tesco), they have also performed, as a whole, fairly well. The low-cost Aldi and Lidl have been causing havoc for these supermarket chains, but the Christmas period seemed to prove fruitful for them.
Tesco saw UK like-for-like sales up by 1.8%, which showed significant progress in light of previously difficult trading periods with the emergence of the low-cost chains. Q$ was its better quarter of sales growth for over five years. One of the key drivers of this growth is fresh food sales and its Chief Executive, Dave Lewis said “we are very encouraged by the sustained strong progress that we are making across the group.” However, despite these positive numbers, Tesco only really met market expectation, rather than surpassing them as Morrison, Sainsbury’s and Marks & Spencer did.
Perhaps the stand-out performance came from Morrisons, with its best Christmas performance for seven years. Another casualty of the low-cost competitors, it has been making a recovery and Q4 of 2016 demonstrated this beyond doubt. Like-for-like sales for the nine weeks to the start of 2017 were up by 2.9%, with growth in both food and drink and clothing.
Morrisons has been on a long and painful journey, with significant reorganisation of its stores and management. While this has created problems, it does appear to be working.
We also saw a general move up to the more premium own-brands and this again benefited all supermarkets. Morrisons Chief Executive, David Potts said:
“We are delighted to have found our mojo … Every year does bring its challenges, but so far we haven’t seen any change in consumer sentiment. Customers splashed out over Christmas and wanted to trade up … We are becoming more relevant to more people as we turn the company around.”
So it seems to be success all round for traders over the Christmas period and that, in many cases, this has been a reversal of fortunes. The question now is whether or not this will continue with the uncertainty over Brexit and the economy.
Articles
M&S beats Christmas sales forecast in clothing and homeware BBC News (12/1/17)
Marks & Spencer reports long-awaited rise in clothing sales The Telegraph, Ashley Armstrong (12/1/17)
Marks and Spencer reveals signs of growth in clothing business Financial Times, Mark Vandevelde (12/1/17)
Tesco’s festive sales lifted by fresh food The Telegraph, Ashley Armstrong (12/01/17)
Tesco caps year of recovery with solid Christmas Reuters, James Davey and Kate Holton (12/1/17)
Tesco, Marks & Spencer, Debenhams, John Lewis and co cheer strong Christmas trading Independent, Josie Cox and Zlata Rodionova (12/1/17)
Morrisons sees best Christmas performance for seven years BBC News (10/12/17)
Morrisons enjoys some ‘remarkable’ Christmas cheer’ The Guardian, Sarah butler and Angela Monaghan (10/1/17)
Record Christmas as Sainsbury’s ‘shows logic of Argos takeover’ The Guardian, Sarah Butler and Angela Monaghan (11/1/17)
Questions
- Why have the big four in the supermarket industry been under pressure over the past 2 years in terms of their sales, profits and market share?
- How have the changes that have been made by M&S’ Chief Executive helped to boost sales once more?
- Share prices for supermarkets have risen. Illustrate why this is on a demand and supply diagram. Why has Tesco, despite its performance, seen a fall in its share price?
- What are the key factors behind Morrison’s success?
- What type of market structure is the supermarket industry? Does this help to explain why the big four have faced so many challenges in recent times?
- If there has been a general increase in sales across all stores over the Christmas trading period, that goes beyond expectations, can we infer anything about customer tastes and their expectations about the future?