Category: Essentials of Economics 9e

Rising costs of cloth and a rise in VAT could mean that clothes prices are set to rise. Does this spell the end of cheap fashion from the likes of Primark and H&M? Or can they absorb the cost increases?

The following articles look at the causes of the rise in costs of clothing and what the cheap fashion chains can do about it.

Articles
Primark follows fashion rivals as it warns of rising costs Guardian, David Teather and Zoe Wood (13/9/10)
Primark warns on costs as growth slows Telegraph, James Hall (14/9/10)
Is this the end of cheap clothes era? Price of cotton has rocketed because of floods, Primark warns Mail Online, Sean Poulter (14/9/10)
Fashion chains far from cheerful about future of cheap chic Observer, Zoe Wood, David Teather and Julia Finch (19/9/10)

Data
Commodity prices (including cotton) Index Mundi
Cotton futures BBC Business: Commodities

Questions

  1. Why have cotton prices been rising? Illustrate your arguments with a demand and supply diagram.
  2. Would you expect a rise in the price of cotton of 45% to lead to a rise in the price of cotton clothes of 45%, or of more than 45% or of less than 45%? Explain.
  3. For what other reasons are the prices of clothing rising?
  4. How did the process of globalisation keep the price of clothing down?
  5. Next’s chief executive, Lord (Simon) Wolfson said that if prices of Next’s clothes go up 8% then the number of units sold will fall by 10%. What is the value of the price elasticity of demand that he is assuming?
  6. Why is the ‘Fairtrade system so important’?
  7. “Some retailers have already increased prices but there is more to come. The products most under threat are T-shirts, underwear and socks. More complicated garments such as heavy jeans will be less affected.” Why are the prices of more complicated garments likely to rise by a smaller percentage than those of simple garments?
  8. What has been happening to the demand for cheap fashion clothing and why? Combine this effect with those of costs on a demand and supply diagram.
  9. What type of market structure is the market for fashion clothing? What are the implications of this for the profits of retailers?

With the full impact of the fiscal austerity measures yet to come, the fall in unemployment revealed in the latest ONS labour market release is probably a lull before the storm. Nonetheless, in the three months to July unemployment fell by 8,000 to 2.467 million, while the rate of unemployment – the number of people unemployed expressed as a percentage of those economically active – fell from 7.9% from 7.8%. But, within the ONS release we again saw an increase in the number of people who are long-term unemployed.

The number of people aged 16 or over who have been unemployed for at least 12 months stood at 797,000 in the three months to July. This represents an increase of 15,000 over the previous 3 months. While the pace of increase appears to have slowed – the number had risen by 100,000 in the three months to April – the pool of people who can be described as long-term unemployed is undoubtedly of much concern. To put this number into perspective, it means that of the 2.467 million people unemployed 32.3% have been so for at least a year. In effect, one-third of the pool of unemployed can now be thought of as long-term unemployed.

Of the long-term unemployed, 547,000 or 69% are male. This is the highest number of males described as long-term unemployed since the three months to May 1997 – the month when the Labour government of Tony Blair came to power. But, the historical context for female long-term unemployment is even bleaker. A further increase of 4,000 over the 3 months to July means that the number of females who are long-term unemployed has risen to 250,000. The last time long-term female unemployment was higher than this was in the three months to September 1995.

An obvious concern with the expectation that the total unemployment figure will grow in the not too distant future is that the number of long-term unemployed people will carry on growing. Of course, this not only has unfortunate implications for these individuals but for society and the economy more generally. Consequently, it raises some important and very difficult economic and social policy questions. One important economic question, for instance, is how we tackle the erosion of human capital as more and more individuals are divorced for longer and longer from the labour market. An erosion of human capital affects individuals and society not only in the present, but in the future too.

Articles

UK unemployment falls by 0.1 pct to 7.8 pct Associated Press (16/9/10)
Wasteland: Europe stalked by spectre of mass unemployment Independent, Alistair Dawber (16/9/10)
Job fears despite employment rise Telegraph, Angela Monaghan (16/9/10)
Part-time jobs fuel record rise in employment Express, Macer Hall (16/9/10)
UK unemployment falls to 2.47 million BBC News (15/9/10)

Data

Latest on employment and unemployment Office for National Statistics (15/9/10)
Labour Market Statistics, September 2010 Office for National Statistics (15/9/10)
Labour market data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission

Questions

  1. If the overall number of unemployed people is falling why is the number of long-term unemployed rising?
  2. The current unemployment rate is 7.8%. But, what do we mean by the unemployment rate?
  3. Draw up a list of the problems that you think arise out of long-term unemployment.
  4. Use your list to draw up a series of potential policies to tackle these problems.
  5. Why do some economists think the current fall in unemployment is a ‘lull before the storm’? What impact might this have on the number of people long-term unemployed?

There has been talk for some time about the possibility of standing room on flights, but it is hardly surprising that this has been rejected by the Civil Aviation Authority. Not the safest option, you might say, nor the comfiest – certainly not for a long haul flight to the other side of the world! However, this could be coming closer to reality, as we see The Skyrider, which is a new saddle-style airplane designed by Avioninteriors. It has yet to be snapped up, but Ryanair could be top of the list with their plans for a new style of flying.

It may not be quite what you imagine – you don’t literally stand up in the stalls at the front of the aircraft. Passengers will have seats, but these seats give a completely new meaning to ‘upright seats’. Seats would be 23 inches apart (some 10 inches closer than we’re used to), but they would only be available for flights up to 3 hours. Despite the publicity, the design is yet to be approved. Ryanair believe that such a design would increase passenger capacity by some 40%. However, passengers remain rather skeptical, as many struggled to fit in to the seats when it was unveiled in New York.

Technological development is vital in any dynamic industry, but is this one step too far? One day, it could be a game of sardines when packing passengers into a plane!

New airline seat for Ryanair resembles a saddle Irish Central, Molly Muldoon (18/9/10)
New plane ‘saddle’ would pack in passengers Edmonton Journal (19/9/10)
Ryanair one step closer to fulfilling dream of getting more people on each plane Travel News, Natalie Cooper (16/9/10)
Budget airlines love bad new stories about how cramped their planes are Telegraph, Harry Mount (15/9/10)
Behold! The world’s most cramped airline seat Reuters, Charlie Sorrel (13/9/10)

Questions

  1. Is it a rational decision for a passenger to travel in a new upright seat?
  2. Is it a cost-effective strategy for Ryanair or any other airline to adopt? Explain (a) why it is, but also explain (b) why it may not be cost-effective.
  3. Using a diagram, illustrate the opportunity cost to an airline of providing more upright seats.
  4. If successive airlines adopt the new saddle style seats, what is likely to happen to the price of such seats?
  5. As passengers become aware of these cheaper seats, what is likely to happen to the market price? Illustrate this on a diagram.
  6. If Ryanair were the only airline to offer such seats, does this mean it would have a monopoly? Explain your answer.

The market for food in the UK is highly competitive. From dining in style to a simple take-away, one of the key words when it comes to dining seems to be choice. Competitive prices and high quality are on offer, which is largely due to the sheer number of restaurants available to consumers. However, consolidation seems to be on the menu.

Nando’s is a well known restaurant and a popular eating destination on UK and Irish high streets, with more than 230 restaurants. This chicken restaurant group has made a £30 million bid for Clapham House, the company behind the Gourmet Burger Kitchen chain with 53 branches. Clapham’s shareholders were advised to accept the deal and on the 17th September 2010, it is reported that a deal was reached with Nando’s Group Holdings and its private equity owner Capricorn Ventures International. The 74 pence per share deal was met with disappointment by some analysts, who felt that the company was under-valued, despite failed attempts by Clapham House’s Board to persuade Capricorn to raise the offer price or find an alternative bidder.

The restaurant industry has suffered from the recession and especially by the weak economic recovery, so perhaps lower valuations are to be expected. Nando’s said:

‘As macroeconomic weakness has persisted in the UK, the trading environment for restaurant businesses in the UK has been difficult. This is evidenced by Clapham House’s vaolatile weekly trading performance.’

Nando’s intend to invest significantly in Clapham Houses’ businesses to reinvigorate their previous competitor. This may be essential, given the expectation that conditions in the UK will remain fragile, with consumer confidence staying low, as well as a somewhat untimely rise in VAT in January next year, which is almost certain to have an adverse effect on the restaurant business.

This take-over deal is not the first in the restaurant industry and nor is it likely to be the last, as the UK economy remains in a vulnerable state. The following articles look at this and over takeovers.

Nando’s to buy Gourmet Burger Kitchen for £30m BBC News (17/9/10)
UK restaurants serve up £50m in takeover deals Management Today, Emma Haslett (17/9/10)
Nando’s swallows Gourmet Burger Daily Mirror News, Clinton Manning (18/9/10)
GBK team plots next move after Nandos deal Telegraph, Jonathan Sibun (18/9/10)
Nando’s to buy Real Greek chain for £30m Independent, Alistair Dawber (18/9/10)
Mithcells & Butlers and Nando’s to feast on rival restaurant chains Mail Online, Ben Laurance (17/9/10)
GBK owner Clapham agrees to Nando’s offer Reuters (17/9/10)

Questions

  1. What type of takeover is Nando’s purchase of Clapham House?
  2. Why has the weak macroeconomic environment adversely affected the restaurant industry? What might be the impact of next January’s rise in VAT?
  3. Will Nando’s takeover (or indeed any other takeover in the restaurant industry) allow the company to prosper from the weak economic climate?
  4. In which type of market structure would you place the restaurant industry in the UK? Explain the characteristics of the market structure you choose and why you have placed the restaurant industry in it.
  5. How was the finance for the deal raised by Nando’s Holdings Group? What other sources of finance are available to firms for this purpose? What are the (a) advantages and (b) disadvantages of each?
  6. What other takeovers have occurred recently in the restaurant industry? What types of takeovers are they?

Under the Basel II arrangements, banks were required to maintain particular capital adequacy ratios (CARs). These were to ensure that banks had sufficient capital to allow them to meet all demands from depositors and to cover losses if a borrower defaulted on payment. Basel II, it was (wrongly) thought would ensure that the banking system could not collapse.

There were three key ratios. The first was an overall minimum CAR of 8%, measured as Tier 1 capital plus Tier 2 capital as a percentage of total risk-weighted assets. As Economics 7th edition page 509 explains:

Tier 1 capital includes bank reserves (from retained profits) and ordinary share capital, where dividends to shareholders vary with the amount of profit the bank makes. Such capital thus places no burden on banks in times of losses as no dividend need be paid. What is more, unlike depositors, shareholders cannot ask for their money back. Tier 2 capital consists largely of preference shares. These pay a fixed rate of interest and thus do continue to place a burden on the bank even when losses are made (unless the bank goes out of business).

Risk-weighted assets are the value of assets, where each type of asset is multiplied by a risk factor. Under the internationally agreed Basel II accord, cash and government bonds have a risk factor of zero and are thus not included. Inter-bank lending between the major banks has a risk factor of 0.2 and is thus included at only 20 per cent of its value; residential mortgages have a risk factor of 0.35; personal loans, credit-card debt and overdrafts have a risk factor of 1; loans to companies carry a risk factor of 0.2, 0.5, 1 or 1.5, depending on the credit rating of the company. Thus the greater the average risk factor of a bank’s assets, the greater will be the value of its risk weighted assets, and the lower will be its CAR.

The second CAR was that Tier 1 capital should be at least 4% of risk weighted assets.

The third CAR was that equity capital (i.e. money raised from the issue of ordinary shares) should be at least 2% of risk weighted assets. This is known as the ‘core capital ratio’.

Before 2008, it was thought by most commentators that these capital adequacy ratios were sufficiently high. But then the banking crisis erupted. Banks were too exposed to sub-prime debt (i.e. debt that was excessively risky, such as mortgages on property at a time when property prices were rapidly declining). Much of this debt was disguised by being bundled up with other securities in what were known as collateralised debt obligations (CDOs). On 15 September 2008, Lehman Brothers filed for bankruptcy: the largest bankruptcy in history, with Lehmans owing $613 billion. Although its assets had a book value of $639, these were insufficiently liquid to enable Lehmans to meet the demands of its creditors.

The collapse of Lehmans sent shock waves around the world. Banks across the globe came under tremendous pressure. Many held too much sub-prime debt and had insufficient capital to meet creditors’ demands. As a result, they had to be bailed out by their governments. Clearly the Basel II regulations were too lax.

For several months there have been discussions about new tighter regulations and, on 12 September 2010, central bankers from the major countries met in Basel, Switzerland, and agreed the Basel III regulations. Although the overall CAR (Tier 1 and 2) was kept at 8%, the Tier 1 ratio was raised from 4% to 6% and the core Tier 1 ratio was raised from 2% to 4.5%, to be phased in by 2015. In addition there were two ‘buffers’ introduced.

As well as having to maintain a core Tier 1 ratio of 4.5%, banks would also have to hold a ‘conservation buffer’ of 2.5%. “The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions.” In effect, then, the core Tier 1 ratio will rise from 2% to 7% (i.e. 4.5% minimum plus a buffer of 2.5%).

The other buffer is a ‘countercyclical buffer’. This will be “within a range of 0% – 2.5% of common equity or other fully loss absorbing capital and will be implemented according to national circumstances.” The idea of this buffer is to allow banks to withstand volatility in the global economy. It will be phased in between 2016 and 2019.

The Basel III agreement will still need to be ratified by the G20 countries meeting at Seoul on 10 and 11 November this year. That meeting will also consider other elements of bank regulation.

So will these extra capital requirements be sufficient to allow banks to withstand any future crisis? The following articles discuss this question.

Articles
Global bankers agree new capital reserve rules BBC News (12/9/10)
Q&A: Basel rules on bank capital – who cares? BBC News, Laurence Knight (13/9/10)
Basel III and Sound Banking New American, Charles Scaliger (17/9/10)
Wishy-washy rules might come back to haunt regulators Financial Times, Patrick Jenkins (18/9/10)
Basel III proposal released Newsweek, Joel Schectman (17/9/10)
New Bank Rules May Not Prevent More Meltdowns FXstreet, Henrik Arnt (16/9/10)
Basel III CBS Money Watch, Mark Thoma (14/9/10)
Basel III: To lend or not to lend Investment Week, Martin Morris (16/9/10)
Taming the banks The Economist (16/9/10)
Basel’s buttress The Economist (16/9/10)
Do new bank-capital requirements pose a risk to growth? The Economist, guest contributions
Myners: New rules ‘ignore bank liquidity’ BBC Today Programme, Robert Peston and Lord Myners (18/9/10)

Official press releases and documents
Group of Governors and Heads of Supervision announces higher global minimum capital standards Bank for International Settlements Press Release (12/9/10)
The Basel iii Accord Basel iii Compliance Professionals Association (BiiiCPA)
Details of the new capital requirements Bank for International Settlements
Details of the phase-in arrangements Bank for International Settlements

Questions

  1. What impact will a higher capital adequacy ratio have on banks’ behaviour?
  2. For what reasons may the Basel III regulations be considered too lax?
  3. When there is an increase in deposits into the banking sector, banks can increase loans by a multiple of this. This bank deposits multiplier is the inverse of the liquidity ratio. Is there a similar bank capital multiplier and, if so, what determines its size?
  4. Why will Basel III be phased in over a number of years? Is this too long?