A big expenditure for many households is petrol. The price of petrol is affected by various factors, but the key determinant is what happens in the oil market. When oil prices rise, this pushes up the price of petrol at the pumps. But, when they fall, do petrol prices also fall? That is the question the government is asking.
The price of oil is a key cost of production for companies providing petrol and so when oil prices rise, it shifts the supply curve up to the left and hence prices begin to increase. We also see supply issues developing with political turmoil, fears of war and disruption and they have a similar effect. As such, it is unsurprising that petrol prices rise with concern of supply and rising costs. But, what happens when the opposite occurs? Oil prices have fallen significantly: by a quarter. Yet, prices at the pump have fallen by around 6%. This has caused anger amongst customers and the government is now urging petrol retailers to pass their cost savings from a lower price of oil onto customers. Danny Alexander, Chief Secretary to the Treasury said:
“I believe it’s called the rocket-and-feather effect. The public have a suspicion that when the price of oil rises, pump prices go up like a rocket. But when the price of oil falls, pump prices drift down like a feather … This has been investigated before and no conclusive evidence was found. But even if there were a suspicion it could be true this time it would be an outrage.”
However, critics suggest that tax policy is partly to blame as 63% of the cost of petrol is in the form taxation through fuel duty and VAT. Therefore even if oil prices do fall, the bulk of the price we pay at the pumps is made up of tax revenue for the government. Professor Stephen Glaister, director of the RAC Foundation said:
“It’s a simple story. Before tax we have just about the cheapest petrol and diesel in Europe. After tax we have just about the most expensive … It’s right to keep the pressure on fuel retailers but if drivers want to know what’s behind the high pump prices of recent years all they have to do is follow the trail back to the Treasury … if ministers are serious about reducing fuel prices further then they should cut duty further.”
(Click here for a PowerPoint of the chart.)
However, even taking out the fuel duty and VAT, Arthur Renshaw, an analyst at Experian has said that the actual price of petrol has fallen by 21% since last year. Still, a much bigger decrease than we have seen at the pumps. One further reason for this may be the fact that dollars is the currency in which oil is traded. The pound has been relatively weak, falling by almost 7% over the past few months and hence even though the price of oil has fallen, the effect on UK consumers has been less pronounced.
The big supermarkets have responded to government calls to cut petrol prices, but how much of this cut was influenced by the government and how much was influenced by the actions of the other supermarkets is another story. A typical oligopoly, where interdependence is key, price wars are a constant feature, so even if one supermarket cut petrol prices, this would force others to respond in kind. If such price wars continue, further price cuts may emerge. Furthermore, with oil production still at such high levels, this market may continue to put downward pressure on petrol prices. Certainly good news for consumers – we now just have to wait to see how long it lasts, with key oil producing countries, such as Russia taking a big hit. The following articles consider this story.
Articles
Supermarkets cut fuel prices again The Telegraph, Nick Collins (6/11/14)
Petrol retailers urged to cut prices in line with falling oil costs The Guardian, Terry Macalister (6/11/14)
Supermarkets cut petrol prices after chancellor’s criticism Financial Times, Michael Kavanagh (6/11/14)
Governent ‘watching petrol firms’ Mail Online (6/11/14)
Our horrendous tax rates are the real reason why petrol is still so expensive The Telegraph, Allister Heath (6/11/14)
Osborne ‘expects’ fuel price drop after fall in oil price BBC News (6/11/14)
Danny Alexander tells fuel suppliers to pass on oil price cuts to drivers The Telegraph, Peter Dominiczak (5/11/14)
Further UK fuel cuts expected as pound strengthens The Scotsman, Alastair Dalton (6/11/14)
Data
Spot oil prices Energy Information Administration
Weekly European Brent Spot Price Energy Information Administration (Note: you can also select daily, monthly or annual.)
Annual Statistical Bulletin OPEC
Questions
- Using a supply and demand diagram, illustrate the impact that a fall in the price of oil should have on the price of petrol.
- What is the impact of a tax on petrol?
- Why is petrol a market that is so heavily taxed? You should think about the incidence of taxation in your answer.
- Why does the strength of the pound have an impact on petrol prices in the UK and how much of the oil price is passed onto customers at the pumps?
- Does the structure of the supermarket industry help customers when it comes to the price of petrol? Explain your answer.
- Militant action in some key oil producing countries has caused fears of oil disruption. Why is that oil prices don’t reflect these very big concerns?
The market structure in which firms operate has important implications for prices, products, suppliers and profits. In competitive markets, we expect to see low prices, many firms competing with new innovations and firm behavior that is in, or at least not against the public interest. As a firm becomes dominant in a market, its behavior is likely to change and consumers and suppliers can be adversely affected. Is this the case with Amazon?
Much attention has been given to the dispute centering around Amazon and its actions in the market for e-books, where it holds close to two thirds of the market share. Critics of Amazon suggest that this is just one example of Amazon using its monopoly power to exploit consumers and suppliers, including the publishers and their authors. Although Amazon is not breaking any laws, there are suggestions that its behavior is ‘brutal’ and is taking advantage of consumers, suppliers and its workforce.
But rather than criticizing the actions of a monopolist like Amazon, should we instead be praising the company and its ability to compete other firms out of the market? One of the main reasons why consumers use Amazon to buy goods is that prices are cheap. So, in this respect, perhaps Amazon is not acting against consumers’ interests, as under a monopoly we typically expect low output and high prices, relative to a model of perfect competition. The question of the methods used to keep prices so low is another matter. Two conflicting views on Amazon can be seen from Annie Lowrey and Franklin Foer, who respectively said:
“Amazon relentlessly drives down prices for goods and services and delivers them fast and cheap. It ploughs its profits into price cuts and innovation rather than putting them in the hands of its investors. That benefits millions of families – full stop.”
“In effect, we’ve been thrust back 100 years to a time when the law was not up to the task of protecting the threats to democracy posed by monopoly; a time when the new nature of the corporation demanded a significant revision of government.”
So, with Amazon we have an interesting case of a monopolist, where many aspects of its behaviour fit exactly into the mould of the traditional monopolist. But, some of the outcomes we observe indicate a more competitive market. Paul Krugman has been relatively blunt in his opinion that Amazon’s dominance is bad for America. His comments are timely, given the recognition for Jean Tirole’s work in considering the problems faced when trying to regulate any firm that has significant market power. He has been awarded the Nobel Prize in Economics. I’ll leave you to decide where you place this company on the traditional spectrum of market structures, as you read the following articles.
Amazon: Monopoly or capitalist success story? BBC News, Kierran Petersen (14/10/14)
Why the Justice Department won’t go after Amazon, even though Paul Krugman thinks it’s hurting America Business Insider, Erin Fuchs (20/10/14)
Is Amazon a monopoly? The Week, Sergio Hernandez (19/11/14)
Big, bad Amazon The Economist (20/10/14)
Questions
- What are the typical characteristics of a monopoly? To what extent does Amazon fit into this market structure?
- Why does Paul Krugman suggest that Amazon is hurting America?
- How does Amazon’s behaviour with regard to (a) its suppliers and (b) its workers affect its profitability? Would it be able to behave in this way if it were a smaller company?
- Why is Amazon able to charge its customers such low prices? Why does it do this, given its market power?
- Is there an argument for more regulation of firms with such dominance in a market, as is the case with Amazon?
- The debate over e-books is ingoing. What is the argument for publishers to be able to set a minimum price? What is the argument against this?
- Should customers boycott Amazon in a protest over the alleged working conditions of Amazon factory employees?
With the new Premier League football season only a week away, TV companies are heavily advertising the matches they will be showing. Until recently, BSkyB, having seen off competition from Setanta and ESPN, appeared to have an untouchable position in this market. However, competition now appears to be intensifying.
BT entered the market in 2012 by paying £738m for the rights to screen 38 Premier League matches a season for 3 seasons, with Sky showing another 116 matches. BT is clearly heavily backing its sports coverage with an initial outlay of £1.5b and them continuing to sign up high profile presenters and ambassadors including former players and a current manager.
Furthermore, BT dealt Sky (and ITV) a hefty blow last year when it outbid them to win the rights to exclusively show European club competition matches from 2015. Sky responded by saying that:
We bid with a clear view of what the rights are worth to us. It seems BT chose to pay far in excess of our valuation
If true, this would illustrate the winner’s curse which can arise in auctions. However, John Petter, chief executive of BT Retail, said that the deal demonstrated that BT Sport was committed to establishing itself in this market and countered Sky’s suggestion that they had overpaid by saying:
They would say that, wouldn’t they? Secretly, I’d expect them to be kicking themselves and full of regrets this morning
Clearly important to BT’s strategy is bundling its sports coverage in for free with their broadband packages. This is not without controversy since, at the same time as spending vast amounts of money to setup its sports coverage, BT is receiving large government subsidies to improve rural broadband provision.
An important forthcoming ruling from the Competition Appeal Tribunal will have a significant effect on how competition between BT and Sky develops. In this case Sky is accused of abusing its dominant position by refusing to supply BT’s YouView service with its sports channels at a reasonable wholesale price and could now be forced to do so.
It will also be fascinating to see how BT Sport’s strategy develops over time. BT is unlikely to continue 
to provide all its coverage for free once it includes the European matches that it has won the rights to show at great expense. It will also be fascinating to see the extent to which it continues to have success in winning broadcasting rights in the future.
Competition will inevitably push up the amount that the Premier League raises in the next rights auction. Current predictions are that these will be sold for over £4bn, up from £3bn in the previous auction. This will increase the amount the Premier League clubs receive and is also likely to further push up player wages. It remains to be seen the extent to which this will benefit viewers, not to mention pubs wishing to show the games some of whom have in the past looked for alternative solutions because of the high prices they have to pay.
BT wins court battle forcing review of Sky wholesale pricing decision The Guardian, Mark Sweney (17/02/14)
BT Sport does little to lift BT TV homes informitv – connected vision (01/08/14)
BT Sport continues to invest in football line-up MediaWeek, Arif Durrani (29/07/14)
Questions
- What are the key characteristics of the market for sports broadcasting rights?
- What are the pros and cons for consumers of BT Sport’s emergence?
- How do you think Sky might respond to competition from BT Sport?
- How do you think BT Sport’s strategy might develop over time?
There have been two significant changes in prices for travel in Bristol. At the end of April, the toll on Brunel’s iconic Clifton Suspension Bridge doubled from 50p to £1 for a single crossing by car. The bridge over the Avon Gorge links North Somerset with the Clifton area of Bristol and is a major access route to the north west of the city. Avoiding the bridge could add around 2 miles or 8 minutes to a journey from North Somerset to Clifton.
The justification given by the Clifton Suspension Bridge Trust for the increase was that extra revenue was needed for maintenance and repair. As Trust Chairman Chris Booy said, ‘The higher toll will enable the Trust to continue its £9 million 10-year vital repair and maintenance programme which aims to secure the bridge’s long-term future as a key traffic route, one of Bristol’s major tourist destinations and the icon of the city’.
The other price change has been downwards. In November 2013, the First Group cut bus fares in Bristol and surrounding areas. Single fares for up to three miles were cut from £2.90 to £1.50; 30% discounts were introduced for those aged 16 to 21; half-price tickets were introduced for children from 5 to 15; and the two fare zones for £4 and £6 day tickets were substantially increased in size.
First hoped that the anticipated increase in passengers would lead to an increase in revenue. Evidence so far is that passenger numbers have increased, with journeys rising by some 15%. Part of this is due to other factors, such as extra bus services, new buses, free wifi and refurbished bus stops with larger shelters and seats. But the company attributes a 9% rise in passengers to the fare
reductions. As far as revenue is concerned, indications from the company are that, after an initial fall, revenue has risen back to levels earned before the fare reduction.
What are the longer-term implications for revenue and profit of these two decisions? This depends on the price elasticity of demand and on changes in costs. Read the articles and then consider the implications by having a go at answering the questions.
Clifton Suspension Bridge toll to rise from 50p to £1 BBC News (9/4/14)
Regular Users of Clifton Suspension Bridge will be Protected from the Increase in the Bridge Toll Clifton Suspension Bridge (9/4/14)
Clifton Suspension Bridge Review Decision Letter Department of Transport (24/3/14)
Clifton Suspension Bridge Trust: bridge toll review inspector’s report Department of Transport (8/4/14)
Clifton Suspension Bridge Toll Increase – Account of the May 2013 Public Inquiry The National Alliance Against Tolls (NAAT)
First Bus Bristol fare cuts sees passenger growth BBC News (6/6/14)
First gamble over cheaper bus fares pays off as passengers increase in Bristol The Bristol Post (6/6/14)
Bristol bus fares deal to extend to South Gloucestershire and North Somerset The Bristol Post, Gavin Thompson (12/6/14)
Questions
- What assumptions is the Clifton Suspension Bridge Trust making about the price elasticity of demand for bridge crossings?
- What determines the price elasticity for bridge crossings in general? Why is this likely to differ from one bridge to another?
- How is the long-term price elasticity of demand likely to differ from the short-term elasticity for Clifton Suspension Bridge crossings and what implications will this have for revenues, costs and profit?
- How is the price elasticity of demand for the bridge likely to vary from one user to another?
- How is offering substantial price reductions for multiple-crossing cards likely to affect revenue?
- What determines the price elasticity of demand for bus travel?
- What could a local council do to encourage people to use buses?
- How is the long-term price elasticity of demand for bus travel likely to differ from the short-term elasticity?
- In the long run, is First likely to see profits increase from its fare reduction policy? Explain what will determine this likelihood.
Oligopoly is the most complex market structure, characterised by a few large firms which dominate the industry. Typically there are high barriers to entry and prices can be very sticky. However, perhaps the most important characteristic is interdependence. With this feature of the market, oligopolies, despite being dominated by a few big firms, can be the most competitive market structure.
There are many examples of oligopolies and one of the best is the supermarket industry. Dominated by the likes of Tesco, Morrisons and Asda, competition in terms of branding, product development and quality is constant, but so is price competition. 
During the recession, you could hardly watch a TV programme that included advert breaks without seeing one of the big four advertising their low prices.
However, in the past few years, the supermarket industry has seen competition grow even further and the big four are now facing competition from low-cost retailers, including Aldi and Lidl. This has led to falling sales and profits for the likes of Tesco and Morrisons.
Tesco, Morrisons, Sainsbury’s and Asda have all felt the emergence of discount retailers and have seen their customer numbers fall. All have reacted with rounds of price cuts and new deals, and this price war looks set to continue. Morrisons have just announced a 14% average price cut on 135 products to match earlier changes in pricing strategies by the other main competitors. As I’m writing this during the Algeria v. South Korea match, I have just seen an advert from Sainsbury’s, promoting their milk chocolate digestive biscuits, priced at £1. The advert explicitly states that they are ‘less than Morrisons’, where the price is £1.50. This was soon followed by another from Sainsbury’s saying that 
the Cif bathroom spray is £1.50, which is ‘less than Tesco’, priced at £2.75. I need say no more.
So, what is it about this industry which means it is so susceptible to price wars? Are all oligopolies like this? The following articles consider the supermarket industry and the price wars that have emerged. Think about this sector in terms of oligopoly power and consider the questions that follow.
Morrisons announces another round of price cuts/a> BBC News (22/6/14)
Tesco suffers worst sales for decades The Guardian, Sarah Butler and Sean Farrell (4/6/14)
Britain’s Morrisons to cut prices on 135 products Reuters (22/6/14)
Morrisons slashes more prices by up to 41pct The Telegraph, Scott Campbell (22/6/14)
Sainsbury’s and Netto in discount store tie-up BBC News (20/6/14)
Slow to respond, Tesco now pays the price Wall Street Journal, Peter Evans and Ese Erheriene (19/6/14)
One million fewer customer visits a week at Tesco The Guardian, Sean Farrell (3/6/14)
Asda only one of big four to grow share as Lidl achieves highest ever growth Retail Week, Nicola Harrison (3/6/14)
Will Asda shoot itself in the foot with in-store cost cutting? The Grocer, Alec Mattinson (28/5/14)
Tesco sales slide at record speed as discounters pile on the pressure Independent, Simon Neville (3/6/14)
Quester: Back J Sainsbury to prove doubters wrong The Telegraph, Graham Ruddick (11/6/14)
Questions
- What are the key characteristics of an oligopoly?
- How do the above characteristics explain the conduct of firms in an oligopoly? How relevant is this to the supermarket industry?
- In many oligopolies, prices are sticky. Why is it that in the supermarket industry price wars break out?
- Is the kinked demand curve a relevant model to use when talking about the supermarket industry?
- What other industries fit into the category of an oligopoly? Is the kinked demand curve model relevant in these industries?
- Would there be an incentive for the big 4 supermarkets to collude and fix price? Explain your answer.
- Interdependence is the key characteristic in an oligopoly. Can this explain the behaviour of the supermarkets?
- Given that oligopolies are characterised by high barriers to entry, how is that Aldi and Lidl have been able to compete with them?
