Ukraine conflict sees oil prices go above $100

An excellent video from the Wall Street Journal which explains how higher oil prices impact the inflation rate. By pushing up the price of transport this in turn affects the price of goods / services as producers pass on this extra cost to consumers. Although US focused it does go through simple supply and demand theory to explain how the price may fall or rise.

Today Brent Crude Oil prices rose above $105 a barrel (see graph below) for the first time since 2014 after Russia’s attack on Ukraine amplified concerns about supply disruptions. United States is working with other countries including OPEC on a combined release of additional oil from global strategic crude reserves – in theory the supply curve moves to the right to try and reduce prices. Russia is the third-largest oil producer and second-largest oil exporter and low oil stocks and limited spare capacity, will see additional pressure on prices. Furthermore increased demand with a lot of economies coming out their COVID restrictions will put further pressure on prices.

The RBNZ made a forecast that oil prices should head back to around the $80 per barrel mark but that seems to be rather optimistic with the current political climate. What is sure is that higher global oil prices will continue to put pressure on New Zealand’s CPI.

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Milk prices on the up – supply and demand

With the start of the academic year in New Zealand the first week of teaching usually looks at the price mechanism and scarcity. A good example in the NZ economy is the reasoning behind the payout that Fonterra pays its farmers that supply them with milk. Fonterra is a monopsony (they have approximately 81% share of the NZ dairy market) in that it is one buyer and many sellers (the farmers) – the farmers look to Fonterra to get them the best price in the Global Dairy market. Fonterra has indicated that the price for the current 2021/2022 season is going to be between $8.90 to $9.50/kgMS.

The mid-point is $9.20/kg and at that level it will be paying out New Zealand suppliers $13.8 bln – see graph below. Ultimately the price of the Fonterra payout is determined by supply and demand on the Global Dairy Trade auction – see below.

Why have prices increased?

Supply – there has been weak production in New Zealand and overseas with poor weather with challenging growing conditions and higher feed costs. Fonterra lowered its forecast on the amount of milk collected by 1.6% – 1,525 million kgMS in 2020/21 to 1,500 million kgMS in 2021/22. A lower production outlook for Europe and North America has increased the forecast milk price.

Demand – demand globally remains strong with North Asian buyers securing over 50% of the total volume sold in the recent Global Dairy Auction. According to the OECD the world per capita consumption of fresh dairy products is projected to increase by 1.0% p.a. over the coming decade, slightly faster than over the past ten years, driven by higher per-capita income growth. Today total dairy consumption in Africa, South East Asian countries, and the Middle East and North Africa is expected to grow faster than production, leading to an increase in dairy imports. As liquid milk is more expensive to trade, this additional demand growth is expected to be met with milk powders, where water is added for final consumption or further processing.

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.

Quota and Allocative Efficiency

Below are notes on Quota and Allocative Efficiency from elearneconomics.

When the government imposes a quota (a restriction on the quantity that can be produced, exported or imported) it forces the market price up and decreases the quantity sold or produced. Because the market is not allowed to clear (restore or reach the equilibrium) there is a loss of allocative efficiency (termed a deadweight loss). Part of the original consumer surplus and producer surplus is not picked up as part of the quota. Consumer surplus and producer surplus are no longer maximised.

Source: elearneconomics.com

At the original equilibrium (P1, Q1) the value of consumer surplus for butter is $80m (0.5 x 40m x $40, area P3CP1) and the value of producer surplus for butter is $160m (0.5 x 40m x $8, area P1CP0), the market is allocatively efficient because consumer surplus and producer surplus are maximised. When the government imposes a quota and restricts the quantity to 30m (Qs) there is a change in consumer surplus, producer surplus and allocative efficiency.

The total value of consumer surplus decreases by $35m because consumer surplus before the quota was $80m and is now $45m (0.5 x 30m x $3, area P3BP2). The higher price means that the difference between what consumers are willing to pay and what they actually pay will decrease. The lower quantity demanded (30m units rather than 40m units) means there are fewer units from which wool buyers can gain a surplus. Therefore, consumer surplus will decrease.

The total value of producer surplus increases by $20m because producer surplus before the quota was $160m and is now $180m ($9 plus $3 divided by 2 multiplied by 30m area P2BFP0). Producer surplus will increase despite some loss of producer surplus due to the lower quantity sold, 30m (Qs) rather than 40m (Q1). The increase in producer surplus is a result of the higher price from the quota that is more than sufficient to offset the loss of producer surplus due to lower sales. Overall producer surplus increases.

There will be a loss of allocative efficiency because the loss in consumer surplus (CS) of $35m outweighs the gain in producer surplus (PS) of $20m, which results in a net welfare loss (deadweight loss) of $15m (0.5 x 10m x $3, area BCF). This is because producer surplus and consumer surplus are no longer maximised following the imposition of the quota on butter.

More at: elearneconomics.com

NZ House prices forecast to drop after 30% increase

If you look at the housing data over the last 15 years it has been a bit of a rollercoaster. The boom period of the early 2000’s saw significant increases in the house prices which was sharply curtailed by the Global Financial Crisis in 2008. Following the GFC the RBNZ embarked on an expansionary monetary policy with near zero level interest rates which saw rebound in house prices up to 2016. However up to 2018 price increases start to plateau as the economy entered a phase of slower growth with average household debts reaching 162% of their disposable income and this debt-fuelled growth proved unsustainable.

Westpac Economic Overview (Nov 2021)

Since the first lockdown in 2020 prices have escalated and this could be partly due to the fact that as well as demand outstripping supply, people have spent more income on refurbishing their house for a future sale. This came about by their inability to spend money on holidays or overseas trips. So why is there a forecast of decreasing and even negative house price increase? Below are some reasons:

  • Increase in official cash rate (OCR) from the RBNZ will be passed onto consumers – higher mortgage rates – see graph below showing the correlation between interest rates and house prices.
  • The tightening of lending regulations by the RBNZ – debt-to-income limits on mortgage lending.
  • With the borders being closed population growth has decreased significantly and therefore less demand.
  • There is less of a financial incentive for developers as material and labour costs have risen rapidly. Also a cooling housing market could lead to fewer projects.
Dominic Stephens: University of Victoria – Commerce Teachers’ Professional Development Day. 3-12-21

Source: Westpac Economic Overview (Nov 2021)

Fossil fuels – not going away soon.

Following on from my previous post on COP26 you have to ask if there has been any move away from fossil fuels and what is the likelihood that there will be some reduction in their use.

Thompson Clark of Mauldin Economics made some good points on his Smart Money Monday article. Even with the investment being put into green energy stocks the performance of them compared to traditional energy stocks has been interesting to say the least – see graph below.

TAN = solar and green energy stocks – dropped 20%
XLE = traditional energy companies (Exxon, Chevron) – increased by 44%

Oil prices have risen to over $80 a barrel (see graph) which in turn has led to the US releasing 50m barrels of oil — about 2.5 days worth of US oil consumption. This comes as Saudi Arabia, Russia and other members of OPEC have rejected pleas to pump more supply into the market. Furthermore with the drilling bans in the US this summer this will only further limit the supply and therefore push up the price. For the move to a more green energy environment there needs to be more available supply of solar etc to quell the demand for fossil fuels.

Today 83% of the world’s energy supply comes from oil, gas and coal and there is no real change in consumption patterns. With supply pressures (no drilling) and demand (people coming out of lockdown) stocks in oil companies should continue to perform well.

Inflation – all the talk is supply but what about demand?

In simple economics supply and demand are in equilibrium at a particular level of output and price. If something is in short supply the price will go up to cancel out the shortage.

All the talk in the media about supply costs/problems – shipping delays, energy prices, semiconductors shortage, truck drivers in the UK – there seems to be little mention of MP3 (Monetary Policy 3) and the increasing levels of demand.

MP3 is a continuum of coordinated monetary and fiscal policies that vary who gets the money (private sector versus public sector) and how directly that printed money is provided (directly providing “helicopter money” to spenders versus more indirect means of financing spending).

With the COVID-19 crisis governments around the world sought to protect people’s job and businesses by providing a wage subsidy and financial assistance to businesses in the hope of staying afloat. However this creates more demand (wage subsidy / business support) with no increase in supply (companies are closed due to COCVID-19). Supply is struggling to cope with this extra demand. Areas of supply pressure are: raw materials, energy, productive capacity, stock, housing and workers. The graph below the supply of goods is above pre-COVID levels

As economies open up there will be an increasing demand for services – e.g. bars, restaurants etc.
Demand for services is rapidly returning to pre-COVID levels and services employment is lagging, as employers are having trouble finding workers. The latter is a major concern with unemployment at low levels there will be upward pressure on wages to entice workers to work longer hours as well as investment to improve productivity.

Whack-a-mole economics
With so many supply constraints you can fix it in one place but you can’t fix it everywhere. Long-term investment is needed if supply is to close the increasing gap with demand but expansionary policies still remain even if central bank interest rates are going up.

Productive Capacity higher than pre-COVID
Global production has risen above the trend line and with most of the marginal productive capacity coming from China. They have increased their production by 20% with exports 40% higher that at the start of 2020.

World goods price index has increased dramatically since 2020. As a result of trying to keep up with demand, capital investment is at significant highs and although this will put less strain on inflation in the longer term there are still short-term pressures.

With demand outstripping supply everywhere you look, policy makers are unlikely to be able fix shortages across the board. They can open ports for longer, as in the US, or ease environmental regulations, as in China, but in order for supply and demand to clear at levels that don’t lead to sustained price increases, there would need to be a massive investment in productivity for supply to catch up. The gap between demand and supply is now large enough that high inflation is likely to be reasonably sustained, particularly because extremely easy policy is encouraging further demand rather than constricting it.

Source: It’s Mostly a Demand Shock, Not a Supply Shock, and It’s Everywhere

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.

Short-selling explained – ‘Trading Places’ movie

The 1983 movie ‘Trading Places’, staring Eddie Murphy and Dan Aykroyd tells the story of an upper class commodities broker Louis Winthorpe III (Aykroyd) and a homeless street hustler Billy Ray Valentine (Murphy) whose lives cross paths when they are unknowingly made part of an elaborate bet.

There is a great part in the movie when they are on the commodities trading floor that explains price and scarcity. Winthorpe and Valentine are up against the Duke Brothers in the Frozen Concentrated Orange Juice (FCOJ) futures market.

How a futures market works
As opposed to traditional stock/shares futures contracts can be sold even when the seller doesn’t hold any of the commodity. For instance a contract of $1.30 per pound for a 1000 pounds of FCOJ in February indicates that the seller is compelled to provide the produce at that time and the buyer is compelled to buy the produce.

Here’s how it worked in the movie

The Duke Brothers believe they have inside knowledge about the crop report for the orange harvest over the coming year. They are under the impression that the report will state the harvest will be down on expectations which will necessitate greater demand for stockpiling FCOJ – this will mean more demand and a higher price. Therefore at the start of trading the Dukes representative keeps buying FCOJ futures. Others saw they were only buying and wanted in on the action, those that had futures were not willing to sell so the price kept rising. However the report was fake and Winthorpe and Valentine had access to the genuine report which stated that the orange harvest had not been affected by adverse weather conditions. Knowing this they wait till the the price of FCOJ reaches $1.42 and start to sell future contracts.

Then when the crop report is announced and it indicates a good harvest investors sell their contracts and the price drops very quickly. The Dukes are unable to sell their overpriced contracts and are therefore obliged to buy millions of units of FCOJ at a price which exceeds greatly the price which they can sell them for. In the meantime Winthorpe and Valentine for every unit they sold at $1.42 they only have to pay $0.29 to buy it back to fulfill their obligation. This results in a profit of $1.13 per unit.

War on drugs – focus on supply or demand?

Been looking at Price Elasticity of Demand with my AS Level class and discussed the drug industry with reference to Tom Wainwright’s book “Narconomics: How to Run a Drug Cartel”. He also wrote an article for the Wall Street Journal on “How economists would wage the war on drugs”. Essentially, the war on drugs is being lost. Badly. As Wainwright notes:

The number of people using cannabis and cocaine has risen by half since 1998, while the number taking heroin and other opiates has tripled. Illegal drugs are now a $300 billion world-wide business, and the diplomats of the U.N. aren’t any closer to finding a way to stamp them out.

This failure has a simple reason: Governments continue to treat the drug problem as a battle to be fought, not a market to be tamed. The cartels that run the narcotics business are monstrous, but they face the same dilemmas as ordinary firms-and have the same weaknesses.

El Salvador – a leader of one of the country’s two gangs has a human resource issue with high turnover of employees.

Mexico – the Zetas cartel franchises its brand like McDonalds which in turn has led to arguments over territory.

Rich countries – street corner dealers are struggle to compete on price and quality with the ‘dark web’. It is a similar scenario with Amazon.

To combat the drug trade governments have focused on restricting the supply. Each year acres of coca plants and manufacturing activities are destroyed but the price has remains around $150-$200 per pure gram for the past 20 years. How have the cartels managed to keep this price?

However, supply of drugs might not even be appreciably reduced when drug crops are targeted. Wainwright points out that:

  1. Drug cartels are a monopsony – they are a single buyer of Andean coca leaves, so they have market power over the price of leaves (i.e. the cartels have the ability to strongly influence the market price of coca leaves). So if some crops are wiped out, the price is unlikely to rise because of the cartels’ market power.
  2. The price of cocaine is so much higher than the crop input costs that even a large increase in crop prices would have little effect on the market price of cocaine (i.e. even a big increase in the price of coca leaves would lead to only a small shift in the supply curve for cocaine).

Also because of its addictive nature demand for drugs is relatively inelastic – the decrease in quantity demanded is less than the percentage increase in price. Therefore reduced supply and a higher price doesn’t change demand that much.

Demand-Side interventions seem to be a better option and they are also a lot cheaper. Weighing up reducing supply by destroying coca crops in remote areas against drug education in schools and you find the latter is a much more plausible option. Tom Wainwright’s explain this below in his talk to the Cato Institute below:

A dollar spent on drug education in U.S. schools cuts cocaine consumption by twice as much as spending that dollar on reducing supply in South America

Bigger loses have be inflicted on cartels with some US states making marijuana legal.

Cobweb Theory and Price Elasticity

I have blogged on this topic before and although not in the NCEA or CIE syllabus’ I find it useful theory to mention when doing supply, demand and elasticity. Agricultural markets are particularly vulnerable to price fluctuations. many agricultural products have inelastic demand and inelastic supply. This means that any change in demand or supply has more of an impact on price than on quantity. Price fluctuations can also arise due to the time lag between planning agricultural production and selling the produce. The cobweb theory (so-called because of the appearance of the diagram) suggests that price can fluctuate around the equilibrium for some time, or even move away from the equilibrium. Dairy farmers base their production decisions on the price prevailing in the previous time period.


The supply of dairy products in New Zealand fits this assumption – farmers make their production decisions today, but the dairy cooperatives (Fonterra, Westland, etc.) don’t make a final decision on the price farmers will receive until close to the end of the season.

Cobweb scenarios:
Convergent
At the equilibrium point, if the demand curve is more elastic than the supply curve, we get the price volatility falling, and the price will converge on the equilibrium. For example:

  • Adverse weather conditions means their is a poor crop – Qt
  • The excess demand causes the price to rise – Pt
  • Because of the higher price famers plant more crops and therefore greater supply – Qt+1
  • With supply so high prices drop to meet demand – Pt+1
  • Lower prices mean that famers supply less to the following year – Qt+2
  • This results in higher prices again – Pt+2
  • Because of the higher price famers plant more crops and therefore greater supply – Qt+3 etc.
  • This process continues until you get to an equilibrium as the PED is greater than the PES – supply curve is steeper than the demand curve.
Source: Policonomics

Continuous
This is occurs where there is a continuous fluctuation between two equilibriums – Pt and Pt+1. The PED and the PES are equal to each other.
Divergent
Prices will diverge from the equilibrium when the PES greater than the PED at the equilibrium point – i.e.the demand curve is steeper than the supply – price changes could increase and the market becomes more changeable.

Even though these three diagrams show very different results they are dependent on the PES and the PED of the market.

Source:
https://policonomics.com/lp-closed-economy-cobweb-model/

Ludicrous regulations of the US Airline Industry and Contestable Markets

With Auckland now at COVID-19 Alert Level 3 and schools operating online we continued going through the A2 syllabus and discussed Contestable Markets using Webex. I used this clip from Commanding Heights to show how regulated the US airline industry was during the 1970’s. Regulations meant that major carriers like Pan Am never had to compete with newcomers. However an Englishman named Freddie Laker was determined to break this tradition and set-up Laker airways to compete on trans-atlantic flights. He offered flights at less than half the price of what Pan Am charged. Alfred Kahn was given the task by the then President Jimmy Carter to breakup the Civil Aeronautics Board (the regulatory body) and he wanted a leaner regulatory environment in which the market was free to dictate price. There is a piece in the clip that shows how ludicrous some of the regulations were:

When I got to the Civil Aeronauts Board, the biggest division under me was the division of enforcement – in effect, FBI agents who would go around and seek out secret discounts and then impose fines. We would discipline them. It was illegal to compete in price. That means it was illegal to compete in the discounts you offer travel agents. So we regulated travel agents’ discounts. Internationally, since they couldn’t cut rates, they competed by having more and more sumptuous meals. We actually regulated the size of sandwiches. Alfred Kahn

When the CAB was closed down competition was the rule and the industry had vastly underestimated the demand for air travel at lower prices – a very elastic demand curve – see graph below.

In the A2 course contestable markets is a popular essay question and is usually combined with another market structure.

What is a contestable market?

• One in which there is one firm (or a small number of firms)
• Because of freedom of entry and exit, the firm faces competition and might operate in a way similar to a perfectly competitive firm
• The threat of “hit and run entry” from new firms may be sufficient to keep the industry operating at a competitive price and output
• The key requirement for a contestable market is the absence of sunk costs – i.e. costs that cannot be recovered if a business decides to leave a market
• When sunk costs are high, a market is more likely to produce an price and output similar to monopoly (with the risk of allocative inefficiency and loss of economic welfare)
• A perfectly contestable market occurs only when entry and exit into and out of a market is perfectly costless
• Contestable markets are different from perfect competitive markets
• It is possible for one incumbent firm to dominate the industry
• Each existing firm in the market produces a differentiated product (i.e. goods and services are not perfect substitutes for each other)

There are 3 conditions for market contestability:

• Perfect information and the ability and or legal right to use the best available technology
• Freedom to market / advertise and enter a market
• The absence of sunk costs

Example
• Liberalisation of the US Airline Industry in the 1970’s and the European Airline Market in late 1990s
• Traditional “flag-flying” airlines faced new competition
• Barriers to entry in the industry were lowered (including greater use of leased aircraft)
• New Entrants – easyJet- Ryanair

The challenges for the oil market with COVID-19

Another good video from the FT this time on the future of the oil industry. There is a movement towards more cleaner fuels by major companies in Europe but the same can’t be said about the US. Oil producing countries have been hit by lower prices but some like Saudi Arabia have sufficient reserves to fall back whilst others like Nigeria and Venezuela are financially exposed. Below is a graphic from the video looking at supply and demand – useful for an introductory lesson on the market.

Source: FT

Income Elasticity of Demand and Consumer Purchases Post-Covid

I came across this material on the blog ‘Sex, Drugs and Economics’ which discusses Bruce Wydick’s post on his blog ‘Across Two Worlds’. This is very useful for NCEA Level 3 and CIE AS Level Unit 2 both of which look at Income Elasticity of Demand.

Wydick looks at who is most likely to do well and who is likely to suffer in a post-covid environment. A typical recession is generally caused by supply-side factors (oil crisis years of 1973 – prices up by 400% – 1979 – prices up by 200%) or demand-side impact (loss of business confidence and consumer confidence). Covid-19 is very different as it is a complete shut-down of certain businesses and it forced people to stop buying things that they normal do. Wydick puts goods and services into two categories:

Snap-Back goods and services – things we couldn’t buy during the Level 4 lock-down period but were purchased when we went to Level 3. Pent up demand meant that purchases of these goods and service might have been higher than normal – buying less now means buying more later.

Gone Forever – as it states. Invariably this generally refers to services like air travel, tourism, haircuts, public transport and entertainment. When it becomes safe to have a haircut you still only get one haircut as the rest of your haircuts have disappeared and there is no catch-up spending like with snap-back goods.

These are the differences between goods with low versus high income elasticity. Income elasticity of demand measures the responsiveness of quantity demanded to changes in income. We can have different types of normal goods. If a 10% increase in income brought about a 10% increase in quantity demanded, we can say the income elasticity of demand is unitary. If EY>1 we classify the good as a luxury, and if EY<1, a necessity.

Income elasticity of demand will also affect the pattern of demand over time. For normal luxury goods, whose income elasticity of demand exceeds +1, as incomes rise, the proportion of a consumer’s income spent on that product will go up. For normal necessities (income elasticity of demand is positive but less than 1 and for inferior goods (where the income elasticity of demand is negative) – then as income rises, the share or proportion of their budget on these products will fall. Wydick puts the different types of purchases in a simple 2 x 2 matrix“Snap-Back” vs. “Gone Forever” and High vs. Low income elasticity. 

It then becomes easy to see which industries are in the most trouble in 2020.  So, when goods and services are both “gone forever” and have a high income elasticity, we can expect the impact of the coronavirus pandemic to be most severe. Wydick identifies air travel, tourism, sporting events, hospitality, and transport (but not public transport). Everything else either snaps back and experiences some catch-up spending, or isn’t as affected by lower incomes. Goods that have a high income elasticity means that when you lose your job during the recession, you and others like you are even less likely to buy these things. For New Zealand the decline of the tourism industry is a significant hit to GDP and employment in this sector.

What causes a recession? TED-Ed

Showed this to my IGCSE class today – great video which is well put together with good examples that explain a recession and its causes. Particularly apt for today’s economic environment. Makes good use of supply and demand graphs as well as supply side and demand side variables. Detailed explanation of the business cycle. Useful for NCEA Level 2 growth standard.

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.

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.