According to the supply and demand model, we would expect the price of turkeys to be high at this time of year. After all, last Christmas in the UK over 10 million turkeys were consumed and, therefore, this high level of demand should cause prices to rise. This is certainly what happens in other markets when there is a substantial increase in demand.
However, evidence from Thanksgiving in the USA suggests that this might not be the case. According to this article from the New York Times, data suggests that the price of frozen turkeys in the US falls by around 9% between October and November, coinciding with the substantial increase in demand for Thanksgiving celebrations. The article then goes on to suggest a number of plausible demand and supply-side explanations for this fall in price.
Turkey Economics 101: Why turkeys are so darn cheap this time of year Culinate (25/11/13)
Why Does Turkey Get Cheaper Around Thanksgiving? Slate, Matthew Yglesias (21/11/12)
Questions
- How elastic do you think the demand for turkeys will be at Christmas?
- What type of products are well suited to being used as loss-leaders?
- Which of the explanations for the increase in prices do you find most convincing?
- What evidence might be useful to distinguish between the different explanations?
There are a number of surveys that attempt to measure the spending intentions of people in the run up towards Christmas. For example a recent study carried out by YouGov found that people in the UK planned to spend an average of £599 on presents for their family and friends. This represented a 5.8% increase on the previous year. Planned total spending on Christmas was estimated to be a staggering £22 billion.
Respondents to another survey, carried out by the hotel chain Travelodge, stated that on average they planned to buy presents for 12 people. This study also found that the average expected spend on each present was £28.70 – an increase of £1.70 on the previous year. A rather obvious question for anyone interested in economics is whether this is either a sensible or an efficient way of allocating resources. One way to think about how an economist might approach this issue is to ask yourself the following questions after you have opened a present on Christmas day.
• How much money do you think the person who gave you the present paid for it?
• Ignoring the sentimental value, if you had not received this present how much would
you be willing to pay to purchase it?
Exactly 20 years ago the economist Joel Waldfogel posed questions very similar to these to a group of 86 students studying an intermediate microeconomics module at Yale University in the USA. On average the respondents to the questions estimated that friends and family had spent $438 on 
the gifts they had received that Christmas. Unfortunately their willingness to pay for these same gifts was $313 on average. Economists would argue that this is an example of economic inefficiency because the recipients’ valuation of the gifts – as measured by their willingness to pay – was only 71.5% of the price paid by the person who gave them the presents. This means that it is possible to make the person who received the gift better off without making the person who purchased the gift any worse off. This argument can be illustrated with a simple example.
Assume you have purchased a Liverpool football club shirt as a present for Sir Alex Ferguson and it cost you £50! Rather surprisingly Sir Alex likes the shirt but would have only been willing to pay £20 if he was buying it for himself. Imagine now that you have given him £50 cash instead of the shirt. This would not make you any worse off – your cash outlay would remain unchanged. However, Sir Alex would now be able to spend the £50 cash in a way which would give him far more satisfaction than the Liverpool football shirt would have given him. Sir Alex can therefore be made better off without making you worse off. The present in this example generates a deadweight welfare loss of £30. Waldfogel concluded from his later research based on a larger sample of people that, on average, people’s valuations of their presents is about 90% of the money actually spent on them. If this figure is accurate, it suggests that over £2 billion will be wasted in the UK this Christmas.
The size of the deadweight welfare loss depends on how well the person who is buying the present knows or understands the preferences of the recipient. The closeness of age, friendship or family relationship are all likely to influence the accuracy of this knowledge. Interestingly, Waldfogel found that presents from grandparents to grandchildren were the most inefficient: i.e. the difference between the recipient’s valuation of the gift and the price paid for the present was the greatest. The study also found that grandparents were more likely to give their grandchildren cash gifts.
Do economists always advise people to give cash as presents? Thankfully the dismal science can find some positive things to say about giving gifts. The previous analysis can be criticised in a number of different ways. It assumes that the recipients are perfectly informed about all the potential gifts that are available. If the person buying the present can find an item that the recipient was unaware of, then it is possible that economic welfare might be increased. It has also been assumed that the pleasure or value people obtain from an item is not influenced by who has purchased it. It may be the case that people place a greater value on an item when it is a gift from somebody else. In the previous example, perhaps Sir Alex would value the Liverpool shirt at £60 if you had purchased it for him as a present. The analysis has also ignored the possibility that the person buying the present derives pleasure from trying to find a gift that they think the person would like. Perhaps people feel a ‘warm glow’ when they see the happiness of somebody opening their present on Christmas day.
A final interesting economic explanation for buying presents is that they might act as an effective signal in a situation where there is asymmetric information. It can be argued that this is the case in relationships where people have private information about their true feelings towards one another. One way of communicating these feelings is by simply telling someone how you feel about them. However, this might not be an effective signal, as someone who does not have such strong feelings could say the same things as someone who does! However, by taking the time and trouble to buy someone a present that they really like, you are able to signal more effectively how you really feel about them. The signal can be particularly strong if the person buying the present really dislikes shopping. Just giving someone cash, or not taking the time to buy a present the person really likes, might signal that you simply could not be bothered to exert the effort because your feelings are not that strong. The potential consequences of giving your partner money are amusingly demonstrated in the following clip: The Economics of Seinfeld: What’s the right Gift to give; cash?
Perhaps giving presents instead of cash is an economically efficient way of dealing with situations where asymmetric information is potentially an important issue.
Articles
British households plan to spend £820 on Christmas YouGov (11/11/13)
Brits ‘to spend more on Christmas presents this year with average gift costing £28.70’ Daily Mirror (13/11/13)
Christmas shoppers hit the sales in biggest spending spree since the recession began Daily Express (15/12/13)
Bah, Humbug The Joy of Economics: Making Sense out of Life, Robert J. Stonebraker (22/05/13)
What many economists don’t understand about Christmas Quartz, Tim Fernholz (19/12/13)
The Economics of Gifts Greg Mankiw’s Blog (24/12/06)
The case against Christmas presents The Guardian (19/12/13)
Grinchonomics or how the Economist stole Christmas Economics in Plain English (16/12/10)
The true value of the 12 days of Christmas reveals giving cash may be the most cost-effective gift Perth Now, Jessica Irvine (21/12/13)
Questions
- Explain what is meant by the term ‘allocative efficiency’. Use a diagram to help illustrate and explain your answer.
- Draw an indifference curve diagram to illustrate the potential welfare costs of giving presents instead of cash.
- Assess whether giving someone a gift card is more economically efficient than giving them a present.
- Using a simple numerical example, explain how economic welfare could be higher if someone buys a present that the recipient was unaware of. What factors might you have to take into account when carrying out this economic analysis?
- Explain what is meant by the term ‘asymmetric information’. Provide a number of examples to help illustrate your answer.
- What properties must a signal have if it is to successfully overcome problems caused by asymmetric information?
Over the past few years lobster prices in Maine have tumbled. Eight years ago the price paid to fishermen was around $4.60 per pound. Today it’s around $2.20. The problem is one of booming lobster populations and the dominance of lobster in catches. Last year’s haul was double that of a decade ago and, in some waters, six times higher.
You would think that larger catches would be good news for fishermen. But prices now are so low that they barely cover variable costs. Individual fishermen fish harder and longer to bring in even bigger catches to make up for the lower price. This, of course, compounds the problem and pushes the price even lower.
So what are the answers for the fishermen of Maine? One solution is to diversify their catch, but with lobster so plentiful and other fish stocks depleted, this is not easy.
Another solution is to cooperate. The Reuters article below quotes John Jordan, a lobsterman and president of Calendar Islands Maine Lobster Co.:
‘If you had an industry that actually cooperated, you wouldn’t be bringing in more product if you couldn’t sell what you already had, right?’
Restricting the catch would require lobster distributors to cooperate and set quotas for what the fishermen would be permitted to sell. But with over 5000 fishermen, this is not easy.
Another solution is to expand the market. One way is for the distributors or other agencies to market lobster and lobster products more aggressively. For example, 
this year the State of Maine has established a $2 million marketing collaborative. Another solution is to find new markets.
Jordan’s company and others are frantically seeking new ways to sneak lobster into unexpected corners of the food market, from gazpacho to puff pastries and quiche.
In the meantime, for consumers the question is whether the low prices paid to the fishermen of Maine will feed through into low prices in the fishmonger, supermarket and restaurant. So far that does not seem to be happening, as the final two articles below explain.
Webcasts
US lobster fishermen’s ‘problem of plenty’ BBC News, Jonny Dymond (5/10/13)
Maine lobstermen in a pinch over low prices, record catch: Part 1, Part 2, Part 3 Aljazeera America, Adam May (11/10/13)
Articles
Something fishy is going on in the nation’s lobster capital CNBC, Heesun Wee (1/9/13)
Booming lobster population pinches profits for Maine’s fishery Reuters, Dave Sherwood (25/8/13)
Lobster’s worth shelling out for The Observer,
Rachel Cooke (21/9/13)
Clawback The New Yorker, James Surowiecki (26/8/13)
Why The Glut Of Cheap Lobster Won’t Lower Price Of Lobster Rolls Gothamist, John Del Signore (20/7/12)
Questions
- Why have lobster prices paid to fishermen fallen? Illustrate your argument with a demand and supply diagram
- What has determined the size of the fall in prices? What is the relevance of price elasticity of demand and price elasticity of supply to your answer?
- How is the fallacy of composition relevant to the effects on profits of an increase in the catch by (a) just one fisherman and (b) all fishermen? What incentive does this create for individual fishermen in a competitive market?
- What can lobster fishermen do to restore profit margins through collaborative action?
- In what ways is there a conflict between economics and ecology in the lobster fishing industry?
- How does stored lobster affect (a) the price elasticity of supply and (b) the price volatility of lobster?
- How could cooperation between lobster fishermen and lobster processors and distributors benefit all those involved in the cooperation?
- Why may restaurants choose to maintain high prices for lobster dishes for ‘psychological reasons’? Are there any other reasons?
A few weeks ago, Elizabeth wrote a blog on the payday loan industry and its referral by the OFT to the Competition Commission (see A payday inquiry). Now the Archbishop of Canterbury, Justin Welby, has joined the debate. He suggests that the problem of sky-high interest rates charged by payday loan companies would be tackled better by increased competition from elsewhere in the industry than by regulation.
In particular, he proposes an expansion of credit unions. These could provide a much cheaper alternative for people in financial difficulties who are seeking short-term loans. He would like church members with relevant skills to volunteer at credit unions and proposes setting up local credit unions operated from church buildings.
* * * * * * * * * *
In this news item we hand over to ‘Kostas Economides’, an imaginary lecturer in Economics at the imaginary ‘University of the South of England’. Kostas’s blog is written by Guy Judge. Guy recently retired from the University of Portsmouth, where he was Deputy Head of Department, and is now a Visiting Fellow.
In his blog, Kostas frequently reflects on various economic issues, as well as on life at USE. Here he recounts a conversation with his colleagues about Justin Welby’s proposals. They consider various implications of the proposals from an economist’s point of view.
Kostas’s blog
Pay day loans Guy’s Other Stuff, Guy Judge (30/7/13)
To provide some background to Kostas’s blog, you’ll see below the normal set of links to newspaper articles.
We may well return to Kostas in the near future, as he is planning to look at a number of topical economic issues.
Articles
Why I support Justin Welby’s battle with Wonga The Telegraph, Jacob Rees-Mogg (30/7/13)
Church plans to compete with payday lender Wonga BBC News, Robert Piggott (25/7/13)
Archbishop of Canterbury wants to ‘compete’ Wonga out of existence The Guardian, Miles Brignall (25/7/13)
Let the payday lenders prosper, but not extort Financial Times (30/7/13)
Coalition will support Archbishop of Canterbury Justin Welby’s plan for credit unions, says Vince Cable Independent, Andrew Grice (28/7/13)
Former Archbishop Rowan Williams backs action against payday loan firms Cambridge News, Jennie Baker (30/7/13)
Why Justin Welby’s vision of kumbayah capitalism is wrong The Telegraph, James Quinn (25/7/13)
Wonga V The Church: Comparing Interest Rates Of Payday Loans And Credit Unions The Huffington Post, Tom Moseley (25/7/13)
Wonga Warned Church Of England Could ‘Compete’ It Out Of Existence The Huffington Post, Tom Moseley (25/7/13)
Credit unions thriving even before Archbishop Welby’s attack on Wonga The Guardian, Rupert Jones (29/7/13)
Questions
- Find out the monthly interest rates being charged by various payday loan companies. Take one loan company as an example and calculate what would happen to your debt over the course of a year if you borrowed £100 and paid nothing back each month. What would be the annualised rate of interest?
- What are the arguments for and against banning payday loan companies?
- What are the arguments for and against imposing an interest rate cap on such companies?
- What are the differences between credit unions and banks?
- Should the interest rates charged by credit unions be uncapped?
- Explain what is meant by ‘moral hazard’ and give some examples. What moral hazard would there be in placing a limit on the number of months over which a debt could go on accumulating?
- How would you decide what a ‘normal’ rate of interest should be? Should this vary with the risk of default and, if so, by how much?
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.
