Second-hand car market – law of unintended consequences
Drive a new car off the forecourt and you it immediately loses a sizeable slice of its value. And, under normal market conditions, second-hand cars lose value by about 15 per cent a year, but this year they are increasing in value – by an average of £600 so far this year – mainly due to a shortage of supply caused by the government’s scrappage scheme.
read more...»McLaren’s new super sports car - income elasticity and status races
We are told that this new product has been forty-five years in the making. McLaren has unveiled its new super sports car, designed using Formula 1 technology.
This BBC video offers a sneak preview of the new car and it might be a good one to use when discussing needs and wants! Or the income elasticity of demand for luxury products and the price premium for motorists already wetting themselves in anticipation of getting behind the wheel! Given the relative absence of economies of scale in production, you might get students to estimate the likely introductory price in the market?
At a pinch I would price it between £175,000 and £200,000 but then again I am happy to potter around in a nine year old Citroen that is just a year from the knackers yard.
World Tea Prices Climb to New High
The price of tea on the global market has surged to a fifteen year high. Supply and demand factors are both at work as this short streamed presentation shows
There are over 1,500 different types of tea so discussing what is happening to the ‘world price’ has its limitations! But this is an interesting market to explore for AS students covering as it does
*Market demand and supply factors
*The impact of price volatility
*Do tea producers actually gain from rising market prices
*Price and income elasticity of demand for tea
*Fair Trade and tea pricing policies
*The impact of changing tea prices on demand for and supply of related products
*The significance of world tea prices for macroeconomic performance of major tea exporting nations
Once students have the core supply and demand analysis, this is a topic that we can return to later on in the course and also in revision
An own goal
With the introduction of the 50% tax rate next year, this article in The Telegraph points out the effects on the Football Premier League – in a sport where players are very geographically mobile, and where tax laws are not harmonized, we could see an exodus of talent.
read more...»Buffett’s Veblen buffet
Whilst it seems that a dinner with the legendary investor Warren Buffett still retains its Veblen good features (when peoples’ preference for buying a good increases as a direct function of its price, instead of decreasing according to the standard laws of demand); it seems that it also has an inelastic YED, with the credit crunch having a limited impact.
read more...»Status Races and Birthday Parties
Over at the Business Studies blog Tom White has a super piece about rising spending levels for birthday parties and other celebrations. It is a clear example of status races and the rising demand for positional goods - I wrote about this a few days ago when reporting on the Bob Frank lecture at the RSA. If we all cut our spending on such celebrations by say twenty per cent would we be any worse off?
Evidence of elasticity in a recession
Here is some terrific evidence of income elasticity of demand, substitute goods and the increase in demand for inferior goods in a recession – sales of baked beans and supermarket ‘own brands’ rose by over 20% in April compared with the same month a year ago, while sales of organic products, which might be considered ‘normal luxury’ goods, fell by over ten percent. Consumers are switching away from the pricier organic ranges to lower priced products. If we take the change in income as minus 4% (the figures in this BBC chart show that GDP has fallen by almost 4% over the last year) then it is possible to work out the income elasticity of demand for those products as minus 5 for the baked beans and own brands, and plus 2.5 for the organic goods – all quite significantly income elastic.
There is evidence of price elasticity in action as well – sales of flat screen TV’s are up by 17.5%, but the prices are down by more than 20%, so that the total revenue earned from those higher sales is actually lower than it was a year ago. Perhaps demand is less responsive to changes in price than retailers hoped, as the percentage change in demand is lower than the percentage change in price, indicating that demand is price inelatic. What does this mean for the manufacturers and retailers? That will depend on whether the lower prices are caused by lower costs, so that their profit margins are retained, or by discounting the price to the consumer in order to increase the volume of sales at the expense of profit margin.
The Power of Relativity - a Doritos Dilemma
One of my students Arno Albici contributed this interesting post to our internal student forum this week - I feel it deserves a broader audience
Anyone who’s read the first chapter of Dan Ariely’s Predictably Irrational will immediately be familiar with what I’m about to discuss. The first chapter is entitled “The truth about relativity”, and in it Ariely sets out to show how the our perceptions of objects and concepts are defined by how we can compare them to similar things. The example given are these three subscription choices for The Economist:
Economist.com yearly subscription - $59.00
Print subscription - $125.00
Print and web subscription - $125.00
In this example we are incited to think that either there is a stupid misprint, or that the “print and web subscription” is a steal. It’s just like getting the web subscription for free! Isn’t it?
Something similar happened to me this week. I went to our local school store to buy myself one of those 45p packs of Doritos (Chilli Heatwave flavour, they’re my favourite), and to my dismay they were now priced 50p! To be fair a 5p difference isn’t going to change my life in any way, but with UK inflation supposedly under 3% (according to recent CPI index figures) I just wasn’t going to have it. Then I had this idea, why not buy the bigger pack instead?
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Rising demand for inferior goods
In a downturn, demand for ‘inferior products’ tends to rise as real incomes fall. To label a product inferior is not to classify it as poor quality but instead to identify a negative relationship between income and quantity demanded. Typically inferior products tend to be basic, often low-priced products that consumers might turn to if they need to save some money. There will be higher priced alternatives that might be considered more of a luxury or a discretionary spend.
This BBC news article offers a window on early signs of a change in spending habits in the foodstores. Sales of baked beans are up - as is demand for the white bread that complements late-night beans on toast. And as staying in is the new going out, the volume of olive oil coming off the shelves is also increasing.
We must be careful to assume that just because demand for these and other products is increasing as the economy slides into a downturn, they are all inferior goods. Frequently there are price changes and other offers available that change the incentives for consumers.
Inconspicuous Discounting
I was browsing in a well-known North East department store this week when I spotted a winter coat that I have had my eye on for some time. Having decided to splash the cash, I was surprised to find a 20 per cent discount applied at the till - a welcome surprise! But there were none of the usual “sale” signs obvious within a store that was busy without being buzzing.
I took the discount without blinking but an article in the Financial Times today reminded me that the inconspicuous sales are becoming more frequent especially among niche retailers towards the higher-end of the retail market. Luxury shops are making greater use of private invitation-only evenings where valued customers can be wined and nudged gently into pre-ordering new products or persuaded to buy up some of the excess stock.
Here is the link to Sarah O’Connor’s piece on discreet discounts.
Just a few months ago sales of luxury products were thought to be immune from the ravages of the credit crunch. But the collapse of investment banks, a steep decline in city bonuses and thousands of job losses in financial services have contributed to a sharp fall in demand for high-value luxuries. The income elasticity of demand for such goods ought to be strongly linked to the economic cycle - we are seeing growing evidence of this now.
But for retailers selling top-end brands who have rarely had to use deep price discounting to shift modest amounts of stock, these are unchartered waters. The danger is that if they cut prices too far their customers may begin to anchor downwards the prices that they regard as a fair reflection of the quality of the products they are buying, and perhaps devaluing the excitement of buying a specific brand?
Price anchoring is an important feature of the behavioural patterns of consumers - I wrote about it in June with a blog about the pricing of the iPhone. - for products such as jewellry, designer clothing, the best seats for the theatre, perfumery and bespoke furniture (there are many other examples) the first price you experience for a product when you enter the market can act as an anchor for what you might be prepared to spend the next time around. The luxury retailers will want to avoid a situation where an eventual economic recovery might start with consumers having lowered significantly their price expectations for discretionary purchases.
Perhaps that is one reason for the invitation-only events for regular customers. The luxury shops are happy in the current climate to offer a generous discount but they want to keep it under wraps reserved for people who they know will return when demand and prices are back to normal levels.
Cheap drinks and government intervention
This BBC clip covers an announcement in the Queen’s Speech about policy proposals contained within a new Crime and Policing Bill to curb the flood of cheap drinks promotions offered by pubs and clubs which the government believes contributes to binge drinking. The Telegraph reports that
“Retailers will not be able to sell any alcohol cheaper than the price of buying one item of it, no matter how many more a customer buys. It means there will be a ban on offers such as two for ones, three bottles of wine for £10, or discounted multipacks of beer where the overall cost is cheaper than the sum of the individual bottles or cans contained.”
A seasonal hat tip to Ben White for spotting the article and for suggesting a number of economic concepts and policy issues that the article might be used to illustrate in a group discussion:
Pricing Incentives and price discrimination
Importance of price elasticity of demand e.g. if minimum drinks prices are imposed
Market Failure - externalities from consumption, alcohol disorders and de-merit goods
Regulation and Legislation - effectiveness and costs of regulatory policies
Risks of government failure including the law of unintended consequences
Social Issues
Premium passengers may be deserting BA
BA has announced a slump in the number of premium passengers.
The airline has taken the strategic decision note to slash prices for these customers because they are the most profitable segment of their operations. But last month the number of passengers fell by over 10 per cent contributing to a decline in the carrier’s load factor, which measures how full each plane is from 76.6% to 74.4%.
Global economic turbulence forces BA and many other airlines into a series of difficult decisions. The income elasticity of demand for airline travel is likely to be strongly positive especially for luxury travel and on routes where there is genuine competition the price elasticity of demand is also likely to be a constraint on how high fares can be.
In line with many other carriers, BA is cutting back services on some routes in a bid to reduce spare capacity and there have been several stories circulating in the media about BA entering into negotiations with the Australian carrier Qantas to form a giant international operator.
The 20 Per Cent Sale
Is anyone heading to a local Marks and Spencer store tomorrow for the 20% off for a day sale?
Opinions are mixed about the motivations behind this marketing ploy. It seems to me that the likeliest explanation is that a struggling M&S is becoming desperate to shift piles of unsold autumn fashions and homeware. John Lewis emailed people tonight with a matching price reduction in stores for the coming weekend. Savvy customers will stay clear of this particular discount window. Indeed if we all stay home and wait, we can expect even bigger reductions in prices as stores try to clear stock ahead of what promises to be a terribly difficult early spring in the shops.
Luxury yachts - holed below the waterline?
This is one of the ultimate ‘big red ticket items’!
Is the luxury yacht market showing signs of being holed below the waterline? The Daily Telegraph reports on fire-sales of some of the most expensive yachts that money can buy - the owner of the 164ft Alibella – is offering a €9.5m (£8.1m) discount to a buyer prepared to complete a deal within the next 30 days - a reflection of a dramatic switch in the balance of power in the market from seller to buyer. A broker at Edmiston reflects that there is now a surplus of yachts on the international market and many owners, desperate for cash (perhaps to meet margin calls on their stock market investments) are offering deep discounts on prices in a bid to find a prospective buyer. Something approaching forty of the larger yachts are now said to be available for sale. Demand from wealthy Russian billionaires and from middle-eastern investors seems to have floated away.
A hat tip to colleague Mo Tanweer for alerting me to this story.
When it comes to income elasticity of demand, surely these highly expensive yachts must count as an ultra luxury product for the vast bulk of consumers - but to their owners they may not be a luxury at all. The private marginal benefit of a long weekend sailing a huge yacht is likely to be sizeable but not one that owners will give up lightly if their financial circumstances change. There are some who argue that the hefty price discount for an early sale is simply a marketing gimmick - the owner may have no intention of selling and just wants people to admire their yacht!
Will price discounting help restaurants survive the crunch?
If eating in is the new going out, life is going to get really tough for hundreds of mid-market restaurants in the months ahead.
Hard-pressed consumers hit by a potent combination of falling property and share prices, declining real incomes, a slump in confidence and fears of huge job losses, are cutting back on non-essential items in their monthly budgets. They are eating out less or perhaps switching to lower-priced chains that – on the plate at least – seem to offer better value for money.
How can restaurants respond to the threat posed by a fall in discretionary spending?
read more...»The Economics of Hotel Deals
e-break deals from the likes of Marriott Hotels regularly end up in the junk-mail bin. But this advert prompted a lively classroom discussion….
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...»Aldi’s explosive growth - can it break through?
“Don’t change your lifestyle, change your supermarket”
Food market share
Tesco: 31.6%
Asda: 17%
Sainsbury’s: 15.8%
Morrisons: 11.1%
Somerfield: 3.7%
Waitrose: 3.8%
Aldi: 3.0%
Lidl: 2.4%
Iceland: 1.7%
Netto: 0.7%
% sales of total grocers in 12 weeks to 12 August 2008
That is the Aldi strap-line as it seeks to change the shopping habits of price conscious consumers across the UK. The dramatic sales growth from the deep-discount food retailers is one of the big stories of 2008 and German-owned Aldi is planning to add one new store a week to its portfolio in a significant bid at organic growth and rising market share. The Telegrpah provides this analysis of the rise of the Aldi chain and how their retail model is radically different from the 24-hour, sell it all mentally of the likes of Tesco. Is the apparent shift from status to value a product of the times in which we live? or evidence of a longer-lasting change in consumer preferences. I have never set foot in an Aldi or a Lidl store, it might not be long before I do!
Immune from the gloom? Choconomics
Do sales of chocolate rise as consumer confidence ebbs away? Market demand for chocolate appears to be growing strongly even as the credit crunch bites and prices rise on the back of increasing cocoa and oil prices.
Chocolate’s long-deserved reputation as a comfort food or snack at times of distress and worry seems to be well founded according to this excellent BBC video report from Nigel Cassidy. Goods whose demand rises during economic downturns have been coined as “counter-cyclical products”. Sean O’Grady writing in the Independent looked back to the emergence of the giant confectionery businesses during the Great Depression of the 1930s.
“During most previous slumps – and especially in the Great Depression of the 1930s – sales of chocolate have bucked the general trend. Indeed, the “Hungry Thirties” were a golden age for chocolatiers. Some famous names were invented then, including Marathon (now Snickers, 1930) and Maltesers (1936, then known as “energy balls”).”
Inexpensive treats are often the last thing we give up when our budgets are under pressure.
Cross-Elasticity: Fertilisers and Bio-solids!
Countryfile is one of my favourite television programmes - a rich source of background on the ever-evolving rural scene and the challenges and opportunities facing the UK farming industry. Last Sunday featured a programme on the growing demand for and use of bio-solids in food production in the UK. It provides a good example of cross-price elasticity of demand!
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Price gouging in Edinburgh
Jimmy Chung’s in Edinburgh occupies a prime location between Waverley Station and Prince’s Street - it appears to thrive on a fast flow through of customers eager for a quick fill of chinese food - it needs the high footfall to pay what must be a hefty rent. An obvious approach is to engage in some price gouging - serving fixed price meals at different prices according to the time of day - all prominently displayed as shown. I will use this with my introductory Economics students in a few weeks time.
read more...»Cheap flights - elasticity and effective demand
Double-digit annual inflation rates in the prices of airline tickets for the low cost carriers will bring about a radical restructuring of the industry according to a report in today’s Times. I have tended to assume in the past that the demand for cheap airline tickets was fairly inelastic - for most people the price of a return flight for a holiday is a low percentage of their annual income; holidays in the sun have come to be regarded as an essential part of the year for millions of travellers. And for those with second homes in the mediterranean flights are pretty much unavoidable. The Times article hints at a low price elasticity of demand
“According to analysts a 10 per cent increase in fares typically leads to a 6.5 per cent fall in passenger numbers. Budget airlines carry an estimated 45million British passengers a year. If fares rise by 20 per cent over two years, passenger demand looks set to fall by more than five million.”
So the predicted large contraction in demand isn’t down to any fudnamental change in demand elasticity - more the scale of the fare hikes which are pricing thousands more out of the market - effective demand is taking a hit. I suspect the response may be even greater if the low cost airlines continue to fashion new ways of extracting revenue from their passengers. Doug McVite is quoted as saying “it is probably only a matter of time before some joker suggests charging for using the toilet. The whole experience of flying budget will become even more unpleasant.”
The 99p effect
The BBC news magazine explores the psychological basis for retailers pricing their products at £1.99 or £3.99 and the disproportionate effect this kind of price point can have on our buying behaviour. It is a great article to use when introducing consumer behaviour and in explaining the non-linearity of demand curves when teaching price elasticity of demand.
read more...»Fares fair?
For occasional taxi journeys from my home to and from Heathrow and to my local station at Slough I am almost completely price insensitive. But in central London I do weigh up the costs and benefits of jumping in a taxi for shorter forays. This is a terrific article on the cost pressures facing London’s metered cabs whose prices are capped by Transport for London. Earlier on this year, the price of metered can journeys was raised by 2.7% - below the CPI and RPI rate of inflation and nowhere near the increase in the cost of fuel at the forecourts.
read more...»Cross elasticity: Demand for new aircraft
Over twenty airlines have gone bust since the price of aviation fuel started to climb and the turbulence in the global aviation market is likely to lead to a fall in demand for new aircraft according to a report in today’s Times.
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Cross elasticity: Demand for Airline Movie Systems
The increase in the price of aviation fuel is causing airlines across the world to think about how they can control costs and the obvious solution is to reduce the weight on flights to increase fuel economy even if only by a slender amount. US airways has announced that it plans to remove the in-flight entertainment systems from many of its flights in an effort to cut down on the amount of fuel - the 500lb movie systems will be discarded from domestic flights from November onwards - the decisions affects around 200 aircraft and is estimated to save around $10 million a year. It will keep movies in its widebody aircraft for international flights and trips to Hawaii (a different type of consumer demand?)
The decision is possibly bad news for Hollywood movie producers whose revenues from selling the rights for airlines to show movies might take a hit. But much depends on whether other airlines follow suit. Demand for the next generation of super-light back of seat entertainment systems is likely to grow in the coming months.
Cross elasticity: Demand for allotments
From Wrexham to Eastbourne and in virtually every part of the country, the demand for allotment space is rising much faster than local councils can supply. The economics of having your own allotment land have changed significantly in the last few years. Allotments peaked in popularity in the immediate post-war years as people looked to grow their own food and drag themselves out of the restrictions of rationing. But gradually the number of allotments declined as the food availabilty improved, real prices fell and the number of supermarketsexpanded. By the 1980s using an allotment was widely regarded as the preserve of the ‘Good Life’ crowd and those in retirement wanting a way to pass the time.
But now the combined effect of rising food prices, growing concerns over the environmental effecs of food miles and demand for locally-grown organic produce has prompted a fresh wave of demand for scarce allotment space.
read more...»Price anchoring
There is a really good article on price anchoring and the iPhone in the Washington Post today.
read more...»Wi-Fi and Consumer Surplus
Despite the odd scare story (the BBC is not blameless) Wi-fi is taking off. There are around 11,477 wi-fi hotspots in the UK and major service providers include the Cloud, BT, and T-Mobile.
How can some hotels continue to get away with charging up to £19.99 per day for wi-fi access and some coffee stores still charge £6 an hour for wi-fi access whilst others (including McDonald’s) are now rolling out wi-fi services for free? There is plenty of interesting economics in looking at the different charges made by different wi-fi service providers often within just a few yards of each other.
read more...»Popcorn and price discrimination
Why do movie theatres sell popcorn, coca cola and hot dogs for such high prices?
On the surface it looks like a classic case of the movie theatre being able to capture the consumer surplus of cinema-goers once they have bought their ticket to see a film.
Say for example you might have been willing to pay £8 to see There will be Blood at your local cinema, but that the ticket price is £6. That implies a consumer surplus of £2. The cinema might try to extract that from you by raising the price of your carton of popcorn well above the marginal cost of supply; you feel like you have got a good deal by getting in to see the film for £6 and psychologically you are perhaps more willing to fork out a little extra for your movie fuel. After all, once inside the theatre, you are hardly likely to go through the hassle of exiting back onto the high street to find a cheaper supply of pop corn or drinks?
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