Two VAT Stories - Sports Goods and Restaurants
Changing the rate of value added tax (VAT applied to a product should bring about a change in the retail price of a good or service to the consumer. The current rate of VAT in the UK is 15% following a temporary cut from 17.5% in November 2008. Today the Public Health Commission has started to lobby for a reduction in VAT to the min rate allowed under EU law - 5% - for products such as sports equipment. The justification is that lower prices will increase the affordability of leisure products and help encourage more people to follow a healthy life style. As always a reduction in an ad valorem tax will have a great impact on the price of more expensive equipment - for example the £1000+ cost of a concept 2 rower compared to an entry level tennis racket. The arguments are raised in this BBC news article.
Across the Channel the cost of eating out will fall as a result of a cut in VAT by the French government. Value-added tax (VAT) has been reduced from 19.6% to 5.5%, in an attempt to increase consumer spending and create thousands of jobs.
On a different matter I didn’t realise until last week that VAT is applied to razor blades - one reason (but not the main one) behind the scandalously high prices that the likes of Gillette and Wilkinson Sword charge for their cartridges.
Petrol-Diesel Price Difference Narrows
Crude oil prices are heading towards $75 a barrel as speculators bet on a stronger-than -expected global economic recovery and naturally prices for fuel on the forecourts are heading northwards too. But an interesting feature of the latest price changes is the narrowing of the price premium that drivers with diesel-fuelled vehicles must pay. Apparently the closing of the gap is due to a relative abundance of diesel fuel stocks on the international market.
The name comes from German inventor Rudolf Diesel, who built the first diesel-powered engine in 1892
Mobile Takeovers - Who will gain if five becomes four?
The press is full of coverage about a possible takeover bid by Vodafone for T-Mobile UK which is currently owned by Deutsche Telekom. Nothing is certain yet - but if a takeover goes ahead and is allowed by the competition authorities, Vodafone will have around 40 per cent of the market for mobile phone users in the UK.
The approximate market shares would look something like this:
Vodafone 40%
O2 (owned by Spain’s Telefónica) 27%
Orange (owned by France Telecom) 22%
3 (owned by Hutchison Whampoa) 8%
If Vodafone and T-Mobile become one business there is one obvious cost saving (or synergy) - namely that the merged business would have to run only one mobile network instead of two, for example, so Vodafone could aim to secure significant savings in capital and operating spending. For any would-be purchaser the risk is over-paying for a business, there are plenty of examples of the ‘winners’ curse’ in past takeover bids.
The mobile phone market is a classic case of an oligopoly with just a handful of corporations dominating the market - but you do not always need a large number of operators to create genuine price and non-price competition in the industry. Indeed the UK is the only major European market with five mobile operators, and some analysts claim that the fierce battle for market share has had the effect of cutting profit margins and reducing the profits needed to reinvest in rolling out the next generation of mobile phone technology and improving the speed and reliability of a mobile phone network that needs to cope with an ever-increasing number of data-rich applications.
Having four rather than five major players looks on the surface to be reducing competition, but perhaps all of the remaining businesses will gain from higher profits at a time when the recession has hit the demand for new handsets and mobile phone services. Vodafone is a giant in the industry reporting revenues of £41bn for the year to March 31, 2009 and an operating profit of £11.8bn.
In the mobile phone service provider market there is always a balance to be struck between economic efficiency and welfare. Competition keeps prices down for consumers and helps to make fast mobile connections more affordable to millions. But the businesses themselves must be able to finance investment on enormous networks and generate a sufficient rate of return for their shareholders. It will be interesting to see how the competition authorities respond to the next wave of consolidation in the industry.
Cadburys, Cocoa and Coconuts
Here is a terrific example of how a long established business sees an emerging economy not just opportunity for growing sales and profits but also as a centre for production.
read more...»Trade Secrets at Irn Bru
Here is a good example of the importance that some busineses attach to their trade secrets!
The Supply-Side Benefits of Imports
Many students on introductory economics courses hold on to a rather naive view that exports are good and that importing is negative for economic performance. Exporting for its own sake (mercantalism) carries obvious risks as countries that have accumulated huge trade surpluses have found out. And access to cheaper imports of goods and service can have a very liberating effect on the supply-side of the economy. Lower priced imports create competition for domestic industries and allow home-based manufacturing businesses to source cheaper intermediate and capital goods.
You would expect the Economist to support trade liberalisation - but this feature in the Economist is worth reading for students who want to understand some of the supply-side benefits of reducing import tariffs.
“As part of those reforms, India slashed tariffs on imports from an average of 90% in 1991 to 30% in 1997. Not surprisingly, imports doubled in value over this period. But the effects on Indian manufacturing were not what the prophets of doom had predicted: output grew by over 50% in that time. And by looking carefully at what was imported and what it was used to make, the researchers found that cheaper and more accessible imports gave a big boost to India’s domestic industrial growth in the 1990s.”
The rest of the article is here - The merits of imports
World cocaine market ‘in retreat’?
According to this BBC report, years of government intervention by the Serious Organised Crime Agency to cut supplies of cocaine has been successful in reducing supply and so raising the price of the drug.
SOCA have followed a strategy of working in South America, the Caribbean, across the Atlantic and with European partners to intercept the suppliers. Wholesale prices have risen from £39,000 per kilo at the end of last year to £45,000, which would indicate a shortage of supply causing the equilibrium price for a demerit good to rise, reflecting some of the negative externalities and moving closer to the social cost.
However, unfortunately there may also be a case of government failure in the form of unintended consequences: data collected by the Forensic Science Service suggests that almost a third of police seizures are now less than 9% pure, the lowest recorded purity level.
The implication is that drug gangs are maintaining their supernormal profit by using increasing amounts of chemicals - so-called cutting agents - to dilute cocaine powder sold on the streets of Britain. They include the cancer-causing drug phenacetin, cockroach insecticide and pet worming powder. As a result, street prices are remaining fairly stable says Drugscope director Martin Barnes. “What is happening is that dealers are maximising their profits by selling a product that is potentially more harmful and much less pure and a lot of people buying it probably don’t realise that’s what’s going on.”
Servicing the Car Makers
Our motor vehicle industry appears to be in a fragile state, rarely a day goes by without one manufacturer or another locked in talks with the government about loan guarantee schemes or other emergency measures designed to prop up production in a sector hit by falling sales and the challenge of an industry with huge global capacity. The Society of Motor Manufacturers and Traders estimate that nigh on 800,000 people are employed in the motor vehicle industry in the UK. But how many of them have jobs on the production line itself, physically assembling the vehicles? The answer is smaller than you might think.
read more...»Revision: Network Economies of Scale
The power of networks is becoming increasingly recognised in the economics of long run costs, revenues and profits. Network economies rarely figure in mainstream AS and A2 economics textbooks but they will have to eventually as the sheer scope of network effects is understood.
read more...»Sewage - The Fuel of the Future?
Waste not want not.
Monopolistic water and sewage companies rarely get a good press but here is a fascinating news story in the Times. Severn Trent, one of the UK’s largest water suppliers which supplies water and waste services to 3.3 million households is researching ways in which the hundreds of thousands of sewage sludge that is generated every year in the UK can be turned into a biomass fuel to produce heat and electricity. The economic incentives to consider this have been boosted by a combination of subsidy, taxation and regulation.
On the subsidy front, since 2003, Renewables Obligation Certificates — a form of subsidy to accredited generators — have been available for electricity that is generated by burning biomass fuels, which include wood, straw or sewage gas and sludge.
On the tax side - the government has gradually increased the size of the landfill tax which covers disposal of waste in landfill sites - the tax is set to increase by 20 per cent to £40 per tonne, up from £32 in 2008. In 2010 it is set to rise again to £48 per tonne.
Regulations now ban the disposal of sewage sludge at sea.
The Times reports that
“About 347,000km of sewers collect more than 11billion litres of waste water in the UK every day. This water is treated at about 9,000 sewage treatment works across the country. Roughly 62 per cent of the country’s sludge is treated and recycled into a type of fertiliser known as biosolids, which is used to fertilise more than 80,000 hectares of British farming land every year.”
This is a good example to use in exam questions because the incentives to develop innovative schemes to find economically viable forms of renewable energy often require a combination of policies working in tandem rather than a single ‘big bang’ approach. Government policies towards waste can be found here.
Passing the burden - Sainsbury’s and their suppliers
AS micro students grappling with their revision on government intervention will come across the issue of who ends up paying for an indirect tax. The conventional view is that a supplier faced with an excise duty or other tax can consider passing it on by raising the final price to the consumer. Price elasticity of demand and supply come into play in deciding who eventually bears the burden of an indirect tax.
Here is a slight twist. Sainsbury’s has written an email to their suppliers of alcholic refreshment more or less insisting that they aborb the recent hike in duty announced in Darling’s budget. According to a report in the Daily Telegraph:
“Duty – April 2009” sent to its beer and cider suppliers prior to the Budget, J Sainsbury said that it would be “replacing” any lines on June 1 “that we cannot maintain margin on” following the announcement of an increase.”
In effect - they are telling them to aborb the tax or risk being delisted by the supermarket. Given Sainsbury’s monopsony power it is clear where the balance of influence lies in the relationship. Is Sainsbury’s decision asymmetric? Did they pass on the 2,5% decrease in VAT to their drinks department customers last Autumn?
Selling Cheese to the Chinese
Savvy businesses target the emerging middle class in emerging market countries whose income elasticity of demand for consumer goods and services is strongly positive. The FT reports today that “British dairy producer Milk Link owner of the Stilton brand, has signed a two-year deal with Yili Group to export Stilton – the first direct exports of the cheese to China. The cheese will be sold in supermarkets along the Chinese east coast, including branches of Tesco, Wal-Mart and Carrefour , while quarter-wheels will also be sent to upmarket hotel chains.”
Two balance of payments aspects here
1/ The direct export of tangible products to the Chinese economy - China accounts for only 2 per cent of total UK exports overseas at present
2/ The use of Tesco (UK), Wal-Mart (USA) and Carrefour (France) as distribution channels - made feasible by direct investment into the Chinese economy
Also worth mentioning that Milk Link is a cooperative of dairy producers - so successful export promotion into emerging markets will provide a flow of extra revenue for UK farmers who are licensed to make Stilton.
There is still a long way to go! Total cheese exports from the UK to China – mostly (processed) cheddar – accounting for just three tonnes in 2008.
More cheese please Gromit
Electric cars - subsidise the consumer or producer?
We can expect a battery of articles in the days and weeks ahead on government incentives to grow the UK electric car market. Gordon Brown is reported as favouring a sizeable subsidy for consumers to purchase electric vehicles - according to the FT, buyers of electric cars will be offered discounts of more than £2,000 – paid for by the state – under plans by Gordon Brown to make Britain a leading centre for manufacturing “greener” vehicles.
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Q&A: Which indirect taxes give the government to most revenue?
Which indirect taxes give the government to most revenue?
For the UK government value added tax provides the biggest source of revenue. In November 2008, VAT was cut from 17.5% to 15% on a temporary basis in a move by the government designed to stimulate consumer spending – the decision was said to be worth around £12 billion of lost tax revenue for the UK Treasury.
There are many other indirect taxes and our chart below highlights six of them. As you can see the flow of tax revenue from indirect taxes on tobacco provides a very important source of money for the UK government. Together these six indirect taxes add nearly £20 billion annually into the government’s coffers.
In a recession where consumer spending is falling and where there is a chance of a period of persistent price deflation, the UK government will see a fall in revenue from indirect taxes.
More revision notes on indirect taxes can be found here
USA triples the tax on cigarettes
I will resist the temptation to roll out the usual cigarette puns .... smokers fuming over tax rise etc etc ...but the news that the Federal tax on puffing away has risen so much remains of interest to economists….
The US government has introduced a huge rise in the tax on cigarettes - reported here by the BBC. For a 10-pack carton, the tax leapt to 10.06 dollars from 3.90 dollars.
It is a good example of how large scale increases in indirect taxes are needed to have a significant impact on demand and the timing of the tax hike is also interesting - is it better to raise taxes during an economic slump when household budgets are under great strain? Does this give people just the right incentive when they might be considering cutting back or stopping altogether? Note too that the article mentions how the extra tax revenue will be used - to pay for health care for uninsured children - an example of ‘earmarked’ or hypothecated taxation at work. Always assuming of course that the tax jump does lead to more revenue coming in.
Keep in mind that this is a federal tax and that individual states can (and do) levy their own supplementary duties on packets or cartons of cigarettes. With the combined city, state and recently raised federal tax, smokers in New York City pay about $10 per pack - $4 higher than in many southern states and a clear incentive for smuggling!
Higher taxes, health warnings, bans on smoking in public has reduced per capita consumption in the USA from almost 4,300 annually in 1965 to below 1,700 now but the market remains highly profitable.
Taxi licences and excess supply
Taxi drivers in Reading are facing an uncertain future after the council increased the number of taxi licences from 120 to 180, despite falling demand as a result of the economic downturn. A local association representing taxi drivers the Reading Taxi Drivers’ Association says that this move is highly dangerous, with cab drivers having to wait on average over an hour for a fare, resulting in more hours being worked to take home the same pay. In effect a cut in their real wage rate.
read more...»Negative mulitplier effects of a brutal outlook for carmakers
There seems to have been grim news from the car industry every day for the last week or so. Nissan and Jaguar are shedding jobs. In November Honda said they would shut down production for February and March, and today said they will extend that to cover April and May as well.
read more...»Our Daily Bread
In a similar vein to Manufactured Landscapes, Our Daily Bread is a no holds barred documentary on industrial farming and food processing. It is available for purchase in DVD format through Amazon UK.
read more...»Costs of Supply - Organic Farmers Divided
As the recession bites, so sales of organic food have started to slump and with it the premium prices that truly organic farmers can command in the market-place. The tough economic climate seems to be causing a deep divide within the organic farming community about whether the rules on the use of organic feed should be relaxed as a cost saving measure for producers facing an uncertain future.
The article in the Times today entitled “Let us bend the rules, say organic farmers” is a great example of how organic farmers face differences in the conditions of supply compared to producers who rely on conventional mass production methods. According to the article, average organic feed prices are £320 a tonne compared with £160 a tonne for conventional feed.
With hundreds of farmers converting some or all of their production to organic methods in response to the rise in organic products sales over recent years, the Soil Association and the Organic Farmers and Growers are trying to persuade the government to relax the regulations imposed on organic suppliers that allow them to trade under the organic quality mark. But hard core organic producers argue that to do so would dilute the brand reputation and cause confusion (information failure) among consumers.
It is interesting how in a recession there are increased pressures on so many different stakeholders. The depth of the downturn in 2009 will create much suffering among producers - but the very best, the most flexible and the most robust should be able to survive without sacrificing their principles or their standards. Organic produce will always be more expensive than conventional farm output - are we about to see yet another industry lobbying for government support to tide them through difficult times?
Crude oil prices and rig counts
Each week Baker Hughes releases a count of the number of active drilling rigs in the international oil and gas industry. Their data has been available for over sixty years and is regarded as a barometer for the oil services industry in particular as a lead indicator of demand for the capital equipment used in drilling, producing and processing hydrocarbons.
Why look at rig counts?
Partly because the number of active rigs might reflect a market-driven response to changes in oil and gas prices and also expectations of future price movements. When crude oil carries a high price in world markets, the profitability of drilling for oil from known reservoirs ought to improve and we might expect to see an expansion in the number of active rigs.
That said there are many factors that affect how many rigs are in operation – it is not simply a question of rigs changing in response to market demand for oil.
Technological change affects the number or rigs needed to develop a reservoir and also allows new known reserves to be exploited – for example the deepwater areas off the west coast of Africa.
Climatic conditions can affect the logistics of drilling schedules including the ability of oil producers to move rigs and establish new drilling sites.
Some reservoirs are only available for exploitation on time-limited leases – and as these leases come to an end, so more rigs might be brought into use.
Our chart shows that in recent years there has been a substantial rise in the world total of active oil rigs – indeed since 2002 the number has grown from around 2,000 to over 3,500 with the number of US-based rigs more than doubling although this figure is still less than half of the peak at the end of 1981.
I have added to the chart an index of global crude oil prices using the Goldman Sachs Commodity Index data series. To what extent do you think that the oil rig count reflects movements in global crude oil prices? Is the volume of active rigs a useful measure of the supply-side response to the recent boom in prices? And what impact might the sudden and dramatic fall in prices have on the number of rigs in operation as we head into 2009? The Times reports today that world crude oil demand will fall in 2009 for the first time since 1983.
Economics of fishing
The BBC today has two stories on the economics of fishing. Firstly the government has announced a £5m plan to fund the de-commissioning of some of the UK’s in-shore fishing fleet in a bid t oreduce what the government regards as fundamental excess capacity in the industry.
£5m fund to scrap fishing boats
This BBC video looks at the background
Secondly the rising stocks of cod in the north sea has led in part oa rise in the size of the annual cod quota given to scottish fishermen by the European Union as part of their common fisheries policy. But the thorny issue of discarding excess fish remains unsettled. The quotas refer to landed cod which encourages fishing vessels to dump much of the fish they have caught before they reach home in order to avoid fines for over-fishing. The result is a deadweight loss of scarce resources in an industry already suffering from the long term decline in fish stocks.
Fishermen land cod deal at talks
See also “Scots anger over discarded fish”
Economies of Scale - Giant Wind Farms
This BBC article on the granting of permission for a giant wind farm off the coast of North Wales might be a good example of the importance of economies of scale in making renewable sources of energy more cost efficient. And heading to the web site of the Gwynt y Môr Offshore Wind Farm accesses some resources on the potential costs and benefits of a scheme that might provide electricity for up to 500,000 homes. If construction goes to plan, the wind farm will start to produce power from 2012.
Frozen Pizzas and Theory of the Firm
A big hat tip to my colleague David Fox who alerted me to this superb three-minute BBC video which takes us inside the Goodfella’s pizza site in Naas, Republic of Ireland - a fully-integrated plant that produces over two million frozen pizzas every week! There is so much in this video. I suggest showing it a couple of times and then gathering together the contributions from students and turning it into a mind map or a word cloud - perhaps using wordle
I tried with one group and they came up with
Capital intensity
Automation
Bulk purchase of ingredients
Economies of linked processes.
High labour productivity (very small workforce)
Standardised products - important for branding
Quality control
Bulky capital
Economies of increased dimensions
Minimising wastage
Perfectly elastic supply
Constant cost
A great short video resource!
Barriers to Entry
In business there are often important barriers to entry which act to limit the ability of businesses to break into new markets. The Bottom Line on Radio 4 this week considered the existence of these barriers. Leading the discussion was Will King, the founder and CEO of KMI King of Shaves, the innovative UK-based personal grooming business that has successfully broken into the shaving product markets and whose new four bladed razor is now number three in handle sales to Gillette. King mentioned that there were over 20,000 patents in the razor and personal grooming industry including mechanical hinges on the construction of razors which requires new entrants to design their way around the patents.
The panelists on the programme discussed a number of other entry barriers - among them:
1. Intellectual patents and ownership of technology - but patents are needed to provide an incentive to invest
2. Expertise and reputation of the incumbent - intangibles
3. Licences are important such as professional qualifications
4. Inherent suspicion among consumers about new ideas - behavioural economics tells us that many people are quite happy with their default choices - it may take a while for any change in preferences to occur.
5. Regulations and legislation involving employing people - a major barrier for fast-growing smaller businesses many of whom are highly innovative
The Bottom Line is always worth a listen - the podcast is available for free from iTunes. And this weeks programme also considered which kinds of sectors will weather the storm and do well in a recession? The different nature of a recession this time around may well give us a clue to the likely winners from the downturn especially with credit so hard to find.
It was thought that successful businesses during the current downturn would tend to be:
1. Agile and entrepreneurial, customer centric
2. Businesses with low debts and those who are cash rich - cash flow management is becoming critical - cash flow forecasts will come under increasing scrutiny.
3. High energy businesses that swim against the tide
4. Knowledge building companies
The Bottom Line
Markets in Action: Steel Industry is Hurting
Leander McCormick-Goodhart writes about an industry under pressure
The steel industry is the new victim of the financial crisis. Arcelor (the world’s largest steel producer) is planning to cut its output for the fourth quarter by over 30%. The crippling of the steel industry is explained simply through the consideration of supply and demand in the complex interconnected markets.
read more...»Markets in Action: Economics of Opium Production
Ed Maris writes on the incentives to supply opium in the turbulent country of Afghanistan
The Opium trade has existed for hundreds of years; it was the cause of the Anglo-Chinese wars of the nineteenth century and has been a resilient market despite increasing pressure from law enforcement agencies and governments worldwide. It is a part of most country’s shadow economy - it is an illegal good and a factor of the world narcotic trade. Opium is an example of a good exhibiting derived demand; whilst it may be consumed in its raw state, it is usually processed into Heroin, a powerful and damaging drug. Afghanistan’s opium production is estimated to account for 52% of the country’s legal GDP and 87% of the world’s total supply.
read more...»Why are the car companies cutting production?
This week Nissan became the latest car manufacturer to announce a scaling back of production in the face of falling demand for new vehicles. Nissan, which is 44%-owned by Renault SA, of France plans to halt production at its huge plant in Sunderland for a fortnight and shorten production runs on its main assembly lines for a further three weeks in the lead up to Christmas.
read more...»Maintaining profitability in the airline industry
My students have been tackling this assignment this week as part of their microeconomics course.
(a) Many airlines have reported heavy losses and several have already gone into administration or filed for bankruptcy. Using cost and revenue diagrams, explain why airlines have been experiencing such losses (15)
(b) Discuss the ways in which airlines can control their losses and continue to operate profitably in an industry where costs and revenues are unpredictable (15 marks)
Answers to part (b) sort the wheat out from the chaff!
read more...»Something to chew over
It was a surprise at breakfast today to read the following in the births, deaths and marriages column of my newspaper
Mars Bar
Twix
Snickers
Aero
Then on closer inspection I realised I was reading the A-Bit_Chewy column
This pun reminds me of the cost pressures that confectionery manufacturers are under. Mars is the latest chocolate monalinth to report that the rising cost of ingredients is having a negative effect on their profit margins and that they will be looking to push through higher prices to wholesalers - this will feed through pretty much direct to chocolate-lovers in the days and weeks ahead.
This BBC report looks inside the Bournville chocolate factory in Birmingham
Beet farmers look for better price to sweeten the pill
Here is a story that highlights the monospony power of a business when set against the determination of farmers to get a better price for their product. For some time sugar beet producers in the UK have been battling with British Sugar to reach an agreement for the contracted price for their beet harvest in 2009.
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