Ministers are considering introducing a minimum price of 45p per unit of alcohol on all drinks sold in England and Wales. The Scottish government has already passed legislation for a minimum price of 50p per unit in Scotland. This, however, is being challenged in the Scottish courts and is being examined by the European Commission.
As we saw in a previous blog, Alcohol minimum price, the aim is to prevent the sale of really cheap drinks in supermarkets and other outlets. Sometimes supermarkets sell alcoholic drinks at less than average cost as a ‘loss leader’ in order to encourage people to shop there. Two-litre bottles of strong cider can be sold for as little as £2. Sometimes they offer multibuys which are heavily discounted. The idea of minimum pricing is to stop these practices without affecting ‘normal’ prices.
The effect of a 45p minimum price per unit would give the following typical minimum prices (depending on strength):
Strength
Size
Minimum price
Wine
12.5%
750ml
£4.22
Beer/lager (normal)
4.5%
pint (568ml)
£1.15
Beer/lager (strong)
7.5%
pint (568ml)
£1.92
Beer/lager (normal)
4.5%
2 litres
£4.05
Beer/lager (strong)
7.5%
2 litres
£6.75
Cider (normal)
5%
pint (568ml)
£1.28
Cider (strong)
8%
pint (568ml)
£2.04
Cider (normal)
5%
2 litres
£4.50
Cider (strong)
8%
2 litres
£7.20
Whisky
40%
700ml
£12.60
Vodka
37.5%
700ml
£11.81
The hope is that by preventing the sale of really cheap drinks in supermarkets, people will no longer be encouraged to ‘pre-load’ so that when they go out for the evening they are already drunk.
But how successful will such a policy be in cutting down drunkenness and the associated anti-social behaviour in many towns and cities, especially on Friday and Saturday nights? The following articles discuss the issue and look at some of the evidence on price elasticity of demand.
Draw a diagram to illustrate the effect of a minimum price per unit of alcohol on (a) cheap cider; (b) good quality wine.
How is the price elasticity of demand for alcoholic drinks relevant to determining the success of minimum pricing?
Compare the effects of imposing a minimum unit price of alcohol with raising the duty on alcoholic drinks? What are the revenue implications of the two policies for the government?
What externalities are involved in the consumption of alcohol? How could a socially efficient price for alcohol be determined?
Is imposing a minimum price for alcohol fair? How will it effect the distribution of income?
The environment has been a growing part of government policy for many years. With the Kyoto Protocol and Europe’s carbon trading system, effort has been made to reduce carbon emissions. Part of UK policy to meet its emission’s target requires substantial investment in infrastructure to provide efficient energy.
Details of the government’s Energy Bill sets out plans that will potentially increase average household energy bills by about £100 per annum, although estimates of this vary from about £90 to £170. This money will be used to finance much needed investment in infrastructure that will allow the UK to meet its carbon emissions target. With this extra cost on bills, energy companies will increase bring in something like £7.6bn. The benefit of this higher cost is that investment today will lead to lower energy bills tomorrow. Essentially, we’re looking at a short-term cost for a long-term gain.
The Energy Bill also delayed setting a carbon emission target until 2016. Crucially, this will come after the next election. Environmentalists have naturally criticised this omission. John Sauven of Greenpeace said:
’By failing to agree to any carbon target for the power sector until after the next election, David Cameron has allowed a militant tendency within his own ranks to derail the Energy Bill … It’s a blatant assault on the greening of the UK economy that leaves consumers vulnerable to rising gas prices, and sends billions of pounds of clean-tech investment to our economic rivals.’
One further problem that this lack of a target creates is uncertainty. The energy sector requires significant investment and in order to be encouraged to invest, firms need assurances. Without knowing the target and hence facing a degree of uncertainty, firms may be less likely to invest in building new power plants. And this investment is crucial. The Government has committed to replacing most coal-fired power stations across Britain with low carbon technology at a cost of hundreds of billions of pounds. However, the Chancellor has said “he would not allow saving the planet to come at the cost of ‘putting our country out of business.’”
When this Energy Bill is published, it is claimed that £110bn of spending on different aspects of the National Grid will occur. The suggestion is that this will generate a further 250,000 jobs by 2030 and will be a big step in the right direction towards creating an economy that is more reliant on clean energy.
The following articles consider the wide range of issues surrounding the Energy Bill.
Why does the environment require so much government intervention? Think about the different ways in which the environment as a market fails.
If household bills rise, is there likely to be an income and substitution effect between consumption of ‘energy’ and other goods? Which direction will each effect move in and which do you think would be the largest?
Why is uncertainty such a deterrent for investment? Why does a lack of a carbon emissions target represent uncertainty?
The higher cost of bills today may enable future bills to fall. Why is this? For a household, explain why discount factors could be important here.
Why do some argue that the extra cost to households set out by the government are likely to under-estimate the actual increase households will face?
Is the Chancellor right to say that he will not put our country out of business to save the planet?
Virgin’s franchise to run the West Coast Main Line from London to Birmingham, Manchester, Liverpool, Glasgow and Edinburgh was due to expire in December. The Department of Transport thus invited tenders to run a new 13-year franchise, worth around £5 billion, and on 15 August announced that the franchise had been awarded to FirstGroup. It had bid substantially more than Virgin.
Virgin immediately challenged the decision, arguing that FirstGroup’s figures were flawed. According to the second BBC article below:
It argued that FirstGroup’s revenue projections were wildly optimistic – that passenger growth of 6% a year was unlikely given that Virgin had seen growth of 5% a year from a much lower base. This level of passenger growth would have seen FirstGroup’s revenue from the franchise grow by more than 10% a year, which was simply unrealistic, Virgin argued.
And it is not alone. “Everybody in the industry thought that this bid was not sustainable and that the risks had not been taken into account by the Department for Transport,” says rail industry expert Christian Wolmar.
If revenue targets are not met, the franchisee doesn’t have the money to pay the government the promised fee for the contract, which in FirstGroup’s case was back-loaded towards the end of the 13-year term.
After making its decision, the Transport Secretary at the time, Justine Greening, said that the process of assessing the bid was robust and fair and conducted with due diligence. Sir Richard Branson of Virgin strongly and publicly disagreed and Virgin decided to take the Department of Transport to court. The court case was scheduled to begin on 4 October.
However, in preparing its case to put to the court, the Department of Transport uncovered significant errors in the evaluation of the bids. These errors involved the overestimation of passenger numbers, the undervaluation of risk and a failure to take inflation into account. The errors stemmed from inputting the data incorrectly.
The errors were so serious that the new Transport Secretary, Patrick McLoughlin, on the day before the court case was due to begin, announced that he was scrapping the contract to FirstGroup and would invite new bids. All four of the original bidders would have their costs refunded, amounting to some £40 million.
The minister also announced that he was setting up two reviews. One would seek to establish just what went wrong in the assessment of the West Coat Main Line bids and what lessons could be learned. This is due to report at the end of October. The other review would examine the wider rail franchise programme and how bids are appraised. In the meantime, three other franchise competitions had been ‘paused’ pending the results of this second review, due to report in December.
The articles look at the problems of assessing bids and properly taking into account risks associated with both revenue and cost projections. Not surprisingly, they also look at the politics of this amazing and unprecedented U-turn
What were reasons for awarding the contract to FirstGroup back in August?
How is discounting used to assess the value of projected future revenue and costs? How does the choice of the rate of discount impact on these calculations?
In what way should risk be taken into account?
Why was the FirstGroup bid particularly sensitive to the calculation of risk?
If both costs and revenues go up with inflation, how is inflation relevant to the calculation of the profitability of a bid?
What are the arguments for and against making franchises longer?
Is it only at the bidding stage that there is any competition for train operators? Explain.
Should full social costs and benefits be taken into account when assessing bids for a rail franchise? Explain.
EU environmental legislation is beginning to cause problems in the UK. As it prohibits coal-fired power plants from generating power, they will be forced to close. This means that the UK will be forced to rely more on imported energy, which could lead to price rises, as energy shortages emerge.
Ofgem, the energy regulator has said that the risk of a gas shortage is likely to be at its highest in about 3 years time, as the amount of spare capacity is expected to fall from its current 14% to just 4%. Energy shortages have been a concern for some time, but the report from Ofgem indicates that the predicted time frame for these energy shortages will now be sooner than expected. Ofgem has said that the probability of a black-out has increased from 1 in 3,300 years now to 1 in 12 years by 2015.
The government, however, has said that its Energy Bill soon to be published will set out plans that will secure power supply for the UK. Part of this will be through investment, leading to new methods of generating energy. The Chief Executive of Ofgem, Alistair Buchanan said:
‘The unprecedented challenges in facing Britain’s energy industry … to attract the investment to deliver secure, sustainable and affordable energy supplies for consumers, still remain.’
One particular area that will see growth is wind-farms: a controversial method of power supply, due to the eye-sore they present (to some eyes, at least) and the noise pollution they generate. But with spare capacity predicted to fall to 4%, they will be a much needed investment.
Perhaps of more concern for the everyday household will be the impact on energy prices. As we know, when anything is scarce, the price begins to rise. As energy shortages become more of a concern, the market mechanism will begin to push up prices. With other bills already at record highs and incomes remaining low, the average household is likely to feel the squeeze. The following articles and the Ofgem report considers this issue.
A modern day hindrance is spam email clogging up your inbox with, for example, offers for cheap drugs or notifications that you will inherit enough money to retire to the Bahamas. A recent paper by Justin Rao and David Reiley in the Journal of Economic Perspectives investigates the economics of spam mail (which, as I discovered, from the article gets it’s name from a Monty Python sketch). Remarkably, they quote figures suggesting that 88% of worldwide email traffic is spam. Their paper then provides a number of interesting insights into the business of spam mail.
First, given that most recipients simply delete it, why is spam mail sent out? For the benefits of sending it to exceed the costs, it must be that somebody is reading and responding to it and the costs must also be reasonably low. Rao and Reiley are able to quantify these costs and benefits. They estimate that if 8.3 million spam emails are sent, only 1.8% (approximately 150,000) will reach the intended recipients’ inboxes, with the remainder being blocked or filtered out. Of these 150,000, just 0.25% (375) are clicked on. Furthermore, these 375 clicks generate just a single sale of the advertised product which is typically sold for around $50. Assuming that free entry of spammers leads to them earning zero economic profit, this means that it costs the spammers around $50 to send the 8.3 million emails.
Second, spam mail clearly imposes a considerable negative externality on society. This includes wasted time for consumers and the costs of the extra server hardware capacity required. Rao and Reiley are also able to quantify the size of the negative externality created. First, they estimate that:
“American firms and consumers experience costs of almost $20 billion annually due to spam.”
This can then be compared to the benefits senders of spam get:
“….. we estimate that spammers and spam-advertised merchants collect gross worldwide revenues on the order of $200 million per year. Thus, the ‘externality ratio’ of external costs to internal benefits for spam is around 100:1.”
They then compare this to estimates for other negative externalities such as car pollution and conclude that the size of the negative externality from spam is significantly greater.
Finally, they also point out that it is predominantly the larger email service providers i.e. Yahoo! Mail, Microsoft Hotmail, and Google Gmail who have both the incentives and resources to fund interventions to eradicate spam. For example, in 2009 Microsoft and Pfizer (the manufacturer of Viagra which faces competition from counterfeit versions often advertised by spam) financially supported the successful operation to shut down the largest spam distributor. Clearly, such operations have large positive spillovers for email users. However, as they also discuss, anti-spam technology also increases the fixed costs of competing as an email provider and they suggest that this has contributed to the increased concentration in the market.
Ministers are considering introducing a minimum price of 45p per unit of alcohol on all drinks sold in England and Wales. The Scottish government has already passed legislation for a minimum price of 50p per unit in Scotland. This, however, is being challenged in the Scottish courts and is being examined by the European Commission.
