Tag: prices

The retail food industry is an oligopoly – a market dominated by a few big firms, with interdependence between them. This means that each firm considers the reaction of all its competitors when making any decision. Pricing is one of those key decisions and this is one of the reasons why price wars tend to break out in this industry.

For consumers, price wars are usually seen as a good thing, as it means prices in the supermarkets get forced downwards, thus reducing the cost of living. Low prices in this case are one of the key benefits of competition. However, there are costs of such fierce competition for suppliers. As final prices to customers are pushed down, small competitors are likely to feel the squeeze and may be forced out of the market. The other losers are suppliers. The big supermarkets are likely to pay lower prices to their suppliers, thus adversely affecting their livelihood. Research suggests that throughout 2014, 146 food producers entered insolvency, which is significantly higher than last year.

Accountancy firm, Moore Stephens, has blamed the supermarket price war for this rise in insolvencies in the food production sector. Duncan Swift from this firm said:

“The supermarkets are going through the bloodiest price war in nearly two decades and are using food producers as the cannon fodder…Supermarkets have engaged in questionable buying practices for years, but it’s getting worse and clearly wreaking havoc on the UK food production sector.”

The British Retail Consortium has said that placing the blame in this way was too simplistic. A commentator suggested that many suppliers have long-standing relationships with the supermarkets they deal with, suggesting that relations were good and sustainable. Furthermore, it was suggested that the demise of these producers may be due to many other factors and the data on insolvencies did not show that those firms affected were suppliers to the supermarkets. There is a Groceries Code Adjudicator in place to ensure that the supermarkets do not abuse their power when it comes to dealing with their suppliers, but the power of this person is limited, leaving suggestions remaining that suppliers are vulnerable. The following articles consider both the good and bad of price wars.

Articles

Questions

  1. What are the characteristics of an oligopoly? Why do price wars tend to break out in oligopolies, such as the supermarket industry?
  2. Apart from the supply-chain pressure from supermarkets, what other factors could have caused so many small food producers to become insolvent?
  3. How does the supermarket supply chain work and why have the price wars led to suppliers being squeezed?
  4. Use a diagram to illustrate the impact of the price war on (a) the supermarkets and (b) the suppliers.
  5. How important is the Groceries Code Adjudicator and should she be doing more to protect suppliers?
  6. If supermarkets are cutting prices, is this an indicator of unfair competition or good competition?

The market structure in which firms operate has important implications for prices, products, suppliers and profits. In competitive markets, we expect to see low prices, many firms competing with new innovations and firm behavior that is in, or at least not against the public interest. As a firm becomes dominant in a market, its behavior is likely to change and consumers and suppliers can be adversely affected. Is this the case with Amazon?

Much attention has been given to the dispute centering around Amazon and its actions in the market for e-books, where it holds close to two thirds of the market share. Critics of Amazon suggest that this is just one example of Amazon using its monopoly power to exploit consumers and suppliers, including the publishers and their authors. Although Amazon is not breaking any laws, there are suggestions that its behavior is ‘brutal’ and is taking advantage of consumers, suppliers and its workforce.

But rather than criticizing the actions of a monopolist like Amazon, should we instead be praising the company and its ability to compete other firms out of the market? One of the main reasons why consumers use Amazon to buy goods is that prices are cheap. So, in this respect, perhaps Amazon is not acting against consumers’ interests, as under a monopoly we typically expect low output and high prices, relative to a model of perfect competition. The question of the methods used to keep prices so low is another matter. Two conflicting views on Amazon can be seen from Annie Lowrey and Franklin Foer, who respectively said:

“Amazon relentlessly drives down prices for goods and services and delivers them fast and cheap. It ploughs its profits into price cuts and innovation rather than putting them in the hands of its investors. That benefits millions of families – full stop.”

“In effect, we’ve been thrust back 100 years to a time when the law was not up to the task of protecting the threats to democracy posed by monopoly; a time when the new nature of the corporation demanded a significant revision of government.”

So, with Amazon we have an interesting case of a monopolist, where many aspects of its behaviour fit exactly into the mould of the traditional monopolist. But, some of the outcomes we observe indicate a more competitive market. Paul Krugman has been relatively blunt in his opinion that Amazon’s dominance is bad for America. His comments are timely, given the recognition for Jean Tirole’s work in considering the problems faced when trying to regulate any firm that has significant market power. He has been awarded the Nobel Prize in Economics. I’ll leave you to decide where you place this company on the traditional spectrum of market structures, as you read the following articles.

Amazon: Monopoly or capitalist success story? BBC News, Kierran Petersen (14/10/14)
Why the Justice Department won’t go after Amazon, even though Paul Krugman thinks it’s hurting America Business Insider, Erin Fuchs (20/10/14)
Is Amazon a monopoly? The Week, Sergio Hernandez (19/11/14)
Big, bad Amazon The Economist (20/10/14)

Questions

  1. What are the typical characteristics of a monopoly? To what extent does Amazon fit into this market structure?
  2. Why does Paul Krugman suggest that Amazon is hurting America?
  3. How does Amazon’s behaviour with regard to (a) its suppliers and (b) its workers affect its profitability? Would it be able to behave in this way if it were a smaller company?
  4. Why is Amazon able to charge its customers such low prices? Why does it do this, given its market power?
  5. Is there an argument for more regulation of firms with such dominance in a market, as is the case with Amazon?
  6. The debate over e-books is ingoing. What is the argument for publishers to be able to set a minimum price? What is the argument against this?
  7. Should customers boycott Amazon in a protest over the alleged working conditions of Amazon factory employees?

Over the past few decades, numerous areas within the British economy have been partly or fully privatized and one such case is British Rail. Why is this relevant now? We’re once again looking at the potential increase in rail fares across the country and the impact this will have on commuters and households. So, have the promises of privatisation – namely lower fares – actually materialised?

Comparing the increase in rail fares with that of the RPI makes for interesting reading. Data obtained back in January 2013 shows that since 1995, when the last set of British Rail fares were published, the RPI has been 66%, according to data from Barry Doe and this compares unfavourably with the increase in a single ticket from London to Manchester which had increased by over 200%. However, it compares favourably with a season ticket, which had only increased by 65%. In the last couple of years, increased in rail fares have been capped by the government to increase by no more than the rate of inflation. As such, customers are likely to be somewhat insulated from the increases that were expected, which could have ranged between 3 and 5%.

This announcement has been met with mixed reviews, with many in support of such caps and the benefit this will bring to working households, including Passenger Focus, the rail customer watchdog. Its Passenger Director, David Sidebottom said:

The capping of rail fare rises by inflation will be welcome news to passengers in England, especially those who rely on the train for work, as will the ban on train companies increasing some fares by more than the average. It is something we have been pushing for, for several years now and we are pleased that the Government has recognised the need to act to relieve the burden on passengers.

However, others have criticised the increases in rail fares, given the cost of living crisis and the potential 9% pay rise for MPs. The acting General Secretary of the RMT transport union commented:

The announcement from George Osborne does not stack up to a freeze for millions of people whose incomes are stagnant due to years of austerity. To try and dress this up as benefiting working people is pure fraud on the part of the Government … Tomorrow, RMT will be out at stations across the north where some off-peak fares will double overnight.

Commuters in different parts of the country do face different prices and with some changes in peak travel times in the Northern part of the country, it is expected that some customers will see significant hikes in prices. Peak travel prices being higher is no surprise and there are justifiable reasons for this, but would such changes in peak times in the North have occurred had we still been under British Rail? Privatisation should bring more competition, lower prices and government revenue at the point of sale. Perhaps you might want to look in more detail at the actual to see whether or not you think the benefits of privatisation have actually emerged. The following articles consider the latest announcement regarding rail fares.

Rail fares to increase by 2.5% in January after Osborne caps price rises at no more than inflation Mail Online, Tom McTague (7/9/14)
Have train fares gone up or down since British Rail? BBC News, Tom Castella (22/1/13)
Rail fares to match inflation rate for another 12 months The Guardian (7/9/14)
Britain caps rail fares at inflation Reuters (7/9/14)
Regulated rail fares to increase by 3.5% in 2015 BBC News (19/8/14)
Northern commuters face big rise in fares for evening travel The Guardian, Gwyn Topham (7/9/14)
Commuter rail fares frozen again, says George Osborne BBC News (7/8/14)
Rail fares, the third payroll tax Financial Times, Jonathan Eley (22/8/14)

Questions

  1. What are the general advantages and disadvantages of privatisation, whether it is of British Rail or British Gas?
  2. Why is it that season tickets have increased by less than the RPI, but single tickets have increased by more?
  3. What are the conditions needed to allow train companies to charge a higher price at peak travel times?
  4. Are higher prices at peak times an example of price discrimination? Explain why or why not.
  5. In the Financial Times article, it is suggested that rail fares are like a payroll tax. What is a payroll tax and why are rail fares related to this? Does it suggest that the current method of setting rail fares is equitable?
  6. Based on the arguments contained in the articles, do you think the cap on rail fares is sufficient?

Rising inflation: not normally a cause for celebration, but that’s not the case for Japan. Having been subject to the spectre of deflation for many years, the 22-year high for the CPI at 2.7% is a welcome figure, even it is slightly lower than expected. This surge in prices is partly the result of a growth in domestic demand and a sign, therefore, that output will expand in response to the rise in demand.

The Japanese economy has experienced largely stagnant growth for two decades and a key cause has been falling prices. Although consumers like bargains, this has been problematic for this large economy. Deflation creates continuously falling prices and this means consumers hold back from purchasing durable goods, preferring to wait until prices have fallen further.

In the blog, Japan’s recovery, we looked at inflation data showing Japanese consumer prices growing at a faster rate than expected. This ‘positive’ trend has continued.

When it comes to inflation, expectations are crucial. If people think prices will rise in the future, they are more likely to buy now to get the lower price. This can therefore help to stimulate aggregate demand and it is this that has been the target for Japan. Part of the growth in the CPI is down to the sales tax rise from 5% to 8%. This was the first time in 17 years that the sales tax had increased. Further increases in it are expected in 2015. There were concerns about the impact of this rise, based on the depression that followed the last rise back in 1997, but so far the signs seem good.

Monetary easing was a key component in ending the downward trajectory of the Japanese economy and, following the sales tax rise, many believe that another round of monetary easing may be needed to counter the effects and create further growth in the economy and in the CPI. As the Bank of Japan Governor said:

There are various ways to adjust policy. We will decide what among these measures is appropriate depending on economic and price developments at the time … For now, we can say Japan is making steady progress toward achieving 2 per cent inflation.

One of the ‘three arrows‘ of the government’s policy has been to boost government spending, which should directly increase aggregate demand. Furthermore, with signs of the CPI rising, consumers may be encouraged to spend more, giving a much needed boost to consumption. The economy is certainly not out of the woods, but appears to be on the right path. The following articles consider the Japanese economy.

Japan CPI rises less than expected Wall Street Journal, Takashi Nakamichi (25/4/14)
Japan inflation may beat BOJ forecast Reuters, Leika Kihara (22/4/14)
Tokyo consumer price growth at 22-year high BBC News (25/4/14)
Japan inflation quickens to over 5-year high, output rebounds Reuters, Leika Kihara and Stanley White (31/1/14)
Japan’s consumer inflation set to reach five-year high Guardian (18/4/14)
Tokyo inflation hits 22-year high, inching toward BOJ goal Reuters, Tetsushi Kajimoto and Leika Kihara (25/4/14)
Tokyo’s core CPI got 2.7% lift in April from tax hike The Japan Times (25/4/14)
Is Japan winning the war against deflation? CNBC, Ansuya Harjani (25/4/14)

Questions

  1. Why is deflation a problem?
  2. Using an AD/AS diagram, illustrate the problem of expectations and how this contributes to stagnant growth.
  3. Use the same diagram to explain how expectations of rising prices can help to boost AD.
  4. Why is the sales tax expected to reduce growth?
  5. Why is another round of monetary easing expected?
  6. What government policies would you recommend to a government faced with stagnant growth and falling prices?

The energy market is complex and is a prime example of an oligopoly: a few dominant firms in the market and interdependence between the suppliers. Over 95% of the market is supplied by the so-called ‘big six’ and collectively they generate 80% of the country’s electricity. There are two further large generators (Drax Power Limited and GDF Suez Energy UK), meaning the electricity generation is also an oligopoly.

This sector has seen media attention for some years, with criticisms about the high profits made by suppliers, the high prices they charge and the lack of competition. Numerous investigations have taken place by Ofgem, the energy market regulator, and the latest development builds on a simple concept that has been a known problem for decades: barriers to entry. It is very difficult for new firms to enter this market, in particular because of the vertically integrated nature of the big six. Not only are they the suppliers of the energy, but they are also the energy generators. It is therefore very difficult for new suppliers to enter the market and access the energy that is generated.

Ofgem’s new plans will aim to reduce the barriers to entry in the market and thus make it easier for new firms to enter and act as effective competitors. The big six energy generators are vertically integrated companies and thus effectively sell their energy to themselves, whereas other suppliers have to purchase their energy before they can sell it. The regulator’s plans aim to improve transparency by ensuring that wholesale power prices are published two years in advance, thus making it easier for smaller companies to buy energy and then re-sell it. Andrew Wright, the Chief Executive of Ofgem, said:

These reforms give independent suppliers, generators and new entrants to the market, both the visibility of prices, and [the] opportunities to trade, [that] they need to compete with the largest energy suppliers…Almost two million customers are with independent suppliers, and we expect these reforms to help these suppliers and any new entrants to grow.

Although such reforms will reduce the barriers to entry in the market and thus should aim to increase competition and hence benefit consumers, many argue that the reforms don’t go far enough and will have only minor effects on the competitiveness in the market. There are still calls for further reforms in the market and a more in-depth investigation to ensure that consumers are really getting the best deal. The following articles consider this ongoing saga and this highly complex market.

Ofgem ramps up scrutiny of Big six accounts Telegraph, Denise Roland (27/2/14)
Energy firms told to trade fairly with smaller rivals BBC News (26/2/14)
Energy regulator Ofgem force trading rules on ‘big six’ suppliers Financial Times, Andy Sharman (26/2/14)
Ed Davey calls on Ofgem to investigate energy firms’ gas profits The Guardian, Sean Farrell and Jennifer Rankin (10/2/14)
UK forces big power companies to reveal wholesale prices Reuters (26/2/14)
Watchdog unveils new rules on Big six energy prices Independent, Tom Bawden (26/2/14)
Energy Bills: New rules to boost competition Sky News, (26/2/14)

Questions

  1. What are the characteristics of an oligopoly?
  2. Explain the reason why the vertically integrated nature of the big six energy companies creates a barrier to the entry of new firms.
  3. What are the barriers to entry in (a) the electricity supply market and (b) the electricity generating market?
  4. What action has Ofgem suggested to increase competition in the market? How effective are the proposals likely to be/
  5. Why is there a concern about liquidity in the market?
  6. If barriers to entry are reduced, how will this affect competition in the market? How will consumers be affected?
  7. Why are there suggestions that Ofgem’s proposals don’t go far enough?