Tag Archives: New Zealand

New Zealand Supermarket Duopoly – maximax and maximin strategies

Michael Cameron did a very relevant post on his blog ‘Sex, Drugs and Economics’ which focused on the duopoly market structure of New Zealand’s supermarkets. Part of the NCEA Level 3 and the CIE A2 economics courses look at market structures – monopolistic, oligopoly, duopoly, monopoly, and monopsony. A duopoly refers to two firms in a market whilst an oligopoly has a small number of firms but greater than two. Therefore we can say that Oligopoly and Duopoly are very similar market structures and they can co-ordinate their behaviour to exploit the market by lowering competition which in turn leads to greater profits for all.

Using the example of the supermarket duopoly Foodstuffs and Woolworths. Each company has two options – high price or low price. Obviously if they both price low they stand to be worse off and if they price high they are both set to gain. The outcome and payoffs are illustrated below:

Maximax – riskier strategy
A maximax strategy is one where the player attempts to earn the maximum possible benefit available. This means they will prefer the alternative which includes the chance of achieving the best possible outcome – even if a highly unfavourable outcome is possible. This strategy, often referred to as the best of the best is often seen as ‘naive’ and overly optimistic strategy, in that it assumes a highly favourable environment for decision making.

In this case, for both food providers, the aggressive maximax strategy is $140m from a low price and $120m from a high price, so a low price gives the maximax pay-off.

Maximin – conservative strategy
A maximin strategy is where a player chooses the best of the worst pay-off. This is commonly chosen when a player cannot rely on the other party to keep any agreement that has been made – for example, to deny.

In terms of the pessimistic maximin strategy, the worst outcome from a low price is $100m, and from a high price is $70m – hence a low price provides the best of the worst outcomes.

Again, lowering price is the dominant strategy, and the only way to increase the pay-off would be to collude and increase price together. Of course, this requires an agreement, and collusion, and this creates two further risks – one of the food companies reneges on the agreement and ‘rats’, and the competition authorities investigate the food companies, and impose a penalty.

Nash equilibrium
Nash equilibrium, named after Nobel winning economist, John Nash, is a solution to a game involving two or more players who want the best outcome for themselves and must take the actions of others into account. When Nash equilibrium is reached, players cannot improve their payoff by independently changing their strategy. This means that it is the best strategy assuming the other has chosen a strategy and will not change it. For example, in the Prisoner’s Dilemma game, confessing is a Nash equilibrium because it is the best outcome, taking into account the likely actions of others.

Countries with early lockdown top the list for GDP in 2020

Below is a useful graph looking at the 2020 GDP levels in most developed countries. New Zealand had a quick rebound with its elimination strategy, a supportive fiscal response and an expansionary monetary policy. The 2020 GDP figures considered the scale of lost activity from the COVID-19 lockdown as well as the rebound when restrictions were lifted. There seemed to be the trend that early lockdowns led to better GDP figures. Taiwan (2.98%) and China (2.3%) were the only countries to experience positive growth levels with New Zealand down 2.9% compared to 2019. Taiwan’s investment into public health infrastructure pre-COVID-19 enabled them to avoid a national lockdown. Early screening, effective methods for isolation/quarantine, digital technologies for identifying potential cases and mass mask use led to a much more controlled environment. China did experience a positive growth rate (2.3%) but this was well below 7% which they have been averaging since 2010.

However it is important to be aware that some countries were more impacted by COVID-19 than others, not only because of their hesitation to lockdown but also their reliance on certain sectors for GDP growth. Countries like Spain, who are very dependent on the tourist industry were hit hard by the pandemic. Many emerging and developing countries were already experiencing weaker growth before the pandemic struck.

Source: Westpac Bank

The America’s Cup: multiplier effect and cost-benefit analysis

Source: RNZ

I was fortunate enough to be out in the spectator fleet for yesterday’s America’s Cup racing between Emirates Team New Zealand and Luna Rosa Prada Pirelli – honours were even in the two races. As with most events, analysts attempt to work out the multiplier effect and the impact it will have on an economy. In 2017 forecast, predicted that the America’s Cup would add between $600 million and $1 billion to the New Zealand economy. Employment would be boosted and in the longer term for every $1 put into infrastructure would generate $7.50 of economic activity. However with the impact of COVID-19, New Zealand will suffer a loss on the $249.5 million it invested in the America’s Cup, but there maybe benefits over time.

The Multiplier Explained

Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy

Source: CIE Revision Guide by Susan Grant

The economic impact is based a lot on the multiplier effect but the use of cost benefit analysis also considers those external costs and benefits which are not easily convertible into a monetary value.

Evaluation of CBA
It is clearly more efficient for public spending to be subject to rigorous analysis, rather than based on the whims of politicians. However, there are a number of criticisms of CBA, including:

1. It is often very costly to undertake, though usually this forms a very small proportion of total project spending.
2. Assessing the monetary value of external costs and benefits is often very difficult. What precisely is the value of the congestion that would be reduced if a new bi-pass were built around a busy town? How much extra tourist revenue will actually be gained from a new airport? How long will the building be used as a venue, as in the case of the Viaduct area in Auckland for the 2020/21 America’s Cup. One solution to this problem is shadow pricing, where analysts attempt to place a value on the costs and benefits of a decision or a project where an actual market price does not exist.
3. Changing circumstances can make initial projections appear grossly inaccurate. The Wembley Stadium project in London went considerably over-budget, and the majority Olympic Games are far more costly than originally estimated. For instance the Montreal Olympics in 1976 was eventually paid off in December 2006. Higher interest and inflation rates, and falling exchange rates can all dramatically affect costs.
4. Actual costs can also rise above planned costs as a result of moral hazard, where project managers go over budget because they expect that those who fund the project will make extra funds available, providing an insurance against their over-spending.
5. Ultimately, decisions to go ahead with projects are only guided by CBA, leaving politicians to make the final decision. Politicians are free, of course, to ignore the results of an appraisal.

If you have read the book Circus Maximus you will no doubt be aware that most big sporting events run over budget and in some cases don’t generate the benefits until well after the event if at all. So just because an event runs over budget is that enough to say that we shouldn’t go ahead with the event. There are a great many other benefits of hosting an event like the Americas Cup which are not measured by GDP. The sense of community and wellbeing that comes from New Zealander’s performance whether it be in rugby or at the Olympics. It tends to bring people together feel a sense of belonging which has external benefits.

Unemployment figures in New Zealand nearing pre-Covid levels.

Been covering unemployment with my Yr 13 class and showed them this graph today during our online class. As well as talking about recent changes it was useful to mention the boom period in the early 2000’s, the GFC in 2007 and how they impacted the level of unemployment. Also note the correlation between the labour cost index (changes in wages and salaries) and the unemployment rate. As labour becomes more scarce (lower levels unemployment) the LCI starts to rise and vice versa.

Source: Westpac Economic Overview. February 2021

The most recent figures publish show that the unemployment rate in New Zealand fell 0.4 percentage points to 4.9 percent in the December 2020 quarter which surprised a lot of commentators who predicted an increase. This time last year the unemployment rate was 4.1%. The number of those unemployed fell by 10,000 to 141,000 in the December quarter, while the number of those employed rose by 17,000 to 2,734,000 in seasonally adjusted terms. The proportion of the working-age population that were in the labour force also rose in the quarter. The labour force has seen sectors affected in different ways:

Negative – sectors in retail, hospitality and transport have seen major job losses.
Positive – with increased government spending there was employment growth in health, education and public services. Employment in the construction industry expanded by 8.2 percent between the December quarters, with Stats NZ reporting that more people were “working in areas such as plumbing and electrical services, roofing, and concreting”.

Differences in the economic fortunes of various sectors explain why there are reports of skill shortages at the same time as unemployment has risen. On the whole New Zealand is in a very lucky position relative to other parts of the world.

Milk prices on the up – supply and demand

Demand – this has been healthy especially from China as higher domestic milk prices there has likely led to greater milk imports from New Zealand. The number of unsatisfied buyers at recent auctions has been elevated and forward price curves for major products are relatively flat suggesting fundamental strength rather than a near term short squeeze.

Supply – NZ supply as milk production dipped below usual levels in November and with drier weather in North Island extra supply for this time of year will be unlikely.

Fonterra lifted its 2020/21 milk price forecast to a range of $6.90 to $7.50 (up from $6.70 to $7.30 previously) – see graph below.

BNZ Bank – Economy Watch

This being said Fonterra has to be cautious with:

  • NZ weather conditions – drought can increase the price of feed and deplete water stores for cows and can reduce the ability of dairy farmers to grow feed and ultimately reduce their herd.
  • challenges from further escalation of COVID – global demand could soften as a result of extended shutdowns, or large falls in discretionary spending.
  • increasing milk production in the Northern Hemisphere – In Europe and the US, previous dairy stockpiles are now reaching commercial markets which will depress prices.
  • Strong NZ$ – milk is sold on the GlobalDairyTrade (see below) in US$. If the NZ$ gets stronger it will take more US$ to convert into NZ$ so higher domestic milk prices.

How does the GDT work?

GlobalDairyTrade trading events are conducted as ascending-price clock auctions run over several bidding rounds.  In each auction a specified maximum quantity of each product is offered for sale at a pre-announced starting price. Bidders bid the quantity of each product that they wish to purchase at the announced price. If the price of a product increases between rounds, to ensure their desired quantity a bidder must bid their desired quantity at the new, higher price. Generally, as the price of a product increases, the quantity of bids received for that product decreases. The trading event runs over several rounds with the prices increasing round to round until the quantity of bids received for each product on offer matches the quantity on offer for the product (as shown in the diagram below). Each trading event typically lasts approximately 2 hours.

New Zealand’s export risk exposure to China.

On 7th April 2008 New Zealand became the first OECD country to sign a free trade deal with China, an economy which in the 1970’s was one of the poorest countries in the global economy. Today China is the world’s second largest economy and the fastest growing at a rate around 7% per year. China is now comfortably New Zealand’s largest export market, accounting for the largest share of our exports in all but a few sectors.

Source: Westpac Bank

In 2017, China surpassed Australia and became our largest export market. But as exporters’ focus has switched to China, New Zealand’s exports have become less diversified, exposing exporters to concentration risk.

Westpac Bank reported in their November 2020 Quarterly Overview that while the New Zealand-China trade relationship is strong, China could in the future choose to disrupt New Zealand exports. Recently Australian exports into China had the following restrictions imposed on them:

  • 80% tariff on Australian barley exports
  • ban on Australia’s biggest grain exporter
  • suspension of beef imports from five major meat-processing plants
  • China has also launched an anti-dumping investigation into Australian wine exports
  • Chinese cotton mills were told not to process Australian imports

At a high level, NZ-China trade flows reflect each economy’s comparative advantage and because of this trade relationship New Zealand faces less risk exposure. The risk exposure really depends on how important New Zealand’s export supply is to China and the other markets where the product/service can be sourced which includes other countries as well as domestically.

More Options = More Risk

China exposure risk by export sector

Westpac Bank

High risk
It seems that tourism, seafood, and gold kiwifruit have the highest exposure. For these exports, essentially China has options (including domestically) for alternate supply. Education (universities and English language schools) also faces similarly high risk.

Also kiwifruit as New Zealand only account for 4.5% of China’s total fruit imports. China does have a competitive domestic horticulture industry which has started to grow Zespri’s Sungold kiwifruit variety.

Medium risk
Wood and wider fruit sectors – have medium exposure risk. New Zealand accounts for a relatively significant share of global meat and wood exports, so China is reliant on New Zealand.
Meat – China also recognises New Zealand as a reliable and safe exporter. Looking at the wider fruit sector, exporters remain relatively diversified and thus less reliant on China.

Low risk
Dairy – in a strong position as China imports around 50% of its dairy produce from New Zealand.
Wine – China is a small market for New Zealand, so the sector’s reliance on China is also small.

Overall the complementary nature of the NZ China trade relationship means New Zealand’s risk exposure is less than the outright level of exports would suggest.
China needs New Zealand’s food (and wood) as it cannot produce enough (efficiently) on its own – while New Zealand remains the most competitive supplier. New Zealand needs China’s manufactured goods – while China remains the most competitive supplier.

Source: New Zealand’s exports to China: where is New Zealand most exposed? Westpac Economic Bulletin – 8 October 2020

OCR – LSAP – FLP = New Zealand’s Monetary Policy Toolkit

Below is a useful flow diagram from the ANZ bank which adds Large Scale Asset Purchases (LSAP) and Funding for Lending Programme (FLP) to the Official Cash Rate (OCR – Base Rate)

LSAP – this is the buying of up $100 billion of government bonds – quantitative easing
FLP – this gives banks cheap lending based on the Official Cash Rate – could be about $28 billion based on take up
OCR – wholesale interest rate currently at 0.25%. Commercial banks borrow at 0.5% above OCR and can save at the Reserve Bank of New Zealand (RBNZ) at 1% below OCR.

With FLP and more LSAP this will mean lower lending rates and deposit rates. This should provide more stimulus in the economy and allay fears of future funding constraints making banks more confident about lending. Add to this a third stimulus – an OCR of 0.25%. The flow chart shows the impact that these three stimulus policies have on a variety of variables including – exchange rates – inflation -unemployment – consumer spending – investment – GDP. Very useful for a class discussion on the monetary policy mechanism.

US Farm subsidies and EU dump cost New Zealand farmers

Donald Trump’s subsidies to US farmers (see below) could be above what is allowed under international trade rules and it has been suggested that subsidies in 2020 will make up 36% of farm incomes.

US farm subsidies

  • 2018 – US$12bn
  • 2019 – US$16bn

This year US farm incomes are set to drop 15% even after the payment of subsidies and billions of dollars have been set aside to assist the farming sector. New Zealand officials are concerned that the subsidies given to US farmers will exceed the US$19billion which is the WTO’s limit. They want formal notification of payments in 2020 and how the US plans to reduce this assistance to farmers. The EU, China, India and China are asking similar questions of the US.

Source: Tutor2u

Subsidies distort trade and entice farmers to keep producing even though prices are falling – see graph . This output tends to be inefficiently produced and would not be competitive in a normal market free of subsidies.What the subsidies did in New Zealand was to encourage people to develop land that was not really suitable for any agricultural use. However as they got a subsidy from the government efficiency or quality didn’t feature as a major factor in maintaining competitiveness. With subsidies prices take longer to recover their former levels while excess supply is worked through as was the case in 2018 and 2019 when the EU dumped subsidised skim milk powder on the global market. But the support package to the US farmers is very significant and has the potential to negatively impact those countries that have unsubsidised farmers.

The Dairy Companies Association of NZ’s (DCANZ) executive director Kimberly Crewther says while other countries had propped up their farmers since the start of the pandemic the US was “way out in front” with the size of its support programmes. 
That was concerning given the growth trajectory the US dairy industry was currently on.
“They have the potential to become the world’s largest dairy exporter, but that is going to come at a high cost to unsubsidised producers and not just exporters like NZ if that growth is coming from subsidies,” she said.

EU dumping has NZ Farmers lose $500m
The dumping of subsidised skim milk powder (SMP) by the EU in 2018 is estimated to have cost New Zealand farmers $500m. In 2016 the EU moved nearly 25% of its production into storage before dumping it on the market in 2018 and 2019 at discounted prices. The purchasing of SMP by the EU was done with the intention of putting a floor price under the low EU farm gate milk prices.
EU stocks – 378,000 tonnes in 2017 – 16% of global supply. Release of stocks onto the market had the estimated impact on prices:

World Price

Source: Tutor2u
  • 2018 – SMP prices down by 3.6%
  • 2019 – SMP prices down by 8.7%

US farm gate prices

  • 2018 – SMP prices down by 1.7%
  • 2019 – SMP prices down by 3.9%

The cost to NZ farmers is estimated at 30c per kg of milk solids in 2018 or 4.7% of the payout. The Eu was able to undercut competitors and increase its share of of the global SMP market from 30.6% in 2016 to 42.3% in 2019. New Zealand’s share fell from 23.5% to 16.3% over the same period.

Source: Farmers Weekly – November 9, 2020

Changes to the CPI in New Zealand – 2020

The consumers price index (CPI), New Zealand’s best known measure of inflation, measures the rate of price change of goods and services purchased by households. The CPI consists of a basket of goods and services that represent purchases made by households. The goods and services in the basket, and their relative importance, are reviewed every three years to ensure the basket remains up to date.

There are about 649 goods and services included in the basket. They are classified into 11 groups:

  • food
  • alcoholic beverages and tobacco
  • clothing and footwear
  • housing and household utilities
  • household contents and services
  • health
  • transport
  • communication
  • recreation and culture
  • education
  • miscellaneous goods and services.

These groups are then broken down further into 45 subgroups and then into 107 classes. The CPI is reported each quarter down to the class level.

After a review in 2020 the following goods or services have been added and removed from the CPI

Items that have been included in the basket of goods

Items that have been removed in the basket of goods

Why are house prices on the rise in New Zealand?

The rise in house prices in New Zealand has been against all expectations. Four indicators tend to have the biggest impact on house prices:

Lower interest rates seem to be the main reason for the major increase in prices but there is fear amongst consumers if they don’t purchase a property now they will miss out on the market as prices start to escalate. With interest rates being predicted to remain low for till at least the end of next year it is likely that house prices will remain elevated with no major correction. However as with most housing markets there will become a time when over-zealous investors push prices to non-sustainable levels. If house price to income and rent ratios blow out then owning a house will simply become an untenable option for a greater proportion of the population. Ultimately, prices will then have to move. Below is a useful graph showing house prices in New Zealand since 1963 – generally on the up for the vast majority of the period.

Source: RESEARCH ECONOMY WATCH – BNZ 15th October 2020