Category: Essential Economics for Business: Ch 07

The USA has seen many horizontal mergers in recent years. This has turned industries that were once relatively competitive into oligopolies, resulting in lower output and higher prices for consumers.

In Europe, by contrast, many markets are becoming more competitive. The result is that in industries such as mobile phone services, airlines and broadband provision, prices are considerably lower in most European countries than in the USA. As the French economist, Thomas Philippon, states in a Guardian article:

When I landed in Boston in 1999, the United States was the land of free markets. Many goods and services were cheaper than in Europe. Twenty years later, American free markets are becoming a myth.

According to Asher Schechter (see linked article below):

Nearly every American industry has experienced an increase in concentration in the last two decades, to the point where … sectors dominated by two or three firms are not the exception, but the rule.

The result has been an increase in deadweight loss, which, according to research by Bruno Pelligrino, now amounts to some 13.3 per cent of total potential surplus.

Philippon in his research estimates that monopolies and oligopolies “cost the median American household about $300 a month” and deprive “American workers of about $1.25tn of labour income every year”.

One industry considered by the final two linked articles below is housebuilding. Since the US housing and financial crash of 2007–8 many US housebuilders have gone out of business. This has meant that the surviving companies have greater market power. According to Andrew van Dam in the linked Washington Post article below:

They have since built on that advantage, consolidating until many markets are controlled by just a few builders. Their power has exacerbated the country’s affordable-housing crisis, some economists say.

According to research by Luis Quintero and Jacob Cosman:

… this dwindling competition has cost the country approximately 150 000 additional homes a year – all else being equal. With fewer competitors, builders are under less pressure to beat out rival projects, and can time their efforts so that they produce fewer homes while charging higher prices.

Thanks to lobbying of regulators and politicians by businesses and various unfair, but just about legal, practices to exclude rivals, competition policy in the USA has been weak.

In the EU, by contrast, the competition authorities have been more active and tougher. For example, in the airline industry, EU regulators have “encouraged the entry of low-cost competitors by making sure they could get access to takeoff and landing slots.” Politicians from individual EU countries have generally favoured tough EU-wide competition policy to prevent companies from other member states getting an unfair advantage over their own country’s companies.

Articles

Questions

  1. What are the possible advantages and disadvantages of oligopoly compared with markets with many competitors?
  2. How can concentration in an industry be measured?
  3. Why have US markets become more concentrated?
  4. Why have markets in the EU generally become more competitive?
  5. Find out what has happened to levels of concentration in the UK housebuilding market.
  6. What are the possible effects of Brexit on concentration and competition policy in the UK?

When did you last think about buying a new car? If not recently, then you may be in for a surprise next time you shop around for car deals. First, you will realise that the range of hybrid cars (i.e. cars that combine conventional combustion and electric engines) has widened significantly. The days when you only had a choice of Toyota Prius and another two or three hybrids are long gone! A quick search on the web returned 10 different models (although five of them belong to the Toyota Prius family), including Chevrolet Malibu, VW Jetta and Ford Fusion. And these are only the cars that are currently available in the UK market.

But the biggest surprise of all may be the number of purely (plug-) electric cars that are available to UK buyers these days. The table below provides a summary of total registrations of light-duty plug-electric cars by model in the UK, between 2010 and June 2016.

Registration of light-duty highway legal plug-electric cars by model in the UK between 2010 and June 2016

Model

Total registered at the end of(1)

Registrations by year between 2010 and December 2013

2Q 2016

2015

2014

2013

2012

2011

2010

Mitsubishi Outlander P-HEV

21 708

16 100

5 273

 

 

 

 

Nissan Leaf

12 837

11 219

6 838

1 812

699

635

 

BMW i3

4 457

3 574

1 534

NA

 

 

 

Renault Zoe

4 339

3 327

1 356

378

 

 

 

Mercedes-Benz C350 e

3 337

628

0

 

 

 

 

Tesla Model S

3 312

2 087

698

 

 

 

 

Volkswagen Golf GTE

2 657

1 359

0

 

 

 

 

Toyota Prius PHV

1 655

1 580

1 324

509

470

 

 

Audi A3 e-tron

1 634

1 218

66

 

 

 

 

Nissan e-NV200

1 487

1 047

399

 

 

 

 

BMW 330e iPerformance

1 479

 

 

 

 

 

 

BMW i8

1 307

1 022

279

 

 

 

 

Vauxhall Ampera

1 267

1 272

1 169

175

455

4

 

Volvo XC90 T8

813

38

 

 

 

 

 

Renault Kangoo Z.E

785

740

663

 

 

 

 

Porsche Panamera S E-Hybrid

475

395

241

 

 

 

 

Volvo V60 Plug-in Hybrid

410

337

232

 

 

 

 

Peugeot iOn

405

374

368

26(2)

251

124

 

Mercedes-Benz B-Class Electric Drive

303

162

0

 

 

 

 

Mitsubishi i MiEV

252

251

266

1(2)

107

125

27

Smart electric drive

215

212

205

3(2)

13

 

63

Citroën C-Zero

213

167

202

45(2)

110

46

 

Kia Soul EV

193

145

20

 

 

 

 

BMW 225xe

163

 

 

 

 

 

 

Volkswagen e-Up!

154

142

118

 

 

 

 

Mercedes-Benz S500 PHEV

125

157

14

 

 

 

 

Volkswagen e-Golf

123

114

47

 

 

 

 

Chevrolet Volt

119

122

124

23(2)

67

 

 

Renault Fluence Z.E.

79

70

73

7(2)

67

 

 

Ford Focus Electric

22

19

19

 

 

 

 

Mercedes-Benz Vito E-Cell

22

23

23

 

 

 

 

Mia electric

15

15

14

 

 

 

 

Volkswagen Passat GTE

1

 

 

 

 

 

 

BYD e6

0

0

0

50(2)

 

 

 

Total registrations

66 374

47 920

21 504

3 586

2 254

1 082

138

Notes: NA: not available. Registrations figures seldom correspond to same sales figure.

(1) Registrations at the end of a period are cumulative figures. (2) CYTD through June 2013.

Source: Wikipedia, “Plug-in electric vehicles in the United Kingdom”

In 2010 there were nly 138 electric vehicles in total registered in the UK. They were indeed an unusual sight at that time – and good luck to you if you had one and you happened to run out of power in the middle of a journey. In 2011 this (small) number increased sevenfold – an increase that was driven mostly by the successful introduction of Nissan Leaf (635 electric Nissans were registered in the UK that year). And since then the number of electric vehicles registered in the country has increased with spectacular speed, at an average rate of 252% per year.

There is clearly strong interest in electric vehicles – an interest likely to increase as their price becomes more competitive. However, they are still very expensive items to buy, especially when compared with their conventional fuel-engine counterparts. What makes electric cars expensive? One thing is the cost of purchasing and maintaining a battery that can deliver a reasonable range. But the cost of batteries is falling, as more and more companies realise the potential of this new market and join the R&D race. As mentioned in a special report that was published recently in the FT:

The cost of lithium-ion batteries has fallen by 75 per cent over the past eight years, measured per kilowatt hour of output. Every time battery production doubles, costs fall by another 5 per cent to 8 per cent, according to analysts at Wood Mackenzie.

There is no doubt that more research will result in more efficient batteries, and will increase the interest in electric cars not only by consumers but also by producers, who already see the opportunity of this new global market. Does this mean that prices will necessarily fall further? You might think so, but then you have to take into consideration the availability and cost of mining further raw materials to make these batteries (such as cobalt, which is one of the materials used in the making of lithium-ion batteries and nearly half of which is currently sourced from the Democratic Republic of Congo). This may lead to bottlenecks in the production of new battery units. In which case, the price of batteries (and, by extension, the price of electric cars) may not fall much further until some new innovation happens that changes either the material or its efficiency.

The good news is that a lot of researchers are currently looking into these questions, and innovation will do what it always does: give solutions to problems that previously appeared insurmountable. They had better be fast because, according to estimates by Wood Mackenzie, the number of electric vehicles globally is expected to rise by over 50 times – from 2 million (in 2017) to over 125 million by 2035.

How many economists does it take to charge an electric car? I guess we are going to find out!

Articles

Information

Questions

  1. Using a demand and supply diagram, explain the relationship between the price of a battery and the market (equilibrium) price of a plug-in electric vehicle.
  2. List all non-price factors that influence demand for plug-in electric vehicles. Briefly explain each.
  3. Should the government subsidise the development and production of electric car batteries? Explain the advantages and disadvantages of such intervention and take a position.

We are coming into the big spending season, with Black Friday, Cyber Monday, the run-up to Christmas and then the winter sales. So will we all be rational maximisers and weigh up the utility we expect to receive from items against the price we pay (plus any other cost, such as time spent searching/shopping)? Or will we use a set of heuristics which make life easier and that we have found to be useful in helping us choose – heuristics such as buying things we’ve liked before, or going for things on special offer?

The answer is that we do probably use a set of heuristics, at least for many items. And don’t the retailers and the marketing firms they employ know this!

They will use all sorts of tricks of the trade to persuade us to part with our money. These tricks are designed to nudge us (or push us), without us feeling manipulated or conned – at least until we’ve bought their product.

And the tricks are getting more sophisticated. They include special offers which are not as good as they seem, time-limited offers which stimulate us to buy quickly without carefully thinking about what we’re doing, cunning positioning of products in shops to encourage us to buy things we had not planned to buy, adverts which play to our idealised perceptions or the ‘good life’ or what we would like to achieve, and packaging or display which make the product seem better than it is.

Also we are increasingly faced with targeted advertising where our smart devices capture information about our spending habits and tastes through our previous online spending or our search behaviour. This is then fed to advertisers to tailor adverts specifically to us on our mobiles, tablets, laptops and even, soon, on our smart TVs.

We may have a general desire to maximise utility from our spending, but market failures, such as consumers having imperfect information about products and a present bias (see also) in decision making, make us easy targets for the advertising and marketing industry. They understand the heuristics we use and try to take maximum advantage of them.

Happy shopping!

Articles

How shops use tricks to get you spending The Conversation, Cathrine Jansson-Boyd (16/11/17)
ColourPop looks to Qubit for next-gen personalization guidance Retail Dive, Dan O’Shea (13/6/17)
Channel 4 to offer 100% ad targeting across All 4 platform, seeking partners for linear equivalent The Drum, Jessica Goodfellow (14/11/17)
How Google aims to bring TV advertising into the 21st century The Drum, Ronan Shields (19/10/17)
How to Use Heuristics to Your Marketing Advantage MarketingProfs, Cam Secore (12/11/15)

Questions

  1. Does the use of heuristics contradict the assumption that consumers behave rationally?
  2. Give some examples of heuristics that you yourself use.
  3. Other than those identified above and in the first article, what ‘tricks’ might companies play on you to persuade you to buy their products?
  4. Is advertising personally targeted to individual consumers desirable for them?
  5. Give some examples of present bias in people’s behaviour.
  6. What factors should a retailer take into account when deciding whether to make pre-Christmas discounts?
  7. Explain what is meant by ‘affect heuristic’ and how the advertising industry uses the concept in setting the background to or scenario of an advertisement.
  8. Have you ever been persuaded into buying something you didn’t want? Why were you persuaded?

The Competition and Markets Authority (CMA) has imposed a record fine of £84m on the American pharmaceutical manufacturing company Pfizer and of £5.2m on its UK distributor, Flynn Pharma. The CMA found that the companies charged unfair prices to the NHS for phenytoin sodium capsules, the anti-epilepsy drug.

The price was previously regulated, but Pfizer deliberately de-branded the drug in September 2012 and immediately raised the price to Flynn Pharma by between 780% and 1600%, which, in turn, raised the price to the NHS by nearly 2600%. This made the drug many times more expensive than in any other European country.

The cost to the NHS rose from around £2m per year to around £50m in 2013. Although other generic drugs are available, there would be serious health risks to patients forced to switch drugs. The NHS thus had no alternative to paying the higher price.

Pfizer claimed that the drug was loss-making before it was de-branded. However, the CMA calculated that this did not justify the size of the price increase; that the higher price enabled Pfizer to recover all these claimed losses within just two months.

The usual practice is for pharmaceutical companies to charge high prices for new drugs for a period of time to enable them to recover high research and development costs. Later, the drugs become available as generic drugs that other manufacturers can produce. The price then normally falls dramatically.

Phenytoin sodium was invented many years ago and there has been no recent innovation and no significant investment. But, unlike with many other drugs, there has been no switching by the NHS because of possible dangers to patients. This has given Pfizer and its distributor considerable market power. As the CMA states in its press release:

Epilepsy patients who are already taking phenytoin sodium capsules should not usually be switched to other products, including another manufacturer’s version of the product, due to the risk of loss of seizure control which can have serious health consequences. As a result, the NHS had no alternative to paying the increased prices for the drug.

In conclusion, the CMA found that “both companies have held a dominant position in their respective markets for the manufacture and supply of phenytoin sodium capsules and each has abused that dominant position by charging excessive and unfair prices”.

Articles

Pfizer fined record £84.2m for overcharging NHS 2600% Independent, Zlata Rodionova (7/12/16)
Pfizer fined record £84.2m over NHS overcharging The Guardian, Angela Monaghan (7/12/16)
CMA fines drug firms £90m for over-charging NHS nhe (7/12/16)
Pfizer hit with record fine after hiking price of NHS epilepsy drug by 2,600pc – costing taxpayer millions The Telegraph (7/12/16)
Pfizer, Flynn Get Record Fine on 2,600% Drug Price Increase Bloomberg, Patrick Gower (7/12/16)

CMA publications
Phenytoin sodium capsules: suspected unfair pricing Competition and Markets Authority: Case reference: CE/9742-13, Competition and Markets Authority cases (updated 7/12/16)
CMA fines Pfizer and Flynn £90 million for drug price hike to NHS CMA Press Release (7/12/16)

Questions

  1. What are the arguments for drug companies being allowed to charge high prices for new drugs?
  2. How long should these high prices persist?
  3. Sketch a diagram to illustrate Pfizer’s price for its anti-epilepsy drug before and after it was de-branded. Illustrate the effect on Pfizer’s profits from the drug.
  4. What determines the price elasticity of demand for (a) a drug which is branded and unique; (b) a drug produced by a specific producer but which is generic and can be produced by a number of producers; (c) a generic drug produced by many producers?
  5. How should a regulator like the CMA decide what price a firm with market power should be allowed to charge?
  6. Under what legislation did the CMA fine Pfizer and Flynn Pharma? What is the upper limit to the fine it is able to impose? Did it impose the maximum fine on Pfizer?

Short-termism is a problem which has dogged British firms and is part of the explanation of low investment in the UK. Shareholders, many of which are large pension funds and other financial institutions, are more concerned with short-term returns than long-term growth and productivity. Likewise, senior managers’ rewards are often linked to short-term performance rather than the long-term health of the company.

But the stakeholders in companies extend well beyond owners and senior managers. Workers, consumers, suppliers, local residents and the country as a whole are all stakeholders in companies.

So is the current model of capitalism fit for purpose? According to the new May government, workers and consumers should be represented on the boards of major British companies. The Personnel Today article quotes Theresa May as saying:

‘The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough.

We’re going to change that system – and we’re going to have not just consumers represented on company boards, but workers as well.’

This model is not new. Many countries, such as France and Germany, have had worker representatives on boards for many years. There the focus is often less on short-term profit maximisation and more on the long-term performance of the company in terms of a range of indicators.

Extending this model to stakeholder groups more generally could see companies taking broader social objectives into account. And the number of companies which put corporate social responsibility high on their agenda could increase significantly.

And this approach can ultimately bring better returns to shareholders. As the first The Conversation article below states:

This is something that research into a ‘Relational Company’ model has found – by putting the interests of all stakeholders at the heart of their decision making, companies can become more competitive, stable and successful. Ultimately, this will generate greater returns for shareholders.

While CSR has become mainstream in terms of the public face of some large corporations, it has tended to be one of the first things to be cut when economic growth weakens. The findings from Business in the Community’s 2016 Corporate Responsibility Index suggest that many firms are considering how corporate responsibility can positively affect profits. However, it remains the case that there are still many firms and consumers that care relatively little about the social or natural environment. Indeed, each year, fewer companies take part in the CR Index. In 2016 there were 43 firms; in 2015, 68 firms; in 2014, 97 firms; in 2013, 126 firms.

In addition to promising to give greater voice to stakeholder groups, Mrs May has also said that she intends to curb executive pay. Shareholders will be given binding powers to block executive remuneration packages. But whether shareholders are best placed to do this questionable. If shareholders’ interests are the short-term returns on their investment, then they may well approve of linking executive remuneration to short-term returns rather than on the long-term health of the company or its role in society more generally.

When leaders come to power, they often make promises that are never fulfilled. Time will tell whether the new government will make radical changes to capitalism in the UK or whether a move to greater stakeholder power will remain merely an aspiration.

Articles

Will Theresa May break from Thatcherism and transform business? The Conversation, Arad Reisberg (19/7/16)
Democratise companies to rein in excessive banker bonuses The Conversation, Prem Sikka (14/3/16)
Theresa May promises worker representatives on boards Personnel Today, Rob Moss (11/7/16)
If Theresa May is serious about inequality she’ll ditch Osbornomics The Guardian, Mariana Mazzucato and Michael Jacobs (19/7/16)
Theresa May should beware of imitating the German model Financial Times, Ursula Weidenfeld (12/7/16)

Questions

  1. To what extent is the pursuit of maximum short-term profits in the interests of (a) shareholders; (b) consumers; (c) workers; (d) suppliers; (e) society generally; (f) the environment?
  2. How could British industry be restructured so as to encourage a greater proportion of GDP being devoted to investment?
  3. How would greater flexibility in labour markets affect the perspectives on company performance of worker representatives on boards?
  4. How does worker representation in capitalism work in Germany? What are the advantages and disadvantages of this model? (See the panel in the Personnel Today article and the Financial Times article.)
  5. What do you understand by ‘industrial policy’? How can it be used to increase investment, productivity, growth and the pursuit of broader stakeholder interests?