Category: Economics: Ch 03

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A soft target for a tax

Back in October, we looked at the growing pressure in the UK for a sugar tax. The issue of childhood obesity was considered by the Parliamentary Health Select Committee and a sugar tax, either on sugar generally, or specifically on soft drinks, was one of the proposals being considered to tackle the problem. The committee studied a report by Public Health England, which stated that:

Research studies and impact data from countries that have already taken action suggest that price increases, such as by taxation, can influence purchasing of sugar sweetened drinks and other high sugar products at least in the short-term with the effect being larger at higher levels of taxation.

In his Budget on 16 March, the Chancellor announced that a tax would be imposed on manufacturers of soft drinks from April 2018. This will be at a rate of 18p per litre on drinks containing between 5g and 8g of sugar per 100ml, such as Dr Pepper, Fanta and Sprite, and 24p per litre for drinks with more than 8g per 100ml, such as Coca-Cola, Pepsi and Red Bull.

Whilst the tax has been welcomed by health campaigners, there are various questions about (a) how effective it is likely to be in reducing childhood obesity; (b) whether it will be enough or whether other measures will be needed; and (c) whether it is likely to raise the £520m in 2018/19, falling to £455m by 2020/21, as predicted by the Treasury: money the government will use for promoting school sport and breakfast clubs.

These questions are all linked. If demand for such drinks is relatively inelastic, the drinks manufacturers will find it easier to pass the tax on to consumers and the government will raise more revenue. However, it will be less effective in cutting sugar consumption and hence in tackling obesity. In other words, there is a trade off between raising revenue and cutting consumption.

This incidence of tax is not easy to predict. Part of the reason is that much of the market is a bilateral oligopoly, with giant drinks manufacturers selling to giant supermarket chains. In such circumstances, the degree to which the tax can be passed on depends on the bargaining strength and skill of both sides. Will the supermarkets be able to put pressure on the manufacturers to absorb the tax themselves and not pass it on in the wholesale price? Or will the demand be such, especially for major brands such as Coca-Cola, that the supermarkets will be willing to accept a higher price from the manufacturers and then pass it on to the consumer?

Then there is the question of the response of the manufacturers. How easy will it be for them to reformulate their drinks to reduce sugar content and yet still retain sales? For example, can they produce a product which tastes like a high sugar drink, but really contains a mix between sugar and artificial sweeteners – effectively a hybrid between a ‘normal’ and a low-cal version? How likely are they to reduce the size of cans, say from 330ml to 300ml, to avoid raising prices?

The success of the tax on soft drinks in cutting sugar consumption depends on whether it is backed up by other policies. The most obvious of these would be to impose a tax on sugar in other products, including cakes, biscuits, low-fat yoghurts, breakfast cereals and desserts, and also many savoury products, such as tinned soups, ready meals and sauces. But there are other policies too. The Public Health England report recommended a national programme to educate people on sugar in foods; reducing price promotions of sugary food and drink; removing confectionery or other sugary foods from end of aisles and till points in supermarkets; setting broader and deeper controls on advertising of high-sugar foods and drinks to children; and reducing the sugar content of the foods we buy through reformulation and portion size reduction.

Articles

Questions

  1. What determines the price elasticity of demand for sugary drinks in general (as opposed to one particular brand)?
  2. How are drinks manufacturers likely to respond to the sugar tax?
  3. How are price elasticity of demand and supply relevant in determining the incidence of the sugar tax between manufacturers and consumers? How is the degree of competition in the market relevant here?
  4. What is meant by a socially optimal allocation of resources?
  5. If the current consumption of sugary drinks is not socially optimal, what categories of market failure are responsible for this?
  6. Will a sugar tax fully tackle these market failures? Explain.
  7. Is a sugar tax progressive, regressive or proportional? Explain.
  8. Assess the argument that the tax on sugar in soft drinks may actually increase the amount that people consume.
  9. The sugar tax can be described as a ‘hypothecated tax’. What does this mean and is it a good idea?
  10. Compare the advantages and disadvantages of a tax on sugar in soft drinks with (a) banning soft drinks with more than a certain amount of sugar per 100ml; (b) a tax on sugar; (c) a tax on sugar in all foods and drinks.
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Will there be an oil price rebound?

People are beginning to get used to low oil prices and acting as if they are going to remain low. Oil is trading at only a little over $30 per barrel and Saudi Arabia is unwilling to backtrack on its policy of maintaining its level of production and not seeking to prevent oil prices from falling. Currently, there is still a position of over supply and hence in the short term the price could continue falling – perhaps to $20 per barrel.

But what of the future? What will happen in the medium term (6 to 12 months) and the longer term? Investment in new oil wells, both conventional and shale oil, have declined substantially. The position of over supply could rapidly come to an end. The Telegraph article below quotes the International Energy Agency’s executive director, Fatih Birol, as saying:

“Investment in oil exploration and production across the world has been cut to the bone, falling 24% last year and an estimated 17% this year. This is… far below the minimum levels needed to keep up with future demand. …

It is easy for consumers to be lulled into complacency by ample stocks and low prices today, but they should heed the writing on the wall: the historic investment cuts raise the odds of unpleasant oil security surprises in the not too distant future.”

And in the Overview of the IEA’s 2016 Medium-Term Oil Market Report, it is stated that

In today’s oil market there is hardly any spare production capacity other than in Saudi Arabia and Iran and significant investment is required just to maintain existing production before we move on to provide the new capacity needed to meet rising oil demand. The risk of a sharp oil price rise towards the later part of our forecast arising from insufficient investment is as potentially de-stabilising as the sharp oil price fall has proved to be.

The higher-cost conventional producers, such as Venezuela, Nigeria, Angola, Russia and off-shore producers, could take a long time to rebuild capacity as investment in conventional wells is costly, especially off-shore.

As far as shale oil producers is concerned – the prime target of Saudi Arabia’s policy of not cutting back supply – production could well bounce back after a relatively short time as wells are re-opened and investment in new wells is resumed.

But, price rises in the medium term could then be followed by lower prices again a year or two thereafter as oil from new investment comes on stream: or they could continue rising if investment is insufficient. It depends on the overall balance of demand and supply. The table shows the IEA’s forecast of production and consumption and the effect on oil stocks. From 2018, it is predicting that consumption will exceed production and that, therefore, stocks will fall – and at an accelerating rate.

But just what happens to the balance of production and consumption will also depend on expectations. If shale oil investors believe that an oil price bounce is temporary, they are likely to hold off investing. But this will, in turn, help to sustain a price bounce, which in turn, could help to encourage investment. So expectations of investors will depend on what other investors expect to happen – a very difficult outcome to predict. It’s a form of Keynesian beauty contest (see the blog post A stock market beauty contest of the machines) where what is important is what other people think will happen, which in turn depends on what they think other people will do, and so on.

Webcast

At $30 oil price, shale rebound may take much, much longer CNBC, Patti Domm , Bob Iaccino, Helima Croft and Matt Smith (25/2/16)

Article

Opec has failed to stop US shale revolution admits energy watchdog The Telegraph, Ambrose Evans-Pritchard (27/2/16)

Report

Medium-term Oil Market Report 2016: Overview International Energy Agency (IEA) (22/2/16)

Questions

  1. Using demand and supply diagrams, demonstrate (a) what happened to oil prices in 2015; (b) what is likely to happen to them in 2016; (c) what is likely to happen to them in 2017/18.
  2. Why have oil prices fallen so much over the past 12 months?
  3. Using aggregate demand and supply analysis, demonstrate the effect of lower oil prices on a national economy.
  4. What have have been the advantages and disadvantages of lower oil prices? In your answer, distinguish between the effects on different people, countries and the world generally.
  5. Why is oil supply more price elastic in the long run than in the short run?
  6. Why does supply elasticity vary between different types of oil fields (a) in the short run; (b) in the long run?
  7. What determines whether speculation about future oil prices is likely to be stabilising or destabilising?
  8. What role has OPEC played in determining the oil price over the past few months? What role can it play over the coming years?
  9. Explain the concept of a ‘Keynesian beauty contest’ in the context of speculation about future oil prices, and why this makes the prediction of future oil prices more difficult.
  10. Give some other examples of human behaviour which is in the form of a Keynesian beauty contest.
  11. Why may playing a Keynesian beauty contest lead to an undesirable Nash equilibrium?
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Venezuela: policies to save the economy?

In the UK, petrol prices have fallen significantly over the past couple of years and currently stand in some places at below £1 per litre. For UK residents, this price is seen as being cheap, but if we compare it to prices in Venezuela, we get quite a different picture. Prices are increasing here for the first time in 20 years from $0.01 per litre to $0.60 per litre – around 40 pence, while lower grade petrol increases to $0.10 per litre.

Venezuela has oil fields in abundance, but has not used this natural resource to its full potential to bolster the struggling economy. The price of petrol has been heavily subsidised for decades and the removal of this subsidy is expected to save around $800 million per year.

This will be important for the economy, given its poor economic growth, high inflation and shortages of some basic products. Venezuela relies on oil as the main component of its export revenues and so it has been hit very badly, by such low oil prices. The money from this reduced subsidy will be used to help social programmes across the country, which over time should help the economy.

In addition to this reduced subsidy on petrol prices, Venezuela’s President has also taken steps to devalue the exchange rate. This will help to boost the economy’s competitiveness and so is another policy being implemented to help the economy. However, some analysts have said that these changes don’t go far enough, calling them ‘small steps’, ‘nowhere near what is required’ and ‘late and insufficient’. The following articles consider the Venezuelan crisis and policies.

Venezuela raises petrol price for first time in 20 years BBC News (18/02/16)
Venezuela president raises fuel price by 6,000% and devalues bolivar to tackle crisis The Guardian, Sibylla Brodzinsky (18/02/16)
Venezuela’s Maduro devalues currency and raises gasoline prices Financial Times, Andres Schipani (18/02/16)
Venezuela hikes gasoline price for first time in 20 years The Economic Times (18/02/16)
Venezuela hikes fuel prices by 6000%, devalues currency to tackle economic crisis International Business Times, Avaneesh Pandey (18/02/16)
Market dislikes Venezuela reforms but debt rallies again Reuters (18/02/16)

Questions

  1. Why are oil prices so important for the Venezuelan economy?
  2. How will they affect the country’s export revenues and hence aggregate demand?
  3. Inflation in Venezuela has been very high recently. What is the cause of such high inflation? Illustrate this using an aggregate demand/aggregate supply diagram.
  4. How will a devaluation of the currency help Venezuela? How does this differ from a depreciation?
  5. Petrol prices have been subsidised in Venezuela for 20 years. Show how this government subsidy has affected petrol prices. Now that this subsidy is being reduced, how will this affect prices – show this on your diagram.
  6. Why are many analysts suggesting that these policies are insufficient to help the Venezuelan economy?
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The Leicester effect: the impact on the preparedness to pay to watch the EPL

Saturday night was a happy one. I had got back from the Kingpower Stadium after watching my beloved Leicester City win and climb back to the top of the English Premier League. It does not get much better than this. My levels of satisfaction are off the scale, at least for now. There is an economics angle here: what affects the level of satisfaction people derive from watching live sport, such as football matches? Satisfaction affects peoples’ preparedness to pay. Understanding this is invaluable to all organisations, including football clubs. Is the Leicester effect good for football?

Economists refer to the satisfaction from consuming something as utility. Understanding how supporters like myself derive utility is vital to the success of football clubs and the industry as a whole. It may, for example, help clubs better understand how to price match tickets or club merchandise and better inform important decisions about the structure of leagues and cup competitions.

According to the BBC Price of Football Survey 2015 there appears to be a high preparedness to pay to watch live football. The report shows that the cheapest season ticket at Arsenal for 2015/16 is £1,014, at Tottenham £765 and at Chelsea £750. You could have bought a Leicester season ticket for just £365. Meanwhile the cheapest match day ticket at Arsenal is £27, at Tottenham £32 and at Chelsea £52. The cheapest match day price at Leicester is £22.

So why can football clubs charge what appear to be such high prices? An important part of the story is considering what influences how much fans are willing to pay. Supporting a club for those like me involves an enormous emotional attachment. I derive a lot of my satisfaction from supporting my home-town team. Supporting another club is not alternative. No substitutes will do: it has to be Leicester. The greater the number of people like me, the higher we can expect, other things being equal, prices to be.

Of course, not everyone is like me. Leicester shirts are seen fairly infrequently outside of Leicester and even as I walk through my home city I am likely to see folks adorned, for example, with Arsenal, Chelsea, Liverpool or Man United shirts. Furthermore, most teams have a section of fans whose interest may wane if the team starts losing and dropping down the league. The responsiveness of match-day attendance to the winning percentage of a team is referred to by economists as the win elasticity of demand. The figure is expected to be positive because if a team’s win percentage improves its match-day attendance should increase.

For some supporters who are considering purchasing match-day tickets the issue may simply be who the two teams playing are. This helps to explain why prices for local derbies tend to be higher. It might also be the case that some matches allow supporters to see particular ‘superstars’. More generally, a rise in the quality of player on show will increase the preparedness to pay.

Another factor that can affect preparedness to pay is the perceived closeness of the contest. Many fans gain particular pleasure from watching their club win a game where they believe the two teams are evenly matched: i.e. where the outcome is very unpredictable. This idea is referred to by economists as the uncertainty of outcome.

As well as the uncertainty of the match outcome, interest and preparedness to pay may be affected by intra-seasonal uncertainty. This is highly pertinent in the English Premier League given ‘the Leicester effect’. Longer term, inter-seasonal uncertainty may also be important. If leagues such as the EPL become less predictable then this may further increase interest among fans.

Of course, the benefits from increased uncertainty may not be evenly felt. While this is probably good for the total preparedness to pay across a league like the EPL – and for the rights to broadcast the league – some clubs might have to adapt should interest in them begin to wane.

Article

Price of football: full results 2015 BBC News (24/10/2015)

Questions

  1. Draw up a list of the characteristics of watching live sport from which people derive utility (satisfaction).
  2. How might we measure the predictability of leagues like the English Premier League (EPL)?
  3. How might an increase in the unpredictability of EPL results affect the preparedness to pay to watch EPL matches?
  4. Is it in the long-term interest of all clubs for total points collected in the EPL to be less concentrated?
  5. What is a superstar effect? How would this affect preparedness to pay to watch live sport?
  6. Analyse what you consider to be the relative importance of the superstar effect and the uncertainty of results in affecting preparedness to pay to watch live football or other sporting events.
  7. Can we describe football clubs as ‘brands’? How does the nature of a brand affect our preparedness to pay for its products and services?
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£1 per litre

The price of petrol is of interest to most families, occupying a key component of weekly expenditure. Over the past decade, it has fluctuated significantly, from around 85p per litre to over £1.40. More recently, prices have been around £1.03 to £1.10, depending on the brand and the location. But, will we see prices falling below that magical £1 per litre mark?

We have recently seen a 2p drop in wholesale fuel prices and it is this which has led to speculation about a further fall in prices at petrol stations to below £1. This, according to the RAC, has a ‘very good chance’ of happening.

A key determinant of petrol prices is the market price for crude oil and it is this which has been contributing towards the low petrol prices. As these prices filter through to the pumps, the RAC suggests that prices may once again come down. Furthermore, with some of the key petrol stations being operated by the big supermarkets, competition for sales and hence on prices may be fierce.

But, now let’s consider another well-informed organisation. According to the AA, the chances of petrol prices falling below £1 are ‘remote’. So, who should we believe? In fact, we can probably believe both. The market price may not fall below £1, but in the run-up to Christmas and in the start of the New Year, we may well see petrol on sale for under £1 as a means to entice shoppers or, as the AA has said, as a ‘marketing gimmick’. As you can see from the picture, Asda has dropped the price below £1 per litre in some of its petrol stations.

You might think this is a little strange, given the inelastic nature of the demand for petrol: after all, as prices of petrol rise and fall, I for one, don’t change my demand. This is also confirmed by HMRC, which reports that total petrol consumption is falling despite the low prices. But, it’s probably less about changing your total demand for petrol and more about from where you buy that total demand. For any one petrol station, the demand may be relatively elastic. It is this which may fuel a price war on petrol. The following articles consider this.

£1 per litre petrol? It’s unlikely The Telegraph, Rozina Sabur (20/11/15)
‘Good chance’ of £1 per litre petrol, says RAC BBC News (20/11/15)
Petrol prices ‘could fall below £1 per litre’ ITV News (20/11/15)
Fuel Prices: ‘Good chance’ of £1 a litre Sky News (20/11/15)

Questions

  1. What are they demand-side and supply-side factors which have helped to cut the price of petrol? Use a diagram to illustrate your answer.
  2. How much of a role has OPEC played in keeping petrol prices down in the UK?
  3. Why is the demand for petrol price inelastic?
  4. HMRC suggests that despite low prices, the demand for petrol has been falling. Does this suggest that the demand curve for petrol is upward sloping? Explain your answer.
  5. If the demand for petrol is falling, can this tell car companies anything about the future demand for vehicles? Which concepts are important here?
  6. If petrol prices do not fall to reflect falling oil prices, what does this suggest about the profit margins on petrol? Should government intervene?