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?
Since the beginning of 2009, central banks around the world have operated an extremely loose monetary policy. Their interest rates have been close to zero (click here for a PowerPoint of the chart) and more than $20 trillion of extra money has been injected into the world economy through various programmes of quantitative easing.
The most recent example of loose monetary policy has been in Japan, where substantial quantitative easing has been the first of Japan’s three arrows to revive the economy (the other two being fiscal policy and supply-side policy).
One consequence of a rise in money supply has been the purchase of a range of financial assets, including shares, bonds and commodities. As a result, despite the sluggish or negative growth in most developed countries, stock markets have soared (see chart). From March 2009 to May 2013, the FTSE 100 rose by 91% and both the USA’s Dow Jones Industrial average and Germany’s DAX rose by 129%. Japan’s NIKKEI 225, while changing little from 2009 to 2012, rose by 78% from November 2012 to May 2013 (click here for a PowerPoint of the chart).
The US economy has been showing stronger growth in recent months and, as a result, the Fed has indicated that it may soon have to begin tightening monetary policy. It is not doing so yet, nor are other central banks, but the concern that this may happen in the medium term has been enough to persuade many investors that stock markets are likely to fall as money eventually becomes tighter. Given the high degree of speculation on stock markets, this has led to a large-scale selling of shares as investors try to ‘get ahead of the curve’.
From mid-May to mid-June, the FTSE 100 fell by 6.2%, the Dow Jones by 2.6%, the DAX by 4.5% and the NIKKEI by 15%. In some developing countries, the falls have been steeper as the cheap money that entered their economies in search of higher returns has been leaving. The falls in their stock markets have been accompanied by falls in their exchange rates.
The core of the problem is that most of the extra money that was created by central banks has been used for asset purchase, rather than in financing extra consumer expenditure or capital investment. If money is tightened, it is possible that not only will stock and bond markets fall, but the fragile recovery may be stifled. In other words, tighter money and higher interest rates may indeed affect the real economy, even though loose monetary policy and record low interest rates had only a very modest effect on the real economy.
This poses a very difficult question for central banks. If even the possibility of monetary tightening some time in the future has spooked markets and may rebound on the real economy, does that compel central banks to maintain their loose policy? If it does, will this create an even bigger adjustment problem in the future? Or could there be a ‘soft landing’, whereby real growth absorbs the extra money and gradually eases the inflationary pressure on asset markets?
Articles
How the Fed bosses all BBC News, Robert Peston (12/6/13)
The great reversal? Is the era of cheap money ending? BBC News, Linda Yueh (12/6/13)
The Great Reversal: Part II (volatility and the real economy) BBC News, Linda Yueh (14/6/13)
The end of the affair The Economist (15/6/13)
Out of favour The Economist, Buttonwood (8/6/13)
The Federal Reserve: Clearer, but less cuddly The Economist (22/6/13)
Global financial markets anxious to avoid many pitfalls of ‘political risk’ The Guardian, Heather Stewart (13/6/13)
Dow Falls Below 15,000; Retailers Add to Slump New York Times, (12/6/13)
Global market sell-off over stimulus fears The Telegraph, Rachel Cooper (13/6/13)
Nikkei sinks over 800 points, falls into bear market Globe and Mail (Canada), Lisa Twaronite (13/6/13)
Global shares drop, dollar slumps as rout gathers pace Reuters, Marc Jones (13/6/13)
The G8, the bond bubble and emerging threats BBC News, Stephanie Flanders (17/6/13)
Global monetary policy and the Fed: vive la difference BBC News, Stephanie Flanders (20/6/13)
The Federal Reserve’s dysfunctional relationship with the markets The Guardian, Heidi Moore (19/6/13)
Global stock markets in steep falls after Fed comment BBC News (20/6/13)
Federal Reserve’s QE withdrawal could signal real trouble ahead The Guardian, Nils Pratley (20/6/13)
Central banks told to head for exit Financial Times, Claire Jones (23/6/13)
Stimulating growth threatens stability, central banks warn The Guardian (23/6/13)
BIS Press Release and Report
Making the most of borrowed time: repair and reform the only way to growth, says BIS in 83rd Annual Report BIS Press Release (23/6/13)
83rd BIS Annual Report 2012/2013 Bank for International Settlements (23/6/13)
Data
Yahoo! Finance: see links for FTSE 100, DAX, Dow Jones, NIKKEI 225
Link to central bank websites Bank for International Settlements
Statistical Interactive Database – Interest & exchange rates data Bank of England
Questions
- Why have stock markets soared in recent years despite the lack of economic growth?
- What is meant by ‘overshooting’? Has overshooting taken place in stock markets (a) up to mid-May this year; (b) since mid-May? How would you establish whether overshooting has taken place?
- What role is speculation currently playing in stock markets? Would you describe this speculation as destabilising?
- What has been the impact of quantitative easing on (a) bond prices; (b) bond yields?
- Argue the case for and against central banks continuing with the policy of quantitative easing for the time being.
- Find out how much the Indian rupee and the Brazilian real have fallen in recent weeks. Explain your findings.
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?
How important are emotions when you go shopping? Many people go shopping when they ‘need’ to buy something, whether it be a new outfit, food/drink, a new DVD release, a gift, etc. Others, of course, simply go window shopping, often with no intention of buying. However, everyone at some point has made a so-called ‘impulse’ purchase.
There is only one article below, which is from the BBC and draws on data released from the National Employment Savings Trust’s survey. This report suggests that British people spend over £1 billion every year on impulse buys – purchases that are not needed, were not intended and are often regretted once the ‘high’ has worn off. Often, it is the way in which a product is advertised or positioned that leads to a spontaneous purchase – seeing chocolate bars/sweets at the tills; a product offered at a huge discount advertised in the window of a shop; 2 for 1 purchases; points for loyalty etc. All of these and more are simple techniques used by retailers to encourage the impulse buy. As consumer psychologist, Dr. James Intriligator says:
Retailers have clever ways of manipulating customers to spend more but if you stick to your plans you can avoid being affected by their tactics.
In other cases, it’s simply the frame of mind of the consumer that can lead to such purchases, such as being hungry when you’re food shopping or having an event to attend the next day and deciding to go window shopping, despite already having something to wear! Dr. Intriligator continues, saying:
Your ability to resist and make rational choices is diminished when your glucose levels are down … When you get irrational, you fall back on trusted brands, which often leads you to spend more money … Later in the shop, you’re more tired and less likely to resist [impulse buys]
But are such purchases irrational? One of the key assumptions made by economists (at least in traditional economics) is that consumers are rational. This implies that consumers weigh up marginal costs and benefits when making a decision, such as deciding whether or not to purchase a product. But, do impulse buys move away from this rational consumer approach? Is buying something because it makes you happy in the short term a rational decision? Behavioural economics is a relatively new ‘branch’ of economics that takes a closer look at the decisions of consumers and what’s behind their behaviour. The following article from the BBC considers the impulse buy and leaves you to consider the question of irrational consumers.
Article
How to stop buying on impulse BBC Consumer (30/5/13)
Questions
- If the marginal benefit of purchasing a television outweighs the marginal cost, what is the rational response?
- Using the concept of marginal cost and benefit, illustrate them on a diagram and explain how equilibrium should be reached.
- What is behavioural economics?
- What are the key factors that can be used to explain impulse buys?
- How can framing help to explain irrational purchases?
- If a product is advertised at a significant discount, what figure for elasticity is it likely to have to encourage further purchases in-store?
- Is bulk-buying always a bad thing?
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?
