Category Archives: Supply & Demand

AS Revision – Indirect Tax

The AS multiple-choice paper is coming up and here is this graphic to explain indirect taxes – a popular question. An indirect tax will have the following effects on the market:

Indirect Tax

• The supply curve shifts vertically upwards(effectively a shift to the left) by the amount of the tax(gf) per unit. The price increases but not by the full amount of the tax. This is because of the slopes of the demand and supply curves.
• The consumer surplus is reduced from acp to agb. The portion gbhp of the old consumer surplus is transferred to government in the form of tax.
• The producer surplus is reduced from pce to fde. The portion phdf of the old producer surplus is transferred to the government in the form of tax.
• The market is no longer able to reach equilibrium, and there is a loss of allocative efficiency resulting in the deadweight lost shown by the area bcd. This represents a loss of both consumer surplus bhc and the producer surplus hcd that is removed from the market. The deadweight loss also represents a loss of welfare to an individual or group where that loss is not offset by a welfare gain to some other individual or group.

AS & A2 Revision – How PED varies along a demand curve

Been doing some more revision sessions on CIE AS economics and went through how the elasticity of demand varies along a demand curve. Notice in Case A that the fall in price from Pa to Pb causes the the total revenue to increase therefore it is elastic – the blue area (-) is less than the orange area (+). In Case B the opposite applies – as the price decreases from Pa to Pb the total revenue decreases therefore it is inelastic – the blue area (-) is greater than the orange area (+). In Case C the drop in price causes the same proportionate change in quantity demanded, therefore there is no change in total revenue – it is unitary elasticity.

Remember where MR = 0 – PED = 1 on the demand curve (AR curve). A particularly popular question at A2 level is ‘where on the demand curve will a profit maximising firm produce at?’. As MC = MR above zero the imperfect firm always produces on the elastic part of the demand curve.

Why is Vanilla so expensive?

The video below from The Economist looks at the supply and demand that impacts the price of vanilla. 80% of the world’s vanilla is grown in the perfectly suited climate of the north-east region of Madagascar. It’s the country’s primary export crop.

In 2014 vanilla was $80 a kilo.

In 2017 was $600.

Today it’s around $500.

The price rise is due in part to global demand. The trend of eating naturally means that food companies have shunned synthetic flavouring in favour of the real deal. Companies have started to look elsewhere for their natural vanilla. Indonesia, Uganda and even the Netherlands are growing the crop. For a century Madagascar has enjoyed a near-monopoly on vanilla. But this industry may be in line for a radical overhaul.

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.

Chile looks to cherries for transition away from copper

As with a lot of developing countries (and developed countries for that matter) there tends to be a reliance on a particular resource which can be to the detriment of its economy. Invariably if an economy is going to become more resilient it must be able to diversify into other areas that generate growth.

Traditionally Chile has relied on copper which accounts for over 50% of its export value but if it is going to become more developed it must start to rely on other goods or services. In November 2017 a free trade agreement (FTA) between Chile and China was signed and this was the catalyst for the cherry industry to flourish. Garces Fruit, just south of the capital Santiago, has become the world’s biggest producer of cherries and the development of the industry has been due to a combination of the government and the private sector. Cherries in China are viewed as a symbol of prosperity and marketed as something closer to a luxury product rather than ordinary fruit. With the harvest in Chile around the Chinese new year they make a perfect gift. However the benefits of the primary sector began in the 1990’s, with rising exports of wine, salmon and grapes but farmers are now tearing out vines and replacing them with cherries which are more profitable. Even though the cherry industry requires a lot of labour, which Chileans are not keen on doing, between 2015 and 2017 700,000 immigrants, mainly from Haiti and Venezuela, averted a labour shortage.

Chile Cherry export destination – 2017

Cherries remain the most planted fruit in Chile along with walnuts and hazelnuts due to its high profits and increasing demand from China. However, prices in China decreased with large supplies exported to that market (demand), but China still pays higher prices than the price other country destinations offer to Chilean exporters. China is the top market for Chilean cherries. Chile exported 156,497 MT or 85 percent to that market in 2017 (see graph above), a 109 percent increase over MY2016/17. Chilean cherry export season starts in November and end in February and it focuses its market promotion and export campaigns in China. It is expected that Chilean exports to China will increase to that market since demand for Chilean fruits keeps increasing, and Chilean exporters get higher prices in China for their fruits than in other destinations.

Sources:

The Economist – January 19th 2019 – Bello Adam Smith in Chile

USDA – Chile Report Stone Fruit – 8th October 2018.

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

Auckland house prices 73.8% overvalued against income.

Whilst there has been a lot of talk about Auckland’s flattening house prices the city is ranked only behind Hong Kong (94.1%) as the most unaffordable city in the Economist’s ‘cities house price index’ – house prices in Auckland are 73.8% overvalued compared to the average income. This figure is ahead of Sydney, Amsterdam, London, New York, Paris and Vancouver – see graph from The Economist – showing how housing is basically unaffordable in proportion to earnings.

There are 3 reasons why house prices globally have been accelerating at such a high rate – Demand, Supply and the cost of borrowing.

Demand
Regional population growth in Auckland has been significant and although is slowing it still has the fastest population growth in NZ. With the influx of people and the housing construction more jobs become available which in turn attracts workers from other areas. Furthermore foreign investors have played their part in increasing demand although this has reduced over the last year with the government putting in place regulations with home ownership.

Supply
Housing has become particularly scarce with supply unable to keep up with demand. But recent consent figures for 2018 show that 13,000 were issued in Auckland compared to 10,000 in 2017. Auckland was previously building too few houses relative to population growth, leading to a worsening housing shortage as indicated by a rise in the estimated number of people per dwelling.

Low interest rates
Since the GFC economics has been dominated by fiscal and monetary policies to stimulate aggregate demand. Tax cuts have added to consumers bank balances but it is monetary policy that has been particularly prevalent with record low interest rates encouraging consumers to borrow money and buy property. Furthermore with the stock market becoming a fickle location for investment investors sought the so-called safety of the housing market and in many cities did particularly well.

But prices are starting to level off and in some cities falling in a response to variety of reasons – rising  yield on treasury bonds – tighter regulations on overseas buyers – uncertainty about Brexit – China tightening up on capital outflows of the super-rich.

Source: The Economist – Buttonwood – November 10th 2018

Why dearer oil impacts developing economies more.

It wasn’t long ago that $100 for a barrel of oil was the norm but with the advent of the shale market the production increased which depressed prices. It was felt that the flexibility of large scale shale production from the USA could act as a stabiliser to global oil prices.

Oil shocks – supply or demand?

Oil shocks are not all the same. They tend to be associated with supply issues caused by conflict or OPEC reducing daily production targets. In the case of an increase in global growth there is the demand side for oil which increases the price. However this doesn’t have a great effect as in such cases the rising cost of imported oil is offset by the increasing export revenue. However today’s increase has a bit of both:

Demand – global consumption has increased as the advanced economies recover after the GFC especially China
Supply – supply constraints in Venezuela from the economic crisis. Also tighter American sanctions on Iran and OPEC producers are not increasing supply with the higher price.

Higher oil prices do squeeze household budgets and therefore reduce demand. Lower prices are expected to act as a stimulus to consumer spending but it can also have negative effects on the petroleum industries.

Emerging economies the impact of higher oil prices

Oil importing emerging economies are badly impacted by higher oil prices:

  • Terms of trade deteriorate as the price of their imports rise relative to their exports
  • Exports pay for fewer imports = importers’ current-account deficits widen.
  • Normally this leads to a depreciation a a country’s currency which makes exports cheaper and imports more expensive.

However this is not the case today. World trade is slowing and with it manufacturing orders therefore higher oil prices make the current account worse which in turn depreciates the exchange rate. For emerging economies who have borrowed from other countries or organisations a weaker exchange rate intensifies the burden of dollar-denominated debt. Companies in emerging economies have borrowed large amounts of money being spurred on by very low interest rates but they earn income in the domestic currency but owe in dollars – a weaker exchange rate means they have to spend more of their local currency to pay off their debt. Therefore indebted borrowers feel the financial squeeze and may reduce investment and layoff workers.

Another problem for emerging economies, as well as higher oil prices, is that central banks are looking to tighten monetary policy (interest rates) with the chance of higher inflation.

Source: The Economist – Crude Awaking – September 29th 2018

New Zealand vegetables prices spike in March with bad weather

Tomato, lettuce, cauliflower, cabbage, and broccoli prices rose sharply in March 2018, boosting vegetable prices 9.5 percent in the month after adjusting for typically seasonal changes.

“Vegetable crops have been affected by a run of storms in recent weeks – lower supply (supply curve to the left) due to bad weather usually means higher prices,” consumer prices manager Matthew Haigh said.

“In February, we saw rising prices for lettuce, broccoli, and cauliflower, due to a combination of humid weather and cyclone Gita. As expected, that wet weather has affected vegetable prices in March too.”

Tomatoes rose more than 60 percent in March to $4.65 a kilo. In March last year, tomatoes were 83 cents cheaper at $3.82 a kilo.