House prices have been rising strongly in London. According to the Halifax House Price index, house prices in London in the first quarter of 2014 were 15.5% higher than a year ago. This compares with 8.7% for the UK as a whole, 1.3% for the North of England and –1.5% for Scotland. CPI inflation was just 1.6% for the same 12-month period.
The London housing market has been stoked by rising incomes in the capital, by speculation that house prices will rise further and by easy access to mortgages, fuelled by the government’s Help to Buy scheme, which allows people to put down a deposit of as little as 5%. House prices in London in the first quarter of 2014 were 5.3 times the average income of new mortgage holders, up from 3.5 times in the last quarter of 2007, just before the financial crisis.
Concerns have been growing about increasing levels of indebtedness, which could leave people in severe financial difficulties if interest rates were to rise significantly. There are also concerns that an increasing proportion of people are being priced out of the housing market and are being forced to remain in the rental sector, where rents are also rising strongly.
But how can the housing market in London be dampened without dampening the housing market in other parts of the country where prices are barely rising, and without putting a break on the still relatively fragile recovery in the economy generally?
The Governor of the Bank of England has just announced two new measures specific to the housing market and which would apply particularly in London.
The first is to require banks to impose stricter affordability tests to new borrowers. Customers should be able demonstrate their ability to continue making their mortgage payments if interest rates were 3 percentage points higher than now.
The second is that mortgage lenders should restrict their lending to 4½ times people’s income for at least 85% of their lending.
Critics are claiming that these measures are likely to be insufficient. Indeed, Vince Cable, the Business Secretary, has argued for a limit of 3½ times people’s income. Also banks are already typically applying a ‘stress test’ that requires people to be able to afford mortgage payments if interest rates rose to 7% (not dissimilar to the Bank of England’s new affordability test).
The videos and articles look at the measures and consider their adequacy in dealing with what is becoming for many living in London a serious problem of being able to afford a place to live. They also look at other measures that could have been taken.
Webcasts and Podcasts
The Bank of England announces plans for a new affordability test BBC News (26/6/14)
Bank of England moves to avert housing boom BBC News, Simon Jack (26/6/14)
Bank of England to act on house prices in south-east BBC News, Robert Peston (25/6/14)
Bank of England measures ‘insure against housing boom’ BBC News, Robert Peston (26/6/14)
Carney: There is a ‘new normal’ for interest rates BBC Today Programme, Mark Carney (27/6/14)
Articles
Bank of England imposes first limits on size of UK mortgages Reuters, Ana Nicolaci da Costa and Huw Jones (26/6/14)
Stability Report – Mark Carney caps mortgages to cool housing market: as it happened June 26, 2014 The Telegraph, Martin Strydom (26/6/14)
Bank of England cracks down on mortgages The Telegraph, Szu Ping Chan (26/6/14)
Mortgage cap ‘insures against housing boom’ BBC News (26/6/14)
Viewpoints: Is the UK housing market broken? BBC News (26/6/14)
How can UK regulators cool house prices? Reuters (25/6/14)
Bank will not act on house prices yet, says Carney The Guardian, Jill Treanor and Larry Elliott (26/6/14)
Mark Carney’s housing pill needs time to let economy digest it The Guardian, Larry Elliott (26/6/14)
Bank Of England Admits Plans To Cool Housing Market Will Have ‘Minimal’ Impact Huffington Post, Asa Bennett (26/6/14)
Carney Surprises Are Confounding Markets as U.K. Central Bank Manages Guidance Bloomberg, Scott Hamilton and Emma Charlton (26/6/14)
House prices: stop meddling, Mark Carney, and bite the bullet on interest rates The Telegraph, Jeremy Warner (27/6/14)
Mark Carney’s Central Bank Mission Creep Bloomberg, Mark Gilbert (26/6/14)
Consultation paper
Implementing the Financial Policy Committee’s Recommendation on loan to income ratios in mortgage lending Bank of England (26/6/14)
Bank of England consults on implementation of loan-to-income ratio limit for mortgage lending Bank of England News Release (26/6/14)
Data
Links to sites with data on UK house prices Economic Data freely available online, The Economics Network
Questions
- Identify the main factors on the demand and supply sides that could cause a rise in the price of houses. How does the price elasticity of demand and supply affect the magnitude of the rise?
- What other measures could have been taken by the Bank of England? What effect would they have had on the economy generally?
- What suggests that the Bank of England is not worried about the current situation but rather is taking the measures as insurance against greater-than-anticipated house price inflation in the future?
- Why are UK households currently in a ‘vulnerable position’?
- What factors are likely to determine the future trend of house prices in London?
- Is house price inflation in London likely to stay significantly above that in other parts of the UK, or is the difference likely to narrow or even disappear?
- Should the Bank of England be given the benefit of the doubt in being rather cautious in its approach to dampening the London housing market?
The ONS has just released its annual publication, The Effects of Taxes and Benefits on Household Income. The report gives data for the financial year 2012/13 and historical data from 1977 to 2012/13.
The publication looks at the distribution of income both before and after taxes and benefits. It divides the population into five and ten equal-sized groups by household income (quintiles and deciles) and shows the distribution of income between these groups. It also looks at distribution within specific categories of the population, such as non-retired and retired households and different types of household composition.
The data show that the richest fifth of households had an average pre-tax-and-benefit income of £81,284 in 2012/13, 14.7 times greater than average of £5536 for the poorest fifth. The richest tenth had an average pre-tax-and-benefit income of £104,940, 27.1 times greater than the average of £3875 for the poorest tenth.
After the receipt of cash benefits, these gaps narrow to 6.6 and 11.0 times respectively. When the effect of direct taxes are included (giving ‘disposable income’), the gaps narrow further to 5.6 and 9.3 times respectively. However, when indirect taxes are also included, the gaps widen again to 6.9 and 13.6 times.
This shows that although direct taxes are progressive between bottom and top quintiles and deciles, indirect taxes are so regressive that the overall effect of taxes is regressive. In fact, the richest fifth paid 35.1% of their income in tax, whereas the poorest fifth paid 37.4%.
Taking the period from 1977 to 2012/13, inequality of disposable income (i.e. income after direct taxes and cash benefits) increased from 1977 to 1988, especially during the second two Thatcher governments (1983 to 1990) (see chart opposite). But then in the first part of the 1990s inequality fell, only to rise again in the late 1990s and early 2000s. However, with the Labour government giving greater cash benefits for the poor, inequality reduced once more, only to widen again in the boom running up to the banking crisis of 2007/8. But then, with recession taking hold, the incomes of many top earners fell and automatic stabilisers helped protect the incomes of the poor. Inequality consequently fell. But with the capping of benefit increases and a rise in incomes of many top earners as the economy recovers, so inequality is beginning to rise once more – in 2012/13, the Gini coefficient rose to 0.332 from 0.323 the previous year.
As far as income after cash benefits and both direct and indirect taxes is concerned, the average income of the richest quintile relative to that of the poorest quintile rose from 7.2 in 2002/3 to 7.6 in 2007/8 and then fell to 6.9 in 2012/13.
Other headlines in the report include:
Since the start of the economic downturn in 2007/08, the average disposable income has decreased for the richest fifth of households but increased for the poorest fifth.
Cash benefits made up over half (56.4%) of the gross income of the poorest fifth of households, compared with 3.2% of the richest fifth, in 2012/13.
The average disposable income in 2012/13 was unchanged from 2011/12, but it remains lower than at the start of the economic downturn, with equivalised disposable income falling by £1200 since 2007/08 in real terms. The fall in income has been largest for the richest fifth of households (5.2%). In contrast, after accounting for inflation and household composition, the average income for the poorest fifth has grown over this period (3.5%).
This is clearly a mixed picture in terms of whether the UK is becoming more or less equal. Politicians will, no doubt, ‘cherry pick’ the data that suit their political position. In general, the government will present a good news story and the opposition a bad news one. As economists, it is hoped that you can take a dispassionate look at the data and attempt to relate the figures to policies and events.
Report
The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (26/6/14)
Data
Reference tables in The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (26/6/14)
The Effects of Taxes and Benefits on Household Income, Historical Data, 1977-2012/13 ONS (26/6/14)
Rates of Income Tax: 1990-91 to 2014-15 HMRC
Articles
Inequality is on the up again – Osborne’s boast is over New Statesman, George Eaton (26/6/14)
Disposable incomes rise for richest fifth households only Money.com, Lucinda Beeman (26/6/14)
Half of families receive more from the state than they pay in taxes but income equality widens as rich get richer Mail Online, Matt Chorley (26/6/14)
Rich getting richer as everyone else is getting poorer, Government’s own figures reveal Mirror, Mark Ellis (26/6/14)
The Richest Households Got Richer Last Year, While Everyone Else Got Poorer The Economic Voice (27/6/14)
Questions
- Define the following terms: original income, gross income, disposable income, post-tax income, final income.
- How does the receipt of benefits in kind vary across the quintile groups? Explain.
- What are meant by the Lorenz curve and the Gini coefficient and how is the Gini coefficient measured? Is it a good way of measuring inequality?
- Paint a picture of how income distribution has changed over the past 35 years.
- Can changes in tax be a means of helping the poorest in society?
- What types of income tax cuts are progressive and what are regressive?
- Why are taxes in the UK regressive?
- Why has the fall in income been largest for the richest fifth of households since 2007/8? Does this mean that, as the economy recovers, the richest fifth of households are likely to experience the fastest increase in disposable incomes?
There have been two significant changes in prices for travel in Bristol. At the end of April, the toll on Brunel’s iconic Clifton Suspension Bridge doubled from 50p to £1 for a single crossing by car. The bridge over the Avon Gorge links North Somerset with the Clifton area of Bristol and is a major access route to the north west of the city. Avoiding the bridge could add around 2 miles or 8 minutes to a journey from North Somerset to Clifton.
The justification given by the Clifton Suspension Bridge Trust for the increase was that extra revenue was needed for maintenance and repair. As Trust Chairman Chris Booy said, ‘The higher toll will enable the Trust to continue its £9 million 10-year vital repair and maintenance programme which aims to secure the bridge’s long-term future as a key traffic route, one of Bristol’s major tourist destinations and the icon of the city’.
The other price change has been downwards. In November 2013, the First Group cut bus fares in Bristol and surrounding areas. Single fares for up to three miles were cut from £2.90 to £1.50; 30% discounts were introduced for those aged 16 to 21; half-price tickets were introduced for children from 5 to 15; and the two fare zones for £4 and £6 day tickets were substantially increased in size.
First hoped that the anticipated increase in passengers would lead to an increase in revenue. Evidence so far is that passenger numbers have increased, with journeys rising by some 15%. Part of this is due to other factors, such as extra bus services, new buses, free wifi and refurbished bus stops with larger shelters and seats. But the company attributes a 9% rise in passengers to the fare
reductions. As far as revenue is concerned, indications from the company are that, after an initial fall, revenue has risen back to levels earned before the fare reduction.
What are the longer-term implications for revenue and profit of these two decisions? This depends on the price elasticity of demand and on changes in costs. Read the articles and then consider the implications by having a go at answering the questions.
Clifton Suspension Bridge toll to rise from 50p to £1 BBC News (9/4/14)
Regular Users of Clifton Suspension Bridge will be Protected from the Increase in the Bridge Toll Clifton Suspension Bridge (9/4/14)
Clifton Suspension Bridge Review Decision Letter Department of Transport (24/3/14)
Clifton Suspension Bridge Trust: bridge toll review inspector’s report Department of Transport (8/4/14)
Clifton Suspension Bridge Toll Increase – Account of the May 2013 Public Inquiry The National Alliance Against Tolls (NAAT)
First Bus Bristol fare cuts sees passenger growth BBC News (6/6/14)
First gamble over cheaper bus fares pays off as passengers increase in Bristol The Bristol Post (6/6/14)
Bristol bus fares deal to extend to South Gloucestershire and North Somerset The Bristol Post, Gavin Thompson (12/6/14)
Questions
- What assumptions is the Clifton Suspension Bridge Trust making about the price elasticity of demand for bridge crossings?
- What determines the price elasticity for bridge crossings in general? Why is this likely to differ from one bridge to another?
- How is the long-term price elasticity of demand likely to differ from the short-term elasticity for Clifton Suspension Bridge crossings and what implications will this have for revenues, costs and profit?
- How is the price elasticity of demand for the bridge likely to vary from one user to another?
- How is offering substantial price reductions for multiple-crossing cards likely to affect revenue?
- What determines the price elasticity of demand for bus travel?
- What could a local council do to encourage people to use buses?
- How is the long-term price elasticity of demand for bus travel likely to differ from the short-term elasticity?
- In the long run, is First likely to see profits increase from its fare reduction policy? Explain what will determine this likelihood.
Oligopoly is the most complex market structure, characterised by a few large firms which dominate the industry. Typically there are high barriers to entry and prices can be very sticky. However, perhaps the most important characteristic is interdependence. With this feature of the market, oligopolies, despite being dominated by a few big firms, can be the most competitive market structure.
There are many examples of oligopolies and one of the best is the supermarket industry. Dominated by the likes of Tesco, Morrisons and Asda, competition in terms of branding, product development and quality is constant, but so is price competition. 
During the recession, you could hardly watch a TV programme that included advert breaks without seeing one of the big four advertising their low prices.
However, in the past few years, the supermarket industry has seen competition grow even further and the big four are now facing competition from low-cost retailers, including Aldi and Lidl. This has led to falling sales and profits for the likes of Tesco and Morrisons.
Tesco, Morrisons, Sainsbury’s and Asda have all felt the emergence of discount retailers and have seen their customer numbers fall. All have reacted with rounds of price cuts and new deals, and this price war looks set to continue. Morrisons have just announced a 14% average price cut on 135 products to match earlier changes in pricing strategies by the other main competitors. As I’m writing this during the Algeria v. South Korea match, I have just seen an advert from Sainsbury’s, promoting their milk chocolate digestive biscuits, priced at £1. The advert explicitly states that they are ‘less than Morrisons’, where the price is £1.50. This was soon followed by another from Sainsbury’s saying that 
the Cif bathroom spray is £1.50, which is ‘less than Tesco’, priced at £2.75. I need say no more.
So, what is it about this industry which means it is so susceptible to price wars? Are all oligopolies like this? The following articles consider the supermarket industry and the price wars that have emerged. Think about this sector in terms of oligopoly power and consider the questions that follow.
Morrisons announces another round of price cuts/a> BBC News (22/6/14)
Tesco suffers worst sales for decades The Guardian, Sarah Butler and Sean Farrell (4/6/14)
Britain’s Morrisons to cut prices on 135 products Reuters (22/6/14)
Morrisons slashes more prices by up to 41pct The Telegraph, Scott Campbell (22/6/14)
Sainsbury’s and Netto in discount store tie-up BBC News (20/6/14)
Slow to respond, Tesco now pays the price Wall Street Journal, Peter Evans and Ese Erheriene (19/6/14)
One million fewer customer visits a week at Tesco The Guardian, Sean Farrell (3/6/14)
Asda only one of big four to grow share as Lidl achieves highest ever growth Retail Week, Nicola Harrison (3/6/14)
Will Asda shoot itself in the foot with in-store cost cutting? The Grocer, Alec Mattinson (28/5/14)
Tesco sales slide at record speed as discounters pile on the pressure Independent, Simon Neville (3/6/14)
Quester: Back J Sainsbury to prove doubters wrong The Telegraph, Graham Ruddick (11/6/14)
Questions
- What are the key characteristics of an oligopoly?
- How do the above characteristics explain the conduct of firms in an oligopoly? How relevant is this to the supermarket industry?
- In many oligopolies, prices are sticky. Why is it that in the supermarket industry price wars break out?
- Is the kinked demand curve a relevant model to use when talking about the supermarket industry?
- What other industries fit into the category of an oligopoly? Is the kinked demand curve model relevant in these industries?
- Would there be an incentive for the big 4 supermarkets to collude and fix price? Explain your answer.
- Interdependence is the key characteristic in an oligopoly. Can this explain the behaviour of the supermarkets?
- Given that oligopolies are characterised by high barriers to entry, how is that Aldi and Lidl have been able to compete with them?
What does it take to create a successful business? From the looks of it: mud, electric barbed wire, icy water, enormous walls to climb, big jumps to make, team work and complete exhaustion – the recipe for every successful business.
Tough Mudder was founded in 2010 and runs gruelling extreme obstacle courses for anyone mad enough to think it might be fun. In the BBC News article below, you’ll see that there is a discussion as to intellectual property rights, but whatever the outcome, this company has become the main provider of such extreme sports in a remarkably short period of time. Within 2 years of being established, it had gained 500,000 participants and now records annual revenues of more than £60m. Add to this, that there has no external funding and this organic growth is beyond impressive.
A key question, then, is what creates such a successful business? Without a doubt, this depends on the product you are selling and the market a firm is in, but there are some aspects that apply across the board. Understanding what your customers want is crucial, as they represent your demand. Differentiating your product to create inelastic demand may be a good strategy to enable price rises, without losing a large number of sales, but the differentiated product is essential in establishing demand, loyalty and reputation. Marketing something in the right way and to the right audience is crucial – word-of-mouth is often the most effective form of advertising.
If you have all of these aspects, then you have the makings of a successful business. The next step is putting it into practice and climbing those high walls, taking the big jumps and hopefully avoiding the mud and ice. The following article considers Will Dean and his fast growing business.
Will Dean: ‘The Mark Zuckerberg of extreme sports’ BBC News, Will Smale (9/6/14)
Questions
- If you were starting up a business, how might you go about finding out if there is a demand for your product?
- Why is product differentiation a key aspect of a successful business? Using a diagram, explain how this might help a firm increase revenue and profits.
- What forms of marketing might be used in persuading customers to buy your product?
- In the case of Tough Mudder, which aspects have proved the most important in creating such a successful business?
- Are there any barriers to the entry of new firms in this sector? If so, what are they are how important are they in allowing Tough Mudder to retain a monopoly position?
- Which factors should be considered by a company when it is thinking of global expansion?
House prices have been rising strongly in London. According to the Halifax House Price index, house prices in London in the first quarter of 2014 were 15.5% higher than a year ago. This compares with 8.7% for the UK as a whole, 1.3% for the North of England and –1.5% for Scotland. CPI inflation was just 1.6% for the same 12-month period.
