Category Archives: Micro

Ethics and Profits – what about the coffee growers?

No business, however great or strong or wealthy it may be at present, can exist on unethical means, or in total disregards to its social concern, for very long. Resorting to unethical behaviour or disregarding social welfare is like calling for its own doom. Thus business needs, in its own interest, to remain ethical and socially responsible. As V.B. Dys in “The Social Relevance of Business ” had stated-

“As a Statement of purpose, maximising of profit is not only unsatisfying, it is not even accurate. A more realistic statement has to be more complicated. The corporation is a creation of society whose purpose is the production and distribution of needed if the whole is to be accurate: you cannot drop one element without doing violence to facts.”

Business needs to remain ethical for its own good. Unethical actions and decisions may yield results only in the very short run. For the long existence and sustained profitability of the firm, business is required to conduct itself ethically and to run activities on ethical lines. Doing so would lay a strong foundation for the business for continued and sustained existence. All over the world, again and again, it has been demonstrated that it is only ethical organisations that have continued to survive and grow, whereas unethical ones have shown results only as flash in the pan, quickly growing and even more quickly dying and forgotten.

Business needs to function as responsible corporate citizens of the country. It is that organ of the society that creates wealth for the country. Hence, business can play a very significant role in the modernisation and development of the country, if it chooses to do so. But this will first require it to come out from its narrow mentality and even narrower goals and motives. However behavioural economists have found that many business people don’t behave in this type of profit-maximising manner in times of crisis – e.g a water shortage means businesses could charge more. If they do, consumers remember and retaliate down the road.

Ethical Consumers

As consumers start to develop a preference for ethical brands, e.g.. Fair Trade Coffee, create a market for such coffee. Firms are therefore pressured to shift toward supplying what consumers want. This is even the case if the firm’s management don’t care how or where the coffee is sourced. Changing consumer preferences force firms to change their ways. Even at higher prices consumers are often willing to pay a premium for ‘ethical’ products or the products of socially responsible firms. Being more expensive doesn’t necessarily mean the company will go out of business if consumers have a preference for ethical products. Higher-priced ethical firms remain highly successful under these circumstances. Instead of being protected by tariffs or subsidies, they’re protected by the preference of consumers.

Coffee supply chain.
However a recent article in the FT outlined the desperate state for coffee growers. The price of high quality arabica beans is trading just above $1 in the New York Commodity Exchange – this is half the value it was 5 years ago. This was due to Brazilian producers flooding the market. Although coffee prices in the cafes have increased the farmers are not the ones to benefit. The image below shows that the grower only gets 1p from the $2.50 and the coffee itself only accounts 10p.

There is a supply chain that takes ‘clips the ticket’ on the way through (see image) but the majority of the cost is associated with rent, wages and tax. The video Black Gold (a bit old now but has some good economics) looks at the growing industry in Ethiopia where they have some of the finest coffee beans in the world. Farmers there have been ripping up coffee plants and replacing it with ‘chat’ – a drug which is banned in the West – which fetches a much higher price.

Indifference Curves – Mindmap and Video

Been covering this topic with my A2 class and it is one of the more complex parts of the micro course. The video is particularly useful.


Income and Substitution Effects with Indifference Curves
Any price change can be conveniently analysed into 2 separate effects – the INCOME EFFECT and the SUBSTITUTION EFFECT.

Income effect of a price change: – when there is a fall in the price of a product, the consumer receives a real income effect and is able to buy more of this and other products in spite of the fact that nominal income is unchanged. If the consumer buys more of the good when the price falls it is a Normal good. If the consumer buys less of the good when the price falls it is seen as an Inferior good.

Substitution effect of a price change: – when there is a rise or fall in the price of a product, the consumer receives a decrease or an increase in the utility derived from each unit of money spent on the product and therefore rearranges demand to maximise utility. This is distinct from the income effect of a price change. For all products, the substitution effect is always positive such that a fall in price leads to an increase in demand as consumers realise an increase in the satisfaction they derive from each unit of money spent on the product.

Remember for normal goods, both the income and substitution effects are positive. But the income effect can be negative: if a negative income effect outweighs the positive substitution effect, this means that less is bought at a lower price and vice-versa. This good is therefore known as a Giffen good.

Giffen goods are generally regarded as goods of low quality which are important elements in the expenditure of those on low incomes. A good example is a basic food such as rice, which forms a significant part of the diet of the poor in many countries. The argument, not accepted by all economists, is that when the price of rice falls sufficiently individuals’ real income will rise to an extent that they will be able to afford more attractive substitutes such as fresh fruit or vegetables to makeup their diet and as a result they will actually purchase less rice even though its price has fallen.

English Premier League – where competition means more revenue and better football

As the season drew to a close with the Europa League and Champions League Finals last week one couldn’t help noticing the dominance of the EPL sides. To have 4 clubs from the EPL in the finals is unprecedented and testament to the strength on the EPL. A lot of the other European leagues have a dominance of one or maybe two teams – EG

  • Spain – La Liga – Barcelona won the championship easily this year. Real Madrid its closest rivals in previous years finished 3rd.
  • Germany – Bundesliga – Bayern Munich won the league for the last 7 years although Borussia Dortmund have been close on a few occasions.
  • France – Ligue 1 – Paris St German won the league by 16 points and have won Ligue 1 6 out of the last 7 seasons
  • Italy – Serie A – Juventus won the league by 11 points and it was their 8th consecutive title.
  • Netherlands – Eredivisie – Ajax won the league by 3 points from PSV Eindhoven. Third place was a further 18 points behind

US Economist Walter Neale said that a pure monopoly in sport is not good. If some team is totally dominant in a league the interest in the competition wanes and fewer fans turn up to games and also television rights become less attractive. Therefore if a club is dominant in a league it will have to look to other alternatives to generate more revenue – creating a super league amongst other teams at the expense of national leagues like the Premier League, La Liga in Spain and Germany’s Bundesliga. This would be like major sports in the USA where the same teams compete without the threat of relegation. It would also be to the detriment of local leagues in which clubs traditionally have huge followings and also generate a lot of income.

However the EPL has done well to have a very competitive competition with 6 clubs being serious contenders for the title – Manchester City, Liverpool, Tottenham, Chelsea, Arsenal and Manchester Utd. With such competition there is interest from the fan base and TV rights which makes for a profitable league. So revenue in the sports arena is generated by competition not monopoly power. The EPL title went down to the last game whilst PSG won the Ligue 1 with 5 games left.

Source: Financial Times – 15th May 2019 – ‘Premier League wins by creating room at the top for football clubs’  by John Gapper.

Veblen Good – £42,000 a night at the Mandarin Oriental Hotel, London

Lucy Kellaway wrote an interesting piece in the FT about the cost of a nights stay at the most expensive hotel in London – a suite in the Mandarin Oriental will cost you £42,000 a night which is £10,000 to £20,000 more than London’s other most expensive suites.

You could say that the Mandarin hotel is a good example of conspicuous consumption which was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status. So-called Veblen goods reverse the normal logic of economics in that the higher the price the more demand for the product.

Over the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever-increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth.

The Economics of Uber

Another video from Paul Solman of PBS in his series ‘Making Sense’. With Uber’s initial public offering expected to be one of the largest ever he  visited their headquarters to better understand what happens when a San Francisco company puts economists in the driver’s seat. Useful for those looking at majoring in Economics.

HT – Sex, Drugs and Economics

IGCSE Economics – Division of Labour

Just been doing Division of Labour with my IGCSE class and came across this very good video from Marginal Revolution University.

Division of Labour  is the breakdown of a production process so that each person can specialise in one part of that process and, through skill development and timesaving, workers’ productivity is increased. Adam Smith in The Wealth of Nations pointed out that the making of pins required 18 distinct operations and if one person did them all, approximately 20 pins would be produced each day. However, if ten people carried out some of the operations, then – through a division of labour – upward of 48,00 pins or 4,800 pins per worker would be produced each day.

A2 Economics – Quantity Theory of Money

Just covered MV = PT with my A2 class and produced some notes followed by a video from Marginal Revolution which I got from the Economics Teacher group.

Quantity Theory of Money

The Monetarist explanation of inflation operates through the Fisher equation.

M x V = P x T

M = Stock of money

V = Income Velocity of Circulation

P = Average Price level

T = Volume of Transactions or Output

For example if M=100 V=5 P=2 T=250.   Therefore MV=PT – 100×5 = 2×250

Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. The Quantity Theory is the familiar monetarist interpretation of the Equation and is based on the following assumptions:

  1. T is broadly equivalent to total output and is fixed in the short run
  2. V is broadly stable (i.e. the demand to hold money is relatively uninfluenced by the change in interest rates that arises from changes in the money stock).
  3. Causality runs from the left hand side to the right hand side of the equation

On these assumptions, increases in the money supply (after a suitable time lag) cause equivalent increases in the price level.

Critics argue that:

  1. V is not stable and responsive to interest rate changes.
  2. T is not fixed and is responsive to increases in the money supply below full employment.
  3. Change is P tend to cause changes in M (and not v.v.). In other words, changes in the money supply accommodate inflation and do not cause it.

Calculation using MV = PT

Since MV=PT (by definition), if M=$60, V=4 and T=12, then P can be found.

P =   MV /T  =  (60 x 4)/12  =  $20 

Is Artificial Intelligence like a typical economist?

Diane Coyle wrote a piece on the Project Syndicate website discussing that computers are designed to think like economists. Artificial intelligence (AI) is a faultless version of homo economicus as it is a rationally calculating, logically consistent, ends-orientated agent capable of achieving its desired outcomes with finite computational resources. They are perceived as much more effective than a human in achieving the maximum amount of utility for an individual. Coyle does go onto say that economists today cannot offer a measure of actual utility.

Jeremy Bentham’s famous formulation of utilitarianism is known as the “greatest-happiness principle”. It holds that one must always act so as to produce the greatest aggregate happiness among all sentient beings, within reason. John Stuart Mill’s method of determining the best utility is that a moral agent, when given the choice between two or more actions, ought to choose the action that contributes most to (maximises) the total happiness in the world. However this assumption can produce some unease.

  • Most of those designing algorithms are utilitarians who believe that if a ‘good’ is known, then it can be maximised. Therefore how much thought is there about possible societal impacts of algorithms as they are designed to optimise efficiency and profitability.
  • Algorithms are created using current and future data that is full of bias. The result could be the institutionalisation of biased and damaging decisions with the excuse of, to quote ‘Little Britain’, ‘the computer says no’. see video below.
  • Algorithms make it easy for consumers to decide things and it acts as a short-cut (heuristic). Therefore we become a slave to the algorithm rather than taking more ownership of our thinking /reasoning. Those who  control of the algorithm have an unfair position.

There is no doubt in certain aspects of society AI is extremely useful and can cut down bureaucracy and lead to improved efficiency in everyday life. The real issue extends beyond the use of algorithmic decision-making in corporate and political governance, and strikes at the ethical foundations of our societies. As Coyle points out we need to engage in self-reflection and decide if we really want to encode current social arrangements into the future.

Airline prices: 2014 – 2018 and dynamic pricing

Another great graphic from The Economist showing the change in the price of an economy class ticket for both short-haul and long-haul flights. Routes longer than 5,000km have generally seen price drops of 30% and 50% on some transatlantic routes.

Reasons for the drop in fares:

  • Fuel costs have come down – 2014 = US$0.81 / litre – 2016 = US$0.22 / litre
  • Increasing long-haul competition from low-cost carriers
  • More fuel efficient planes = lower costs
  • Subsidies to state owned e.g. China
  • Major airline deregulation
  • Airlines have become much better at making more efficient use of their planes – i.e. having them full

Airlines and dynamic pricing

To the average buyer, airline ticket prices appear to fluctuate without reason. But behind the process is actually the science of dynamic pricing, which has less to do with cost and more to do with artificial intelligence. See video below from Tom Chitty of CNBC

A2 Economics – the need to move to more contestable markets.

The Economist had as its main Leader an article on the lack of competition in the global market place. Too many companies have  monopoly power and earn, what the economics textbooks call,  significant ‘abnormal profits’. In 2016 a survey found that more than half of young Americans no longer support capitalism. In the past governments have made it a more level playing field.

  • US – at the start of the 20th century they broke up monopolies in railways and the energy industry. Ronald Reagan also unleashed the power of the market
  • West Germany – created competitive markets to rebuild their post-war economy
  • Britain – Margaret Thatcher exposed state-owned inefficient domestic industries to the dynamic foreign competition. She also privatised the Commanding Heights of the economy.

There are 3 tests that The Economist use to examine the market structure:

Concentration Ratios
A lot of firms have experienced inertia and become very comfortable whilst the tech firms are building significant amounts of market power. In the US Concentration ratios between 1997 and 2012 have risen in approximately 600 census industries, with the weighted average market share of the top 4 firms growing from 26% to 32%. 10% of the US economy is made up of industries where 4 firms have more than 66% of the market share. The concentration ratio is the percentage of market share taken up by the largest firms. It could be a 3 firm concentration ratio (market share of 3 biggest) or 5 firms concentration ratio.

Abnormal Profits
In a healthy economy you would expect profits to be competed down, but the free cashflow of companies is 76% above its 50-year average, relative to GDP. In Europe the trend is similar, if less extreme. The average market share of the biggest four firms in each industry has risen by three percentage points since 2000. On both continents, dominant firms have become harder to dislodge.

Openness
Of US firms that made very high profits in 1997, 50% still did in 2017. There is a reduction in new firms and with a lowdown in globalisation industries that are less exposed to trade have become more dominant in the market place – the domestic market. The current protectionist policies of the Trump Administration don’t help to breakdown the barriers to entry and as the high stock values of profitable firms show, investors believe their advantages will continue. Powerful firms tend to stay and of the total capital spending and R&D done by America’s leading 500 companies the top 20 firms account of 38% of this spending.

The Contestable Market – A2 Economics – Theory

The degree of contestability of a market is measured by the extent to which the gains from market entry for a firm exceed the cost of entering (i.e. the cost of overcoming barriers to entry), with the risks associated with failure taken into account (the cost associated with any barriers to exit). Accordingly, the levels of barriers to entry and exit are crucial in determining the level of a market’s contestability. Barriers to exit consist of sunk costs, that is to say costs that cannot be recovered when leaving the market. The contestable markets approach suggests that potential entrants consider post‑entry profit levels, rather than the pre-entry levels suggested by neo‑classical theory.

Obviously no market is perfectly contestable, i.e. with zero sunk costs. In modern economies it is the degree of contestability which is relevant, some markets are more contestable than others. Also just because there have been no new entrants to a market over a given period of time does not mean that this market is not contestable. The threat of entry will be enough to make the existing (incumbent) firms behave in such a way as to recognise this, i.e. by setting a price which doesn’t attract entry and which only makes normal profits.

Markets which are highly contestable are likely to be vulnerable to ‘hit and run competition’. Consider a situation where existing firms are pricing at above the entry‑limit level. Even in the event that existing firms react in a predatory style, new entry will be profitable as long as there is a time lag between entry and the implementation of such action. Having made a profit in the intervening period, the new entrant can then leave the market at very little cost.

In a contestable market there are no structural barriers to the entry of firms in the long-run. If existing businesses are enjoying high economic profits, there is an incentive for new firms to enter the industry. This increases market competition and dilutes monopoly profits for the incumbent firms.
Market contestability requires there are few sunk costs. A sunk cost is committed by a producer when entering an industry but cannot be recovered if a firm decides to leave a market.

The video below on the Airline Industry in the US from Commanding Heights series is a good example of breaking down monopoly power.

Sources:

The Economist – The Next Capitalist Revolution – November 17th 2018

Anforme – A2 Level Economics Revision Booklet