A weekly expense for most families is filling up their car(s) with petrol, but this activity is becoming increasingly expensive and is putting added pressure on lower and middle income families in particular. For those families on lower incomes, a tank of petrol represents a much larger percentage of their income than it does for a higher income household. Assuming that petrol for a month costs you £70 and your monthly income is £500, as a percentage of your income, a tank of petrol costs you 14%. Whereas, if your income is £900, the percentage falls to 7.7% and with a monthly take-home pay of £2000, the cost of a month’s petrol as a percentage of your income is just 3.5%. This is a stark indication of why those on lower incomes feel the burden of higher petrol prices (and indeed, higher prices for any essential items) more than other families.
The price of petrol will today be debated by MPs, following an e-petition signed by more than 100,000 people and having the support of more than 100 MPs. When in power, the Labour government proposed automatic fuel-tax increases, but these were scrapped by the Coalition. However, in January, the government plans to increase fuel duty by 3p a litre and further increases in prices are expected in August in line with inflation. This could mean that the price of unleaded petrol rises to over 1.40p per litre.
And it’s not just households that are feeling the squeeze. The situation described in the first paragraph is just as relevant to firms. The smaller firms, with lower turnover and profits are feeling the squeeze of higher petrol prices more than their larger counterparts. Any businesses that have to transport goods, whether to customers or from wholesalers to retailers etc, are seeing their costs rise, as a tank of petrol is requiring more and more money. To maintain profit margins, firms must pass these cost increases on to their customers in the form of higher prices. Alternatively, they keep prices as they were and take a hit on profitability. If prices rise, they lose customers and if prices are maintained, profitability suffers, which for some companies, already struggling due to the recession, may not be an option.
Mr. Halfon, the Tory MP whose motion launched the e-petition said that fuel prices were causing ‘immense difficulties’ and the Shadow Treasury Minister Owen Smith has said:
‘With our economic recovery choked off well before the recent eurozone crisis, we need action.’
With inflation at 5.2% (I’m writing an hour or so before new inflation data is released on 15/11/11), higher prices for many goods is putting pressure on households. This is possibly contributing towards sluggish growth, as households have less and less disposable income to spend on other goods, after they have purchased their essential items, such as groceries and petrol. A criticism leveled at oil companies is that they quickly pass on price rises, as the world price of oil increases, but do not pass on cuts in oil prices. The issues raised in the debate and how George Osborne and David Cameron respond, together with inflation data for the coming months, may play a crucial role in determining just how much a tank of petrol will cost in the new year.
MPs to debate motion calling for half in petrol prices BBC News (15/11/11)
Petrol price rise: David Cameron faces Commons revolt after No10 e-petition Guardian, Cherry Wilson (15/11/11)
David Cameron faces backbench rebellion over fuel price hike Telegraph, Rowena Mason (14/11/11)
Petrol prices may be slashed by Rs 2 per litre on November 16 The Economic Times (15/11/11)
Paying the price as fuel costs rise BBC News (15/11/10)
Oil barons the big winners from soaring pump prices, ONS figures reveal Daily Mirror, Graham Hiscott (15/11/11)
Scrap rise in petrol duty: 100 MPs demand Osborne abandon planned 3p increase Mail Online, Ray Massey and Tim Shipman (15/11/11)
Questions
- As the price of petrol rises, why do people continue to buy it? What does it suggest about the elasticity of this product?
- Why do higher prices affect lower income families more than higher income families?
- What are the arguments (a) for and (b) against George Osborne’s planned 3p rise in petrol duty?
- Do you think that higher prices are contributing towards sluggish growth? Why?
- What type of tax is imposed on petrol? Is it equitable? Is it efficient?
- Why can the oil companies pass price rises on to petrol stations, but delay passing on any price reductions? Is there a need for better regulation and more pressure on oil companies to change their behaviour?
The law of demand tells us that when the price of a good falls, quantity demanded will rise. But, firms want to know much more than this. They need to know by how much quantity demanded will rise – we refer to this as the price elasticity of demand (PED) and we can categorise it as relatively inelastic or elastic, depending on by how much demand changes relative to the change in price. The price elasticity of demand is crucial for a firm to know, as it gives them vital information about the best price to charge and getting the price right is probably the most important element in a successful business. As Warren Buffett said in a meeting with the staff from the Federal Crisis Inquiry Commission:
‘Basically, the single most important decision in evaluating a business is pricing power. You’ve the power to raise prices without losing business to a competitor, and you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you got a terrible business.’
The grammar may not be entirely correct, but hopefully you get the gist! Should a firm increase price or reduce it? Whatever action it takes, there will be an effect on demand, total revenue and profit. The key question is: what will be the effect? The answer depends on the PED.
If a firm is selling a product for which there are no close substitutes, we would expect demand to be relatively inelastic. This means that the firm can increase the price it charges without seeing any large fall in quantity. On the other hand, if a firm faces a lot of competition and hence there are many substitutes for a product, then demand becomes much more elastic – any increase in a firm’s price will lead to a proportionately larger decrease in the quantity demanded, as customers will simply switch to a cheaper alternative. The article below looks at the concept of price elasticity of demand and how it is used in practice by competing firms.
The importance of pricing power: PEP, CPB Guru Focus (16/10/11)
Pricing strong for Philip Morris in Q3, but volumes also encouraging; dividend yield attractive MorningStar (7/11/11)
Questions
- How do we define price elasticity of demand and what formula can we use to calculate it?
- If a firm faces an PED of –5, is its demand relatively inelastic or elastic and what does it mean about the responsiveness of customer demand to a change in price?
- If a firm faces demand that is (a) relatively inelastic (b) relatively elastic, (c) perfectly elastic (d) perfectly inelastic, what should it do to its price? Explain your answers.
- In the article, ‘The importance of pricing power’, is demand for the ‘Daily Racing Forum’ relatively inelastic or elastic? Explain your answer and what it means in terms of the company’s ability to change price.
- Is demand for cigarettes likely to be inelastic or elastic? Explain your answer. What does this suggest about a firm’s ability to pass on taxation and excise duties to its customers in the form of higher prices?
- Based on the data given in ‘The importance of pricing power’ about the change in demand for Campbell’s Soup and PepsiCo, what conclusions can we reach about PED? How could these firms use this information to set prices and maximise revenue and profit?
- Following a change in supply (due to a factor other than price), when will the impact on equilibrium price be larger than the impact on equilibrium quantity?
With all the doom and gloom of recent economic data, including rising inflation and higher unemployment, there’s finally a small speck of light and that’s in the form UK retail sales. The latest data from the ONS suggests that sales in the UK in September were higher than previously forecast and reversed the 0.4% decline we saw in August. A big contributing factor to this positive data was a boost to online sales, but this small glimmer of hope is unlikely to be sufficient to keep the economy going – unless sales keep rising, we are unlikely to see any significant increase in economic growth.
The data, while positive, is still unlikely to have any impact on economic policy. The minutes from the Monetary Policy Committee showed that there was unanimous support for further quantitative easing, as the threat of weak growth and financial instability and uncertainty remains. An economist from Barclays Capital said:
‘We don’t think the recent strong growth in monthly sales is likely to be sustained…The environment for retailers is likely to remain challenging as consumer spending remains depressed driven by low confidence and slow earnings growth.’
The data from September is positive, but it does little to offset the decline in sales seen in August. It was revised down from 0.2% to 0.4% – some blame the hot weather, which discouraged consumers from hitting the high streets in preparation for the winter. The key data to look out for will be sales figures for the next few months. Only then will we have more of an indication about exactly which direction the economy is moving in. The following articles consider this latest economic data.
Retail sales in UK unexpectedly increase at fastest pace in five months Bloomberg, Scott Hamilton (20/10/11)
UK retail sales see stronger-than-expected rise BBC News (20/10/11)
Nothing expected from today’s UK retail sales figure FX-MM, Richard Driver (20/10/11)
Retail sales: what the economists say Guardian (20/10/11)
£1 in every £10 now spent online, says ONS Telegraph, Harry Wallop (20/10/11)
Retail sales rise more than expected Financial Times, Sarah O’Connor (20/10/11)
Retail sales up but good weather has a price Sky News (20/10/11)
Questions
- Which factors have contributed to the higher than expected sales figures for September?
- Why do economists not believe that the higher growth in sales means signs of recovery for the UK economy?
- How has higher inflation impacted UK households?
- To what extent do you think the warm weather held back retail sales?
- What could explain why there has been a significant growth in online sales?
The UK Supermarket industry is intensely competitive. It’s hard to slot it directly into a specific market structure, but it has many characteristics of an oligopoly – a market dominated by a few firms with intense competition, both price and non-price.
This competititve aspect of the market structure has become even more important as trading conditions become harsher. The latest development sees Sainsbury’s announcing its price promotion – it will match certain prices offered by Tesco and Asda in a bid to attract customers from its rivals.
The supermarket industry has a history of intense price wars and we can only expect them to increase. This is certainly in the interests of customers, as we face ever decreasing prices. It’s a market in which it certainly pays to shop around and compare prices. The following articles consider the latest developments in one of the most competitive markets out there.
Sainsbury’s joins price cut battle The Press Association (9/10/11)
Sainsbury’s follows rivals in price promotion BBC News (9/10/11)
Every basket helps, as supermarkets battle for shoppers Independent, Laura Chesters (9/10/11)
Sainsbury to extend price match trial Financial Times, Andrea Felsted (7/10/11)
Tesco profits grow but UK sales subdued BBC News (5/10/11)
Sainsbury’s to launch price match scheme The Telegraph, Harry Wallop (7/10/11)
Retail bully boys must not protect themselves unfairly Financial Times, Sarah Gordon (7/10/11)
Questions
- What are the characteristics of an oligopoly? To what extent do you think that the supermarket industry fits into an oligopolistic market structure?
- Are the price wars being carried out by Tesco, Sainsbury’s and Asda in the interests of consumers?
- What aspects of non-price competition have been undertaken by the big supermarket contenders? On what factors does the relative success of these pricing strategies depend?
- What might explain the growing presence of fast food companies in the top 100?
- How could the supermarkets use the concept of elasticity in determining the most effective pricing strategy?
- How has the economic climate affected the supermarket industry? Would you expect the impact to be smaller or larger than that in other sectors of the economy? Explain your answer.
Stock markets have been plummeting. The FTSE 100 index was 6055 on 7 July 2011; by 10 August, it was 17% lower at 5007. Since then it has risen as high as 5418, but by 13 September was down to 5092. Other stock markets have fared worse. The French index fell 30% between early July and September 13, and the German DAX index fell 32% over the same period.
These falls in share prices reflect demand and supply. Investors are worried about the future of the eurozone and the health of the European economy as Greek default looks more and more likely and as the debts of various other European countries, such as Portugal, Ireland and Spain, seem increasingly unsustainable in an environment of sluggish economic growth. They are also worried about high public-sector debt in the USA and the likelihood that global recovery will peter out.
The ‘bear’ market (falling share prices) reflects increased selling of shares and a lack of demand. Not only are investors worried about the global economy, they are also speculating that share prices will fall further, thereby compounding the falls (at least until the ‘bottom’ is reached).
But why have share prices fallen quite so much? And does it matter to the general public that this is happening? The following articles seek to answer these questions.
Articles
Shares tumble on fears over Greek default Guardian, Graeme Wearden (12/9/11)
European Factors-Shares set for steep fall on Greece worries Reuters (12/9/11)
Markets set for turmoil after G-7 letdown BusinessDay (South Africa), Mariam Isa (12/9/11)
What will happen if Greece defaults? The Conversation (Australia), Sam Wylie (12/9/11)
Germany and Greece flirt with mutual assured destruction The Telegraph, Ambrose Evans-Pritchard (11/9/11)
Market Swings Are Becoming New Standard New York Times, Louise Story and Graham Bowley (11/9/11)
The next bull market The Bull (Australia) (12/9/11)
Prepare For Recession And Bear Market Forbes, Sy Harding (9/9/11)
Eurozone crisis: What market turmoil means for you BBC News, Kevin Peachey (8/9/11)
Stock market indices
FTSE 100: historical prices, 1984 to current day Yahoo Finance
Dow Jones Industrial Average: historical prices, 1928 to current day Yahoo Finance
Nikkei 225 (Japan): historical prices, 1984 to current day Yahoo Finance
DAX (Germany): historical prices, 1990 to current day Yahoo Finance
CAC 40 (France): historical prices, 1990 to current day Yahoo Finance
Hang Seng (Hong Kong): historical prices, 1986 to current day Yahoo Finance
SSE Composite (China: Shanghai): historical prices, 2000 to current day Yahoo Finance
BSE Sensex (India): historical prices, 1997 to current day Yahoo Finance
Stock markets BBC
Questions
- What factors have led to the recent falls in stock market prices? Explain just why these factors have contributed to the falls.
- What is likely to happen to stock market prices in the coming weeks? Why is it difficult to predict this?
- What is meant by the efficient capital markets hypothesis? If markets were perfectly efficient, why would it be impossible to predict future movements in stock market prices? Why may stock markets not be perfectly efficient?
- What factors determine stock market prices over the longer term?
- How are share prices influenced by speculation? Distinguish between stabilising and destabilising speculation.
- Explain the various ways in which members of the general public can be affected by share price falls. Are you affected in any way? Explain.
- If Greece defaults, what will determine the resulting effect on stock markets?
- To what extent does the stock market demonstrate the ‘brutal face of supply and demand’?