Every summer a number of air shows take place in the UK, such as those at Farnborough, Cosford and the Royal International Air Tattoo. Some of these events prove to be extremely popular and successful. For example, over 50,000 people attended the event at Cosford on Sunday 9th June to watch a five-and-a-half-hour flying display, including the Red Arrows, a Vulcan bomber and a RAF Battle of Britain Memorial Flight, which featured Spitfire, Hurricane and Lancaster aircrafts.
The event was so popular that some people who had paid £25 for a ticket failed to make it to the show ground because they were stuck in a 9 mile traffic jam! The popularity of these events does raise an interesting economic question. Why do so many people pay to attend when it is possible to watch much of the air show from outside the showground? If people can enjoy the benefits of watching an event whether or not they have paid then we might expect the majority of them not to pay.
Air shows seem to have some of the characteristics of a public good: i.e. to some extent the consumption benefits are both non-rival and non-excludable. By non-rival it is meant that one person’s use or consumption of the good does not decrease the quantity available for somebody else to use or consume. If one person watches the Red Arrows fly by, it does not decrease the ability of others to watch them. Contrast this with a product that has the characteristic of being ‘rival’ such as a hamburger. If someone eats a hamburger, it reduces the amount that is available for others to enjoy. The good is ‘used up’ during consumption. Other people cannot eat the same hamburger!!! Many sporting and music events share this characteristic of non-rivalry. For example if somebody is watching a band playing live at Glastonbury it does not stop somebody else from enjoying the benefits of watching the band. The performance of the band is not ‘used up’ like the hamburger when a person watches the show.
The major difference between Glastonbury and an air show is that the event organisers at Glastonbury can prevent people who have not paid for a ticket from enjoying the show. The event is excludable, as fans have to enter the show arena in order to see the bands. However, as one contributor to an internet discussion site commented:
Air show organisers are at a particular disadvantage compared to other show organisers because the key elements of their show can be seen for miles.
Another contributor added that:
Unfortunately being an air show by its very nature it’s very public – the planes are in the air for everyone to see for free for miles around.
In other words, air shows have the characteristic of being non-excludable, as people can benefit regardless of whether they have paid or not.
These public good properties seem to be causing problems for an air show in Welshpool that appears to have an issue with a number of non-payers watching the event. The organisers recently stated that:
We can’t stop people watching from the hillsides, but perhaps we can make them understand that they need to come to the show and pay.
The previous year the organisers had sent people out with buckets to collect voluntary donations from those sitting on the hillside. However they found that:
People were not for giving much at all and it was noticeable how much copper was in the buckets we’d used and there were hardly any notes.
One solution being proposed in order to generate more revenue is to increase the entry fee, which is currently £5, in order to compensate for those who are not paying.
Articles
Bob Jones Memorial Air Show urges people to buy tick BBC News (9/6/13)
How to make an airshow pay PistonHeads, (9/6/13)
Free or should you pay Talk Photography, (9/6/13)
An organisers view Airshow, (9/6/13)
Cosford Air Show pledge over traffic chaos Shropshire Star, (10/6/13)
RAF Cosford Air Show – Home RAF Cosford Air Show, (12/6/13).
Questions
- What practical problems does a show such as Glastonbury face in trying to make the event excludable?
- In the blog it explains how one person watching a band live does not have a negative impact on the pleasure other people will derive from watching the same band: i.e. it is non-rival. Is this always true? Can you think of any circumstances when watching a live band might become a rival good?
- What term do economists use for goods that are non-rival but are excludable? Think of at least three examples.
- What ideas might the organisers of an air show adopt to encourage people to pay and enter the show ground area?
- Can you think of any strategies that might be used to increase the number and size of the voluntary donations made by those who watch the airshow for free from a hill-side?
- What are the organisers assuming about the price elasticity of demand for the air show at its current price if they claim that increasing prices will lead to an increase in revenue?
The UK electricity supply market is an oligopoly. Over 95% of the market is supplied by the ‘big six’: British Gas (Centrica), EDF Energy, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six also generate much of the electricity they supply; they are vertically integrated companies. Between them they generate nearly 80% of the country’s electricity. There are a further two large generators, Drax Power Limited and GDF Suez Energy UK, making the generation industry an oligopoly of eight key players.
Ofgem, the energy market regulator, has just published a report on the wholesale electricity market, arguing that it is insufficiently liquid. This, argues the report, acts as a barrier to entry to competitor suppliers. It thus proposes measures to increase liquidity and thereby increase effective competition. Liquidity, according to the report, is:
… the ability to quickly buy or sell a commodity without causing a significant change in its price and without incurring significant transaction costs. It is a key feature of a well-functioning market. A liquid market can also be thought of as a ‘deep’ market where there are a number of prices quoted at which firms are prepared to trade a product. This gives firms confidence that they can trade when needed and will not move the price substantially when they do so.
A liquid wholesale electricity market ensures that electricity products are available to trade, and that their prices are robust. These products and price signals are important for electricity generators and suppliers, who need to trade to manage their risks. Liquidity in the wholesale electricity mark et therefore supports competition in generation and supply, which has benefits for consumers in terms of downward pressure on bills, better service and greater choice.
So how can liquidity be increased? Ofgem is proposing that the big six publish prices for two years ahead at which they are contracting to purchase electricity from generators in long-term contracts. These bilateral deals with generators are often with their own company’s generating arm. Publishing prices in this way will allow smaller suppliers to be able to seek out market opportunities. The generating companies will not be allowed to refuse to contract to supply smaller companies at the prices they are being forced to publish.
In addition, Ofgem is proposing that generators would have to sell 20% of output in the open market instead of through bilateral deals. As it is, however, some 30% of output is currently auctioned on the wholesale spot market (i.e. the market for immediate use).
But it is pricing transparency plus small suppliers being able to gain access to longer-term contracts that are the two key elements of the proposed reform.
Articles
UK utilities face having to disclose long-term deals Reuters, Karolin Schaps and Rosalba O’Brien (12/6/13)
Ofgem set to ‘break stranglehold’ in the energy market BBC News, John Moylan (12/6/13)
Ofgem plan ‘to end energy stranglehold’ BBC Today Programme, John Moylan and Ian Marlee (12/6/13)
Ofgem outlines proposals to ‘break stranglehold’ of big six energy suppliers on electricity market The Telegraph (12/6/13)
Ofgem widens investigation into alleged rigging of gas and power markets The Guardian, Terry Macalister (6/6/13)
Ofgem moves to break stranglehold of ‘big six’ energy suppliers Financial Times, Guy Chazan (12/6/13)
Ofgem to crackdown on Big Six energy suppliers in bid to cut electricity prices Independent, Simon Read (12/6/13)
Reports and data
Opening up Electricity Market to Effective Competition Ofgem Press Release (12/6/13)
Wholesale power market liquidity: final proposals for a ‘Secure and Promote’ licence condition – Draft Impact Assessment Ofgem (12/6/13)
Electricity statistics Department of Energy & Climate Change
The Dirty Half Dozen Friends of the Earth (Oct 2011)
Questions
- What barriers to entry exist in (a) the wholesale and (b) the retail market for electricity?
- Distinguish between spot and forward markets. Why is competition in forward markets particularly important for small suppliers of electricity?
- How will ‘liquidity’ be increased by the measures Ofgem is proposing?
- To what extent does vertical integration in the energy industry benefit consumers of electricity?
- What is a price reporting agency (PRA)? What anti-competitive activities have been taking place in the short-term energy market and why may PRAs not be ‘fit for purpose’?
- Do you think that the measures Ofgem is proposing will ensure that the big generators trade fairly with small suppliers? Explain.
- What are the dangers in the proposals for the large generators?
The Clean Energy Bill has been on the agenda for some time and not just in the UK. With climate change an ever growing global concern, investment in other cleaner energy sources has been essential. However, when it comes to investment in wind farms, developers have faced significant opposition. The balancing act for the government appears to be generating sufficient investment in wind farms, while minimising the negative externalities.
The phrase often thrown around with regards to wind farms, seems to be ‘not in my backyard’. That is, people recognise the need for them, but don’t want them to be built in the local areas. The reason is to do with the negative externalities. Not only are the wind farms several metres high and wide, creating a blight on the landscape, but they also create a noise, both of which impose a third party effect on the local communities. These factors, amongst others, have led to numerous protests whenever a new wind farm is suggested. The problem has been that with such challenging targets for energy, wind farms are essential and thus government regulation has been able to over-ride the protests of local communities.
However, planning guidance in the UK will now be changed to give local opposition the ability to override national energy targets. In some sense, more weight is being given to the negative externalities associated with a new wind farm. This doesn’t mean that the government is unwilling to let investment in wind farms stop. Instead, incentives are being used to try to encourage local communities to accept new wind farms. While acknowledging the existence of negative externalities, the government is perhaps trying to put a value on them. The benefits offered to local communities by developers will increase by a factor of five, thus aiming to compensate those affected accordingly. Unsurprisingly, there have been mixed opinions, summed up by Maria McCaffery, the Chief Executive of trade association RenewableUK:
Maria McCaffery, chief executive of trade association RenewableUK, said the proposals would signal the end of many planned developments and that was “disappointing”.
Developing wind farms requires a significant amount of investment to be made upfront. Adding to this cost, by following the government’s advice that we should pay substantially more into community funds for future projects, will unfortunately make some planned wind energy developments uneconomic in England.
That said, we recognise the need to ensure good practice across the industry and will continue to work with government and local authorities to benefit communities right across the country which are hosting our clean energy future.
The improved benefits package by the energy industry is expected to be in place towards the end of the year. The idea is that with greater use of wind farms, energy bills can be subsidised, thereby reducing the cost of living. Investment in wind farms (on-shore and off-shore) is essential. Current energy sources are non-renewable and as such new energy sources must be developed. However, many are focused on the short term cost and not the long term benefit that such investment will bring. The public appears to be in favour of investment in new energy sources, especially with the prospect of subsidised energy bills – but this positive outlook soon turns into protest when the developers pick ‘your back yard’ as the next site. The following articles consider this issue.
Residents to get more say over wind farms The Guardian, Fiona Harvey and Peter Walker (6/6/13)
Local communities offered more say over wind farms BBC News (6/6/13)
Locals to get veto power over wind farms The Telegraph, Robert Winnett (6/6/13)
Wind farms are a ‘complete scam’, claims the Environment Secretary who says turbines are causing ‘huge unhappiness’ Mail Online, Matt Chorley (7/6/13)
New planning guidance will make it harder to build wind farms Financial Times, Jim Pickard, Pilita Clark and Elizabeth Rigby (6/6/13)
Will more power to nimbys be the death of wind farms? Channel 4 News (6/6/13)
Locals given more ground to block wind farms Independent, Tom Bawden (6/6/13)
Questions
- What are the negative externalities associated with wind farms?
- Conduct a cost-benefit analysis as to whether a wind farm should be constructed in your local area. Which factors have you given greatest weight to?
- In question 2 above, were you concerned about the Pareto criterion or the Hicks-Kaldor criterion?
- If local communities can be compensated sufficiently, should wind farms go ahead?
- If the added cost to the development of wind farms means that some will no longer go ahead, is this efficient?
- Why is there a need to invest in new energy sources?
- To what extent is climate change a global problem requiring international (and not national) solution?
Why are 43 companies in the pub and restaurant sector in the UK donating over a £1 million to an 86 year old Frenchman who claims to work a 70 hour week? Jacques Borel has led an interesting and varied life which has included activities such as helping the French resistance in the 2nd world war and opening the first take-away hamburger restaurant in France in 1961. In 2001 he started a campaign to get the European Union to allow member states to reduce the rate of VAT applied to food and drink sold in the pub, hotel and restaurant industry. Organisations such as JD Wetherspoon, Heineken and Pizza Hut are backing his attempts to persuade the UK government of the benefits of this policy.
VAT is paid when goods and services are purchased and is normally included in the price advertised by the seller. It generates a significant amount of money for the UK government and it is estimated that it will raise £102 billion in 2012-13 – the third biggest source of revenue after income tax and national insurance contributions. It is applied at three different rates in the UK – a standard rate of 20%, a reduced rate of 5% and a zero rate i.e. 0%. This may sound straightforward but in reality the tax is extremely complicated as previously discussed in articles on this website . For example most basic or staple items of food sold in shops are zero rated. However there are some rather bizarre exceptions. For example a packet of potato crisps is subject to the standard rate of VAT whereas tortilla chips are not. The standard rate is applied to a packet of Wotsits whereas a zero rate is applied to a packet of Skips!
The campaign headed by Mr Borel focuses on the discrepancy between the zero-rate applied to most food items purchased from a shop and the standard rate applied to food purchased in restaurants or cafes. For example, if you buy a Pizza from a supermarket then you don’t pay any tax on this purchase, whereas if you eat a pizza in a restaurant the standard 20% rate of VAT is applied. Mr Borel is lobbying the UK government to reduce the rate of VAT paid in pubs and restaurants from the standard rate of 20% to the reduced rate of 5%. One reason why so many UK companies are willing to offer him financial support is because of his success in getting governments in other countries such as Germany, Belgium, Finland and France to adopt this policy.
In a recent radio interview Mr Borel was asked to make his case for the proposed reduction of VAT in the UK. He claimed:
I have a commitment from 125 chains of hotels, restaurants and independents to use 60% of the reduction in VAT to lower prices so that would be a 7.5% decrease in price. When you decrease price by that magnitude you will see an increase in customers of 10-12% and you will be forced to hire new staff. In our best case scenario, we plan to create 670,000 jobs in three years.
When asked in another interview why the hospitality sector should be favoured more than others he replied that:
It would create more jobs in a minimal amount of time…you cannot do that with any other industry.
One obvious drawback of the policy would be the loss of revenue for the UK government. Some estimates have suggested that the loss of VAT receipts would be between £5.5 and £7.8 billion. However it has been claimed that over time the impact of the change on government finances would be zero. In response to the proposed tax cut a Treasury spokesman commented:
Any reduced rates would make a significant impact on revenue and, as a significant proportion of spending in these areas is by UK residents, any increase in activity in these areas would largely be at the expense of other consumer spending.
Webcast
Jacques Borel: VAT cut for pubs Morning Advertiser on YouTube (18/5/11)
Articles
Industry VAT campaigner Jacques Borel appears on Radio Four’s Today and Radio Five Propelinfo (24/4/13)
French veteran in fight to cut pub VAT Financial Times, Christopher Thompson (5/6/12)
The fiscal impact of reduced VAT rates VAT Club Jobs (22/4/13)
Pub and restaurant groups pay 86-year-old Frenchman £1m to convince UK government to cut VAT The Mail on Sunday, Sarah Bridge (20/4/13)
French veteran seeks British jobs boost with VAT Reuters (17/1/13)
Questions
- In his radio interview Jacques Borel claims that if firms pass on 60% of the cut in VAT this would cause a 7.5% reduction in prices. Explain why this is the case. Clearly outline any assumptions you have made in the analysis
- If 60% of the reduction was passed on by firms through lower prices, what do you think would happen to the money generated from the other 40% of the reduction?
- Using a demand and supply diagram illustrate the proposed reduction in the rate of VAT on the hospitality industry. Make sure your diagram is drawn in such a way that it clearly illustrates producers passing on 60% of the tax reduction in the form of lower prices.
- Assuming that the hospitality industry was very competitive, what impact would a reduction in VAT have on consumer surplus, producer surplus and deadweight welfare loss?
- Explain any assumptions you have in your answer to question 3 about the price elasticity of demand and supply.
- Using the figures provided in the radio interview is it possible to calculate the price elasticity of demand. Try making the calculation and clearly explain any assumptions you have made.
- Explain why the reduction in VAT might have no net effect on government finances in the long run?
- What factors determine the price elasticity of supply? What assumption is Mr Borel making about the price elasticity of supply in the hospitality industry compared to other industries when he makes the claim that jobs would be created quickly?
- Outline some of the arguments against cutting the rate of VAT.
The UK economy faces a growing problem of energy supplies as energy demand continues to rise and as old power stations come to the end of their lives. In fact some 10% of the UK’s electricity generation capacity will be shut down this month.
Energy prices have risen substantially over the past few years and are set to rise further. Partly this is the result of rising global gas prices.
In 2012, the response to soaring gas prices was to cut gas’s share of generation from 39.9% per cent to 27.5%. Coal’s share of generation increased from 29.5% to 39.3%, its highest share since 1996 (see The Department of Energy and Climate Change’s Energy trends section 5: electricity). But with old coal-fired power stations closing down and with the need to produce a greater proportion of energy from renewables, this trend cannot continue.
But new renewable sources, such as wind and solar, take a time to construct. New nuclear takes much longer (see the News Item, Going nuclear). And electricity from these low-carbon sources, after taking construction costs into account, is much more expensive to produce than electricity from coal-fired power stations.
So how will the change in balance between demand and supply affect prices and the security of supply in the coming years. Will we all have to get used to paying much more for electricity? Do we increasingly run the risk of the lights going out? The following video explores these issues.
Webcast
UK may face power shortages as 10% of energy supply is shut down BBC News, Joe Lynam (4/4/13)
Data
Electricity Statistics Department of Energy & Climate Change
Quarterly energy prices Department of Energy & Climate Change
Questions
- What factors have led to a rise in electricity prices over the past few years? Distinguish between demand-side and supply-side factors and illustrate your arguments with a diagram.
- Are there likely to be power cuts in the coming years as a result of demand exceeding supply?
- What determines the price elasticity of demand for electricity?
- What measures can governments adopt to influence the demand for electricity? Will these affect the position and/or slope of the demand curve?
- Why have electricity prices fallen in the USA? Could the UK experience falling electricity prices for similar reasons in a few years’ time?
- In what ways could the government take into account the externalities from power generation and consumption in its policies towards the energy sector?
