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et

SEPTEMBER 2011 · VOLUME 19 · NUMBER 1

E C O N O M I C S T O D AY

In this issue:
䊳 Elasticities

䊳 Should governments
subsidise rail fares?

䊳 What are the causes of

inequality of income
and wealth in the UK?

䊳 How does the PPF fit

into Economics?

䊳 Measuring economic
growth

䊳 Publishers and the

iPad

The Economics
of Happy Hour
The essential magazine for ‘A’ Level Economics
et
The essential magazine for ‘A’ Level Economics

E C O N O M I C S T O D AY

Online access
Go to: www.anformeresources.com/volume19/online.html and key in:
Username: economicstoday Password: 2684
This will allow you to access all our online and interactive features, including PowerPoint
presentations, interactive multiple choice, weblinks, additional articles and further information
and analysis.

Contents
Happy Hours 2
Stephen Romer
Should governments subsidise rail fares? 5
Steve Earley
What are the causes of inequality of income and wealth in the UK? 8
Tony Darby
The issue of sugar-sweetened drinks in the United States 13
Tony Emery
Making Sense of Economic Data: Measuring economic growth: GDP vs GNP 16
Andrew Reeve
View from the City: Budget deficits and the problem of government debt 18
Subscription Details Neil MacKinnon
The price of an annual subscription
(4 issues) to individuals and institutions Back to Basics: How does the Production Possibility Frontier fit into Economics? 20
is £20.95. Rachel Cole
Further subscriptions are available as part
of a bulk mailing to the same address at Multiple Choice Question & Answer: Questions 25
£10.95 each. A free copy is sent with all Robert Nutter
orders of 20 or more.
Economics Today is edited by The UK housing market 26
Peter Maunder and is published
by Economics Today Ltd.,
Brian Ellis
Stocksfield Hall, Stocksfield,
Northumberland NE43 7TN. Multiple Choice Question & Answer: Answers 29
Tel: (01661) 844000. Robert Nutter
Fax: (01661) 844111.
www.anforme.co.uk The publishers and the iPad 30
No part of this publication may be Stephen Romer
reproduced in any form without the
permission of the publishers.
What policies can be used to stop firms in an oligopoly from colluding? 34
©Economics Today Ltd
ISSN 0969-4641
Ruth Tarrant
Images supplied by www.shutterstock.com Handling Economic Data: Presentation of economic data 39
and www.istockphoto.com
Peter Cramp
Designed by David Usher
Artwork by George Wishart & Associates,
Whitley Bay
Everyday Economics: Chocolate meltdown Back Cover
Printed by Potts Print (UK) Ltd Rachel Cole

Economics Today · September 2011 1

Drunk as a Lord
In the UK after about the mid-1990s, one
became increasingly accustomed to seeing
pubs offering such promotions as:
G All you can drink for £10
G Girls drink free until closing time
G Speed drinking competition –
win free beer
G Drink free when you sit in the
Dentist’s Chair
G Two drinks for the price of one
G Buy two glasses of wine and receive
the whole bottle
This kind of cheap – or free – offer enlarged
and extended the original concept of the
Happy Hour. But why did so many pubs
effectively turn the basic sixty minutes of the
Happy Hour into an evening-long excess of
insobriety and intoxication?
And does the simple price discrimination
explanation of the Happy Hour (noted
Stephen Romer discusses the consequences of low-priced above) also account for promotions of this
alcoholic drinks in pubs kind? Probably not: the driving factor in pub
pricing increasingly in recent years has been
Traditionally, the Happy Hour in a city centre pub meant a strictly limited sixty direct competition with the multiple retail
minutes of early evening price reductions on drinks. Cocktails were available at chains. In 2011, an undiscounted pint of beer
half price from 5.30pm to 6.30pm. It was essentially a variation on that familiar in a pub might cost you about £3. Compare
theme in microeconomic theory, Price Discrimination. Happy Hours meant that this with a visit to a branch of one of the
two segments on the demand side of the pub-going market were identified. major retail chains where a typical promotion
offers three twelve-packs of 440ml lager
Segment A was composed of workers fitting in a drink at half past five or
for £20.
six o’clock before rushing to the railway station to catch the 6.53 commuter
special back to suburbia. Segment B were drinkers spending all of their evening If a rational consumer’s decision making is
hours in the pub. based on this sort of information about
prices, where is he or she more likely to go
For successful price discrimination, you must have monopoly. But if the King’s Head and the to drink beer (or wine and spirits, also
Red Lion, the Cat and Fiddle and the Bull (and all of the other pubs in a given area) were heavily discounted by supermarkets)? Out
offering essentially the same promotion – drinks at half price for an hour from 5.30 – you to the pub? Or at home in the sitting
would have, in effect, a unified monopoly. room, unpacking the Tesco and Sainsbury’s
But the crucial assumption for the price discriminator is differing price elasticity of demand carrier bags?
in each market segment. In Segment A, it would be fairly safe to assume that your average “We’re drinking at home this evening,”
office worker who commutes into the City of London would be largely concerned with the task declare two young drinkers, Terry Toper and
of getting back to Surbiton or Guildford, Orpington or Woking in time for dinner. His dormitory Barry Bacchanal. “With supermarket beer
town the chief preoccupation, the typical commuter’s price elasticity of demand for an after- effectively priced at £20 for 36 pints,” they
work drink would be, one might further assume, significantly higher than that of the leisure explain, “drinking a pint in a pub makes little
drinker in Segment B. economic sense – it would be about five
Thus, it would appeal to the economic logic of a profit-maximising bar steward – the landlord times as expensive.”
of the King’s Head or the Carpenter’s Arms, the Lamb and Flag or the Dew Drop Inn – to offer In this pricing environment, you can see why
a cheap tipple for an hour from 5.30pm. The objective? To pick up Segment A revenue that so many pubs have closed down in recent
might otherwise be largely foregone. And who knows? With any luck, incipient insobriety by years, and why others, trying to stay
6.30pm might mean tipsy salarymen staying on for the whole evening, buying more drinks – competitive have offered the kind of
but at higher prices. extended Happy Hour promotions noted
above.
Exam Board AS Unit A2 Unit
1(3.1.4 3(3.3.3
AQA & 3.1.5) & 3.3.5)
1 3(3.3.9
Edexcel (1.3.7) & 3.3.11)
OCR F581 F583
WEJC EC1(C) EC3(D)
CCEA AS(1) A2(1)
Int. Bacc. Standard 2.2, 2.3 & 2.4 Key words
New 2011: 1.2, 1.3 and 1.4 Price discrimination · Negative externalities
Cambridge Microeconomics Expenditure on the NHS · Price elasticity of demand
Pre-U (c), (d) and (e)

2 Economics Today · September 2011

Three sheets to the wind
REMEMBER In microeconomic theory and practice, the
THIS! existence of significant externalities of this
nature tends to mean that the introduction
Public houses have long been accustomed to giving Happy Hour of a government market-improving policy is
discounts in the early evening; more recently, pubs have responded to appropriate. If cheap alcohol means disease,
competition from retail multiple chains by offering extended price death, crime and yobbery, what can the
promotions. authorities do to mitigate this market failure?
For many years, governments have
emphasised feeble guidelines about ‘sensible
Delirium tremens drinking’ limits to the consumption of
alcohol, recommending that adult males
The trouble with cheap alcohol is that it tends been getting worse rapidly: the hospitalisa-
should drink no more than three or four
to promote the kind of boozing which can tion statistic was 12% up in a year – and twice
‘units’ a day, and women between two and
easily lead to a proliferation of negative the number recorded a mere seven years
three units.
externalities. Specifically, the external earlier. The cost to the NHS of alcohol-
disbenefits of excessive consumption of related treatment in 2009-10 was £2.7 billion But what do they mean by a ‘unit’ of alcohol?
alcohol include: (at 2006/7 prices), up from £1.7 billion in It turns out that half a pint of average
2003 (at 2001 prices). The report cites some strength beer or cider is an example of one
G workplace costs: absenteeism, and low
earlier government estimates of the extent unit. Thus, if the bibulous Terry Toper and his
on-the-job productivity of the alcoholi-
of the crime/anti-social behaviour cost of mate Barry Bacchanal were to stick strictly to
cally impaired;
UK alcohol consumption, £7.3 billion in 2003 the official guidelines, they would be calling
G criminal and anti-social behaviour,
(at 2001 prices), and puts 2003 workplace it a day after a couple of pints (or one large
including the costs of policing Friday
costs at £6.4 billion. glass of wine – equivalent to three units),
night town centre ‘no-go’ areas over-run
wishing each other Good Night and toddling
by drunks; and And the most shocking aspect – enough to
up the wooden hill to Bedfordshire, all tucked
G booze-induced illness and the costs of its make our friends Terry Toper and Barry
up before 10.30pm.
treatment, costs which are imposed on Bacchanal put down their cans of cheap lager
Tommy Taxpayer. and pause for thought – over-drinking will Does this sound realistic? Probably not: it’s
probably kill you. There were, says the report, more likely that we visualise Tel and Baz
Alcohol can cause short-term injury (due to
“6,584 deaths directly related to alcohol” in going out of the house at 10.30 on a Friday
drunken falls, or to the consequences of
2009-10, up 20% in a decade. Of the night, on their way to join the town centre
violence) and long-term morbidity (liver and
fatalities, 4,154 were caused by alcoholic hell-raisers, having spent the early part of
heart diseases, cancers, mental illness).
liver disease. the evening indoors knocking back the cheap
Statistics on Alcohol: England, 2011 Report
supermarket lager, tying the sail to the main-
(published by the NHS Health and Social What about cirrhosis of the liver? The
brace before going out, absolutely plastered.
Care Information Centre, 2011) records some thought of it is enough to take the ‘Happy’
By the way, in the jargon of modern drinking,
remarkable data. In the UK in 2009-10, there out of Happy Hour. The UK liver death rate is
this is a practice known as ‘top-loading’.
were 1,057,000 hospital admissions due to 11.4 per 100,000 people, a statistic that
an alcohol-related injury or disease. At the turns the very phrase ‘Happy Hour’ into a
time of the report’s publication, things had cruel irony.

HEALTH
WARNING!
Do not confuse price cutting
under competitive market
forces with differential pricing
by price discriminating
monopolists.

Economics Today · September 2011 3

Blotto and Stinko
Many observers have been calling for more REMEMBER
effective regulations, especially new legisla- THIS!
tion to enforce minimum unit pricing. The
idea is simple: the more alcoholic the drink, Excessive alcohol consumption invariably causes negative
the more expensive it would be. And if the externalities. The taxpayer must foot the bill for additional
minimum price were high enough, drinkers NHS, public order and other costs.
would either reduce consumption or switch
to cheaper (and therefore alcoholically
weaker) drinks.
Anti-alcohol campaigners were excited in
2009 when news came through that in
drinks industry opposition be off-putting, £2 for a bottle of wine, and £11 for a litre of
Scotland, traditionally a country of heavy
but there is by no means universal agreement spirits.
drinking, the Scottish National Party had
among policy makers about minimum pricing
adopted a unit pricing policy, and would In the UK today, about 70% of alcohol is sold
in principle. Some critics of the measure
attempt to put minimum price legislation in the off-trade, mainly supermarket outlets.
point out that a minimum unit price would
onto the statute book. The SNP was Effectively, there is no pricing constraint:
be comparable to the imposition of an
proposing a minimum unit price of 40p, under the latest policy, retail chains can, with
alcohol tax, but with the difference that the
arguing that this would curb excessive impunity, continue to sell very cheap drink,
revenue raised would go to supermarkets and
drinking and lead to savings in public including tins of beer for as little as 40p.
other retailers – and not to the Treasury.
spending of about £1 billion over ten years. Isn’t there more than this to the Cameron
Thus, says this argument, raising the rate of
Total Scottish alcohol-related fatalities and administration’s response to the alcohol
taxation on alcohol would be preferable to
hospitalisations would drop by more than crisis? Yes. And here it is: in March, 2011,
imposing a minimum price.
3,500 annually. the government launched a so-called
In the event, however, the other parties at Rather than minimum pricing as such, ‘Responsibility Deal’, getting the drinks
Holyrood were opposed, the SNP had the Coalition government at Westminster industry to sign on to a (strictly voluntary)
insufficient Parliamentary support and the planned to curb cheap alcohol by introducing agreement to label bottles with information
measure had to be withdrawn from the a ban on the sale of drink at below cost price. about alcoholic unit content, and taking
Scottish Alcohol Bill. But what was Indeed, this measure was a provision of the steps to make people in pubs more aware of
particularly interesting was that the defeat Police Reform and Social Responsibility Bill units consumed. Drink adverts would include
of unit pricing was a great victory for the foreshadowed in the Queen’s Speech, 2010. messages about “responsible drinking”.
drinks industry lobby which had fought tooth However, reinforcing a reputation for policy
U-turns, the government subsequently The Responsibility Deal did not, however, cut
and nail against the policy. much ice with anti-alcohol campaigners in
switched to a less arduous restriction:
For the industry, the demise of minimum prohibition of sales at below the cost of excise general or the health lobby in particular. The
pricing in Scotland meant that a celebration duty and VAT. Observers have not been slow government has abdicated its responsi-
was called for: to point out that this restriction is likely to bilities, they said, cravenly allowing the
have little, if any, impact on price levels or drinks industry to devise government alcohol
“When unit pricing was taken out of the
consumption volumes. policy on its behalf. And the heavyweight
Bill, all opposition MPs received a free
health organisations – the BMA, the Royal
crate of beer from SAB Miller” (the latter,
Why not? Cheap supermarket drink is College of Physicians, the UK Health Alliance
the world’s second largest brewery
invariably not priced at below the cost – weighed in, refusing to endorse the
firm).1
of duty and VAT. It’s cheap, but not that Responsibility Deal. They called for the
South of the Border, the introduction of a cheap. In 2011, the approximate minimum urgent imposition of enforceable constraints
unit pricing policy has not been attempted. permissible retail prices of drink (i.e. covering which would reign in the affordability,
Not only might the prospect of ferocious duty and VAT) are 40p for a can of beer, availability and promotion of cheap booze.

TRY
THIS!
Imagine that you are a Minister in the Coalition government.
Bewildered by incessant U-turns, you do not know what line
official policy is going to take next week when you are due
to make a speech in the House of Commons. But you like to
be well prepared. Read the NHS report ‘Statistics on Alcohol’
(see www.ic.nhs.uk/) and use it to write two speeches:
(a) making the economic case in favour, and
(b) against minimum unit price regulation in the retailing of
alcohol. 1. The Guardian, 16 February 2011, p. 8.

4 Economics Today · September 2011

res?
il fa
ise ra
ubsid
nts s
rnme
gove
uld
Sho
Steve Earley, Head of Economics, Guernsey Grammar School, analyses
whether public expenditure could ease congestion on the UK road system

In May 2011, after more than a year of collating evidence, Sir Roy McNulty published his
report Rail Value for Money.1 His findings were generally well received as offering sensible
suggestions as to how the rail industry could build on the achievements so far observed since
the privatisation of the industry in the mid-1990s. In the foreword to the report Sir Roy
McNulty expressed a vision for the future where “Intercity and London and the South East
services can operate with little or no subsidy and in which the subsidy for regional services,
while still continuing, is better controlled and much more precisely targeted.” So, should
Governments subsidise the rail industry? Obviously for Sir Roy the answer is “Yes”. But should
such subsidisation be aimed specifically at rail fares?

The background
Economists maintain that government involvement in specific aspects of economic provision
is justified whenever market failure occurs: where the price mechanism fails to produce an
outcome that is desirable from society’s point of view state intervention is seen as a way to
enhance economic welfare. With overcrowding on Britain’s road network seriously impeding
the ability of individuals to efficiently carry out their roles as both units of labour and as
consumers, congestion is acknowledged as a classic example of market failure. The granting Exam Board AS Unit A2 Unit
of fare subsidies to operators of rail services – payments made by the government in order to 1(3.1.2,
reduce the price of the services offered – is suggested as one potential solution that could help
AQA 3.1.4 &
3.1.5)
to decrease road congestion and the economic waste associated with it. 1(1.3.7
Edexcel & 1.3.8)
OCR F581 F584
WEJC 1(C)
CCEA 1
Standard 2.2 and 2.4
Int. Bacc. New 2011: 1.2 and 1.3
Key words Cambridge Microeconomics (b) and (d)
Road congestion · Market failure · Subsidies Pre-U
Marginal social cost · Price elasticity of demand
1. See www.dft.gov.uk

Economics Today · September 2011 5

The problem of The subsidy solution Some issues
road congestion It follows from the above analysis that the The idea outlined above makes the solution
In Figure 1, traffic flows up to quantity OX demand for road space needs to be reduced appear so simple! Reality, of course, is much
are associated with a road capacity that can in certain places/at certain times so that an more complex. Indeed there are many
cope unhindered with the amount of vehicles optimal use of the road infrastructure is reasons to doubt whether subsidies on rail
involved: up to OX the decision of an extra achieved. The provision of subsidies to fares would encourage significant extra use
person to use the road does not have any providers of rail services is seen as one means of rail services and so achieve a more efficient
adverse impact on the speeds attainable by by which such a reduction in the demand for use of road space.
any other road user. Third party ‘time-waste’ road use could be achieved. In Figure 2 with
Figure 2 shows that the subsidised price
problems associated with congestion the government now bearing a proportion of
reduction would encourage demand for rail
therefore do not exist. In technical language, the costs associated with provision of the
services to rise by QQs journeys. But is price
with levels of demand up to that shown by service, rail providers would be more willing
always of prime importance when choosing
D1, as there is no variation between the and able to increase supply within the market
to travel by train? When it is not, the price
marginal private cost and the marginal as reflected in the movement of the supply
elasticity of demand for rail travel may well
social cost of using the road space (i.e. there curve from S to S subsidies. A new market
turn out to be inelastic and so only a limited
is no external cost resulting from road usage), equilibrium results with a lower price (OPs as
amount of extra passengers may be attracted
the equilibrium achieved by the operation of opposed to OP) leading to increased use of
by lower prices. In areas of the UK, for
the free market can be trusted to deliver rail services (from OQ to OQs). With at least
instance, where the rail network has failed to
allocative efficiency. Once the volume of some of the extra passengers having
evolve over the years to adequately service
traffic exceeds OX, however, any additional switched from using cars the demand curve
the spread of urban areas (i.e. the trend for
demand for road space imposes a ‘spill-over’ D2 in Figure 1 would move to the left and so
people to live, work and shop away from
cost on to the other road users: as capacity diminish the market failure of overconsump-
traditional transport hubs), then any
issues arise the decision of an extra person tion of road space.
to use the road necessarily impedes the
progress of others. As time is lost – time
which could have been used to better effect
– a resource issue now exists. If demand, for Figure 1: Road congestion
instance, was at the level associated with Price/
demand curve D2 the operation of the free Cost Marginal
market would deliver a traffic flow of OQ Social
Cost
journeys, determined where D = S (MPC). As
this exceeds society’s optimal level of OQ*,
derived from where D = MSC, inefficient use
of road space is observed: ‘overconsumption’ S (Marginal
of the road space occurs and a deadweight Private
loss to society, shown by the shaded triangle, Cost)
results. Recent estimates by the Confedera-
tion of British Industry put the cost to the
UK economy of this time waste as being over D2
£20 billion!

D1
0
X Q* Q Quantity of
Road Traffic

Figure 2: Rail fares with subsidies

Price
S

REMEMBER S subsidies

THIS!
Road congestion is a classic example of market P
failure. Ps
Subsidies artificially lower business costs which
enable them to lower prices.
Lower prices for rail travel should encourage a
switch away from road use. D

0
Q Qs Quantity of
Rail Journeys

6 Economics Today · September 2011

reduction in price may see little return in respect to a change in the price of rail fares rather than making the service more
terms of increased usage. In this way the is inelastic rail fare subsidies would have very affordable.
inconvenience of the rail network coverage limited impact in reducing the demand for
A further issue worthy of note is that over
would represent more of a negative influence road use. Spending the money to improve
time subsidised rail fares may well lose their
on choice than the positive draw of lower the ‘passenger experience’ of rail travel
attraction to passengers as incomes grow.
prices. Subsidies on fares therefore would do would undoubtedly bring greater returns.
Where rail travel is perceived to be an inferior
little to encourage extra rail usage and travel
It must be recognised that even when good (and so possesses a negative income
by road would therefore be little affected.
price and cross elasticities of demand elasticity of demand) then any gains in
Would it not be better to use the money to
are conducive to encouraging additional passenger numbers from artificially lower
extend service provision instead?
travel by rail the ability of the rail network fares could well be neutralised in periods of
Similar logic can be applied to any non-price itself to handle extra demand must also rising prosperity. Travellers attracted by lower
factor that makes car travel appear superior be taken into account. If, for instance, parts prices are offset by others lost when rising
to journeys by rail. It may well be, for of the network are already close to full incomes encourage use of a better
example, that the benefit of ‘own space’, capacity – existing trains are full and alternative. In this way the impact that
convenience of door-to-door service, (real or access to track space to operate extra subsidies may have in reducing road
perceived) time savings, uncertainties in services is limited – then subsidies to congestion could well be short-lived and
coordinating inter-mode transfers, etc, are cut fares will do little to help with what is, pose a question over the use of public money
more significant considerations than price in after all, an issue of inelastic supply. for this purpose. Could the money be better
making transport decisions. As a result Attracting more passengers but being spent subsidising the quality of the service
subsidies on rail fares would seem to have unable to accommodate them would be offered – better stations, more comfortable
little impact on reducing road use even where rather counter-productive! Subsidies in such trains, improved information systems, etc –
rail coverage is extensive. Where the cross scenarios should be aimed at helping to in order to make the experience of rail travel
elasticity of demand for road journeys with deliver investment in extra infrastructure more appealing to those on rising incomes?

Conclusions
The issues raised in the analysis above TRY
suggest that the use of public money to THIS!
directly fund fare reductions for rail travel
could well have little real impact on rail Subsidisation of rail travel is but one option that could help alleviate
customer numbers in either the short or long the problem of road congestion. Identify other options that are
term. The elasticity concepts of both demand available to policy makers and evaluate the likely success of each
and supply indicate that subsidies which in reducing the current ‘overconsumption’ of Britain’s road space.
lower the price of travel may well fail to
achieve any meaningful effect on our
congested road network. Yet the message is
not that subsidies per se are an inappropriate
policy option. Rather it would be money
better spent if it was used in some locations
to improve the breadth of provision and,
more universally, the overall quality of service
offered. Perhaps this is what Sir Roy McNulty
with Chief Examiner,
is alluding to when he concludes that, in the Robert Nutter
future, subsidies need to be “much more
precisely targeted”.
1. Investigate the role of the pressure group Passengerfocus and its current
views on UK rail fares.
www.passengerfocus.org.uk
REMEMBER 2. What were the main findings and recommendations of the McNulty Report
THIS! and the reaction of the rail unions such as the RMT to it?
www.railnews.co.uk www.togetherfortransport.org
Elasticity considerations may weaken www.rmt.org.uk www.bbc.co.uk/news
the effectiveness of rail fare subsidies.
3. Regulated rail fares can currently rise by RPI + 3%. Investigate how the
Subsidies may best be targeted at government arrived at this figure.
non-price aspects of rail provision. www.bbc.co.uk/news http://www.dft.gov.uk/rail
4. Investigate the role of the Office of Rail Regulation.
www.rail-reg.gov.uk http://www.networkrail.co.uk
5. It has often been asserted that the UK has the most expensive train fares in
Europe. Research the reasons for this.

Economics Today · September 2011 7

What are the causes of inequality
of income and wealth in the UK?
Tony Darby, Head of Economics and Business Studies at Rugby School, examines the reasons
why there are marked differences in household incomes

“Britain is an unequal country, more so than many other industrial countries and more so than a generation
ago.”1 This was the conclusion of the National Equality Panel (Hill’s Report) in January 2010 which detailed
just how unequal the UK now is. The report revealed that the richest 10% of the population are more than
100 times as wealthy as the poorest 10% of the population. This top decile of society has a household wealth
of over £850,000 compared to less than £8,000 for those in the bottom decile.
Figure 1 shows the differences in household houses, pensions, share portfolios and even In most organisations the chief executive is
income when the data is shown as income more exotic belongings such as race horses paid far more than a cleaner working for the
measured in 10 per cent bands. The richest and vintage cars. They are the accumulation same organisation. This can be partly
tenth now have 31% of total income whereas of income, and this income can come from a explained by the marginal revenue product
the poorest tenth have just over 1% of total variety of sources, such as rent, interest on of the board member being significantly
income in Great Britain. savings, profits from a business venture, or greater than the cleaner. The value of their
more likely, the pay from being employed by skills, education and work experience is much
What constitutes household wealth? Assets
a firm. higher to the company than that of the
can be widely defined, and may include
cleaner. According to recent research the
Exam Board AS Unit A2 Unit average FTSE 100 chief executive remunera-
3(3.3.4
Education and skills tion package in 2009 was over £3.7 million
AQA & 3.3.5) One of the characteristics of a free market for per year, and this was 145 times larger than
Edexcel 2(2.3.2) 4(4.3.5) labour is that there are differences in income the average pay for a worker in the UK.2
OCR F583 for different occupations. This suggests that Currently in the UK graduates are generally
WEJC EC1(C) inequalities are the natural consequence of paid more than non-graduates within a
CCEA AS(2) members of society specialising in work that workplace. With the debate about university
Int. Bacc. New 2011: 2.3 and 2.6 they are good at, and so this lack of tuition fees raging, many potential students
Cambridge homogeneity of labour can partly explain the are currently weighing up whether going to
Microeconomics (F)
Pre-U differences there are in wages. university is worth the investment in terms
of time and money. University graduates can
still command a premium in the jobs market
when looking at pay. On average a graduate
will earn £160,000 more than a non-graduate
over a lifetime.3 There are also differences
between universities and eventual pay
differentials. According to The Guardian, one
fifth of people who graduated from elite
universities in the 1990’s are now earning
more than £90,000 per year, compared
with only 5% of those who went to former
polytechnics.4

1. The Hill’s report on ‘An Anatomy of economic

inequality in the UK’ can be found at
www.equalities.gov.uk
2. MM&K and Manifest Data on executive pay
compared to Annual Survey of Hours and Earnings data
on average employee pay, September 2010.
3. http://www.guardian.co.uk/money/2007/feb/07/
higher education.graduates?INTCMP=ILCNETTXT3487
4. http://www.guardian.co.uk/education/2008/may/
21/higher education.uk

Key words
Labour immobility · Discrimination
Marginal revenue product
National Minimum Wage

8
Figure 1: The distribution of income by income bands
35%

Share of the total net income of the population,

30%
Immobility Richest Tenth

after deducting housing costs

Often though, differences in income 25%
may not just come down to
differences in ability. Another
20%
explanation may be because of
labour immobility. Some jobs, such Second Richest Tenth
as doctors and dentists cannot 15%
just accept new recruits into the
profession without them first going 10%
through a long training period.
This is designed to ensure that 5% Second Poorest Tenth
each medical practitioner has the Poorest Tenth
necessary skills and training to do 0%
what is a very demanding job. An ’94/ ’95/ ’96/ ’97/ ’98/ ’99/ ’00/ ’01/ ’02/ ’03/ ’04/ ’05/ ’06/ ’07/ ’08/
increase in demand for these occupa- ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09
Source: Department of Work and Pensions, Households Below Average Income, Great Britain, as at August 2010.
tions cannot easily be matched with
a quick change in supply, and may
ultimately lead to pay differences
increasing between various occupa-
tions. In the longer term of course,
differences in earnings between
groups will attract new entrants to
those professions that are more
highly paid.
Another reason for the differences in
Similarly, some differences in pay
income between jobs could be
REMEMBER
may be explained by geographical THIS!
immobility of labour, especially as compensating differentials. This is
the large cost of living differences in where workers may expect to be The UK is a country that has very
the UK often make moving jobs to a compensated for entering occupa- large differences of income and
more expensive area less attractive. tions that may be more dangerous or wealth between its citizens.
The public sector often recognises dirty than others, or involve shift
work or time away from home in Some differences in income may be
this by giving a specific payment, or explained by the normal functioning
weighting, to those who live close to uncongenial places. Workers in the
NHS for instance get paid more for of the market for labour: some people
the south-east, where the cost of have more education, skills and
living is much higher than other areas working on Sundays and evenings,
and other groups of workers such as talents and these people are likely to
of the country. A recent study by the be better rewarded than those lacking
Joseph Rowntree Foundation con- train drivers also get paid more for
working unsociable shifts such as in these areas.
cluded that during the long period of
house price growth in the south-east during holiday periods. Fishermen Another reason for differences in
during the 1990’s and 2000’s, this have been identified as having one income could be discrimination. Large
contrasted greatly with the smaller of the most dangerous jobs in the differences in income exist between
gains in other areas of the UK, so that UK, and they can rightly expect a men and women, disabled and non-
the regional gap in house prices wage that in part compensates them disabled, and various ethnic groups.
widened.5 Average house price sales for this risk.7
in the spring of 2011 for London were What this theory of earnings
£352,000 compared to £103,000 on suggests then is that the workings of
average for north-eastern areas of the free market within the labour
England.6 Any worker wanting to market naturally leads to income, and
take up a job in the south-east who therefore asset inequalities. What
is currently working outside of this it doesn’t explain is why these
area may find it very difficult to inequalities are greater in the UK 5. http://www.jrf.org.uk, ‘Local housing market volatility’,
relocate and suffer obvious financial than in many similar countries in the January 2011.
6. Land Registry House Price Index April 2011,
hardship. Western world. www.land registry.gov.uk
7. http://www.bbc.co.uk/news/uk

9
Discrimination Government policy: welfare payments
One possible explanation is that The Government through the tax, benefit and minimum wage system has recognised that the
there is discrimination in the work- differences in income may not be desirable for society. Each one of these tries to reduce the
place, leading to some people in the extent of the inequalities of income within the UK. The benefit system for instance aims to
labour force being treated differently provide a safety net to citizens, and was originally set up to provide support from the ‘cradle
to others. The Equal Pay Act was to the grave’, and the introduction of a top rate of income tax of 50% in 2009 was designed
introduced in 1970 to ensure that to make the tax system more progressive and therefore likely to reduce inequalities. However,
workers were paid the same amount recent reforms of the welfare system may well be exacerbating the differences in income and
for work of the equivalent value to asset inequalities.
an organisation. Over forty years on,
Welfare payments constitute one of the biggest areas of public expenditure for any UK
a significant pay gap between men
government, and were greater than income tax receipts last year. These payments include
and women still exists, and a recent
housing benefits, single parent benefits, unemployment benefits and family tax credits. Each
study by the Equality and Human
benefit is designed to top-up income, reducing the harsh realities of income and wealth
Rights Commission identified full
inequalities in the UK.
time female employees receive 39%
less per hour than men, and that the More recently there has been an extensive debate about the levels of these benefits. In June
largest pay gap was in financial 2011, the Welfare Reform Bill started to pass through parliament that will not only bring in
services, where women on average tougher sanctions on those who refuse to work, but will also create a single universal credit
earn 60% less than men for and place a controversial cap on benefits to £26,000 per year. Many economists felt that this
equivalent work.8 The number of may lead to a widening of inequalities of income with The Guardian pronouncing “The effect
females in top jobs has also recently will be most pronounced where rents are high, and consequently housing benefits can be
become a concern. In February 2011 larger”.10
the former Labour minister, Lord On 4th January 2011 the government also increased the rate of VAT to 20% from 17.5%.
Davies of Abersoch, urged top Some economists have argued that even though VAT can be seen as a proportional tax (i.e. the
companies to increase the percent- more you earn, the proportion of tax paid of your income is the same) it can have regressive
age of women in the boardroom to effects. This is because spending can often be lumpy, particularly on big ticket items such as
25% by 2015. Currently women make cars, where a family may typically buy a new car every few years. Anyone purchasing such a big
up only 5.5% of executive director- item will be subject to VAT, meaning that they will be hit hard by the VAT increase. In effect
ships on FTSE 100 boards.9 the government may well be exacerbating the differences in income by making the majority of
Discrimination is not limited to goods more expensive for everyone. Poorer members of society found it more difficult to
gender. The Equality and Human purchase goods and services after this VAT increase.
Rights Commission have said that
disabled men earned 11% less than
non-disabled male workers, whilst
the gap for women is 22%. The report
went on to look at differences of pay
between ethnic groups and found
that black graduates faced a pay
penalty of up to 24% compared to
white equivalent workers. Clearly
differences in pay can be not entirely Figure 2: Average percentage change in real net household incomes
explained by differences in supply between 1998/99 and 2008/09, after deducting housing costs
and demand of labour. 40%

35%

30%

25%

20%

15%

10%

-5%

-10%
8. ‘An Anatomy of economic inequality in the UK’,
Human Right Commission 2010. -15%
9. http://www.bbc.co.uk/news/12560121
10. http://www.guardian.co.uk/commentisfree/
Poorest 2nd 3rd 4th 5th 6th 7th 8th 9th Richest
2011/jun/ 15/benefit-cap-london-poor-families? Tenth Tenth
INTCMP=SRCH Source: Department of Work and Pensions, Households Below Average Income, Great Britain, as at August 2010.

10 Economics Today · September 2011

The National Minimum Wage
A National Minimum Wage (NMW) was first introduced in the UK by the then Labour Government in 1999. From the 1st October 2011, the
minimum wage per hour for those over 21 years of age will increase to £6.08 per hour. The minimum wage has increased by nearly 65 per cent
between its introduction in April 1999 and October 2010. Over that period, the increase was much higher than price inflation or average
earnings growth, allowing the Low Pay Commission Report 2011 to conclude that “the minimum wage has affected earnings and their
distribution”.11 The NMW has clearly improved the bargaining power of the low paid and ensured that many of the lowest paid jobs in the UK
such as hairdressers, school cooks and holiday reps are now better off in real terms than before the minimum wage existed. What is less clear is
the extent to which these extra labour costs have detrimental impact on the numbers employed in these low paid positions, and whether
unemployment has increased due to increasing the NMW above average earnings growth. If this was true then it could be suggested that the
minimum wage policy could well be creating an increase in income and wealth inequalities, as the policy potentially creates unemployment in
these low paid sectors.
Unemployment in January 2009, in the middle of the recession numbered 1.9 million people (6.1% of the labour force). By January 2011 this
number had increased to 2.5 million, approximately 7.9% of the labour force. Economic theory suggests that the NMW may well partly explain
this rise in unemployment, particularly as in times of recession firms will need to try and reduce costs where ever possible, and not take on as
many people when the upturn begins.
However the Low Pay Commission Report of 2011 has suggested that contrary to the basic economic theory, “the evidence available to date
suggests that minimum wages do not appear to have cut employment to any significant degree”.12

This was confirmed by further research from the Low Pay Commission that examined previous recessions and the impact on the industries of
wages set by the Wages Council, a body that set minimum wages for certain industries before 1999. Again they concluded that there was little
evidence to suggest that there was any “significant detrimental impact on employment”.13
The extent to which government policies have potentially increased income inequalities can be seen when looking at recent Department of Work
and Pensions data. Figure 2 shows how the poorest members of society have seen a real decrease in the value of their incomes over the past
ten years, whilst the richest tenth of society have seen their incomes rise the quickest.14 This contrast is highlighted by looking at executive pay
increases over the past ten years. The High Pay Commission has recently calculated that from 1999 to 2009 the remuneration of chief executives
rose far more quickly than that of the average worker in the UK, rising by on average 67% in real terms compared to 31% for average workers.15
However, these figures do not truly reflect the surge in pay and benefits for those non-board members who work predominantly in the financial
services sector. The Financial Services Authority identified that over 2,800 banking employees in the City were paid more than £1m in 2009.16
The coalition government have pledged to examine and potentially regulate financial sector pay, but no firm policies have yet to be agreed, let
alone implemented.

11. The National Minimum Wage, The Low Pay Commission

Report, April 2011, http://www.lowpay.gov.uk
12. The Low Pay Commission Report, April 2011,
http://www.lowpay.gov.uk
13. The Low Pay Commission, ‘Using wage council data
to identify the effect of recessions on the impact of the
minimum wage’, April 2011.
14. http://www.dwp.gov.uk/research-and-statistics
15. The High Pay Commission, ‘More for less: What
has happened to pay at the top and does it matter?’,
www.highpaycommission.co.uk
16. http://www.guardian.co.uk/business/2010/jul/
29/fsa-toughen-city-pay-code-bonuses

Economics Today · September 2011 11

Some conclusions
In summary, vast inequalities of income and wealth TRY
exist within the UK and these have increased over THIS!
recent years. Many of these differences are due to
the normal functioning of a free market, with the Inequalities of wealth are greater than inequalities of income
larger payments made to those who may have greater in the UK. Can you explain why this is?
levels of skills and education and talent for
The Gini coefficient is used to measure how unequal a
performing certain jobs. It is also true that years after
laws have been introduced to ensure equal pay for society is (it is a number between 0 and 1, where 0
those performing the same job, pay differentials corresponds with perfect equality and 1 is perfect
between gender and ethnic groups still exist that inequality). Find out what the Gini coefficient is for the UK,
cannot easily be explained by differences in ability. and how it has changed over the past 50 years.
Finally, there remains in place a welfare state that
limits some of the income inequalities that exist Many recent discussions about executive pay have suggested
within the UK society. However, more recent policies that the government should regulate the amounts that
by governments have to some extent exacerbated
people are paid, particularly when looking at the very large
these income disparities. It seems highly likely that
these differences will become larger in future years pay packets for some individuals. What are the potential
as real incomes become eroded by inflation whilst benefits and problems of adopting such a scheme in the UK?
pay at the top of organisations grows more quickly
than the average rate of pay.
The Government is currently making many cutbacks in
government spending across a wide range of departments.
Discuss where you think cuts to the welfare budget should
be made, and what the impact on income and wealth
inequalities will be.

REMEMBER
THIS!
The tax system and welfare
state have tried to limit some
income disparities, through
progressive taxes and
providing means-tested
benefits.
However some recent
government policies such as
the change in VAT and a cap
on welfare payments may lead
with Chief Examiner,
to greater income inequalities
Robert Nutter
in the future.
Large differences in income
and wealth are likely to remain 1. Investigate the view that inequalities of income create inequalities of wealth and that
in the UK in the future. inequalities of wealth create inequalities of income.
2. On the BBC web site search ‘inequality’ and complete the exercises from the study
guide about social inequality analysing statements and statistics on wealth and health
in Britain.
http://www.bbc.co.uk/scotland/education/ms/wealth
3. Research labour market theory to understand how different elasticities of demand
and supply of labour help explain income inequalities.
www.bized.co.uk www.tutor2u.net
4. (a) Investigate the main findings of the National Equality Panel’s 2010 Report
by Professor John Hills.
http://www.equalities.gov.uk (go to National Equality Panel link and then
publications summary report).
(b) How might the Equality Act 2010 possibly help to reduce income inequalities?
http://www.equalities.gov.uk (follow the link from Equalities Act 2010).

12 Economics Today · September 2011

The issue of sugar-sweetened
drinks in the United States
Tony Emery, a Principal Examiner, discusses a recent study
that offered some estimates on price and cross elasticities
In July 2010 a report by the United States Department of Agriculture (USDA) considered a policy of discouraging the consumption of drinks
sweetened with sugar.1 The relevant sweetened drinks include sodas, fruit drinks and sports and energy drinks. Because of their high sugar
content these drinks are considered to be more harmful to health than alternatives such as milk, fruit juices, bottled water and diet drinks.
The USDA report highlighted the changing consumption of two of these sugar-sweetened drinks and milk between 1977 and 2006 as shown in
Figure 1.
In carrying out the study demand elasticities of a range of drinks were calculated. The estimated figures of own price elasticity for some drinks
and cross elasticity demand values are given in Table 1.
The own price elasticity of demand of sugar-sweetened drinks was calculated as -1.26. The US government was being urged at the time of the
2010 report to take steps to reduce consumption of sugar-sweetened drinks, but it was unwilling to go as far as to ban them.

Figure 1: US consumption of selected drinks 1977 to 2006

Children (ages 2-19) Adults (ages 20 and older)
16 16
Milk

14 14

12 12
Ounces per day

Ounces per day

10 10

8 8
Milk
6 Non-diet 6
soda Non-diet
soda
4 Fruit drinks 4

2 2 Fruit drinks

0 0
’77- ’89- ’94- ’99- ’03- ’77- ’89- ’94- ’99- ’03-
’78 ’91 ’98 ’02 ’06 ’78 ’91 ’98 ’02 ’06

Table 1: Own price elasticity (PED) values and cross elasticity of demand (XED) of selected drinks
to a change in the price of sugar-sweetened drinks, 1998 to 2007
Coffee and tea Diet drinks Bottled water Fruit juices Whole milk
Own price elasticity of
-0.45 -0.75 -0.97 -1.01 -1.12
demand of drink
Cross elasticity of drink to
a change in the price of -0.38 -0.46 0.75 0.56 0.22
sugar-sweetened drinks

1. http://www.ers.usda.gov/Publications/ERR100/ERR100.pdf Exam Board AS Unit A2 Unit

1(3.1.2)
AQA & 3.1.5)
1(1.3.2
Edexcel & 1.3.8)
OCR F581
EC1
WEJC (B & C)
CCEA AS1
Standard 2.2 and 2.4
Int. Bacc.
Key words New 2011: 1.2 and 1.3
Price elasticity · Cross elasticity · Substitutes and components Cambridge Micro (b and e)
Pre-U

Economics Today · September 2011 13

(a) (i) Use Figure 1 to compare the changes between 1977 and 2006 in the consumption of drinks by
children with that of adults. (4 marks)
(ii) Explain two possible reasons why the adult pattern of consumption of drinks in 2003-6 differed
from that of children. (6 marks)
(b) (i) How do the different own price elasticity values, given in the data, illustrate the three common
distinguishing values of price elasticity? (5 marks)
(ii) Comment on the importance of the own price elasticity values for the sellers of the drinks. (6 marks)
(c) (i) What do the cross elasticity values suggest are the relationships between sugar-sweetened drinks
and other drinks? (4 marks)
(ii) Consider how these suggested relationships might be explained. (8 marks)
(d) Discuss the economic consequences of a government ban on the production of sugar-sweetened
drinks. (12 marks)

14 Economics Today · September 2011

(ii) Consider how these suggested relationships might be may have to settle for a less acceptable product reducing their
explained. (8 marks) welfare. Current producers may lose business or face higher costs as
they adjust production. The level of competition within the drinks
The case of substitutes is reasonably straightforward. Different
market may be reduced. Suppliers of raw materials, particularly sugar
drinks are alternatives for quenching thirst and are affected by price
growers in developing economies, may face falls in income and living
changes in other drinks. This is the case with a fall in the price of
standards. The government may lose tax revenue and be faced with
sugar-sweetened drinks which reduces demand for bottled water
enforcement costs.
(0.75). The effect is less pronounced with whole milk (0.22) which
may be a weaker substitute. Taste will be an influence on opinion There are no clear signs to the balance of the effects. The market is
here as some might consider fruit juice (0.56) a better substitute for unlikely to be of great significance within an economy so the total
sweetened drinks than bottled water, but the statistics contradict impact may be limited, but individual groups may benefit or be
this. harmed disproportionately.
A complementary good is consumed in tandem with another good: The key to a logical approach is to distinguish the groups affected
strawberries and cream and cigarettes and matches are examples. by the ban and the nature of the effect that they may experience.
Can this reasoning be applied to sugar-sweetened drinks and diet You may stress the position of particular groups or effects as long as
drinks? Would a consumer buy both of them together and consume you can justify your decision.
both of them together? Would a rise in the price of sugar-sweetened
drinks reduce the demand for diet drinks? This seems hard to justify
or explain. We know that the PED for sugar-sweetened drinks is
elastic (1.26) so a price rise means less is spent on them, so money TRY
does not need to be switched from other drinks. This is a case in THIS!
which it is necessary to conclude that there is no clear explanation
of the complement figures shown in the data. Check the operation of own price, income and cross
elasticity of demand between different foodstuffs in the US
Answers are not always as neat and tidy as textbook theory might
suggest. When there are doubts or the theory only works within at www.ers.usda.gov/Briefing/DietQuality/Data/table1.htm
limits or partially it is necessary to say so. It is also valid to suggest and prepare a summary report.
additional information that might help to provide the answer.
Cigarette smoking remains a major health issue in the US.
A pressure group, Campaign for tobacco-free kids, argues
(d) Discuss the economic consequences of a government ban
on the production of sugar-sweetened drinks. (12 marks)
that a rise in tobacco tax of $1 is a win-win-win situation.
Consult their report at www.tobaccofreekids.org/
Start by identifying the groups that might be affected, including
what_we_do/state_local/ taxes/state_tax_report/
consumers, producers, retailers and government.
and offer a critical asessment.
On the benefit side consumers may face fewer health issues if they
switch to less harmful drinks. Producers and retailers of alternative
drinks may experience an increase in trade that will raise profit and
employment levels. The labour force itself may be healthier and
more productive. The suppliers of alternative raw materials will also
sell more. Government expenditure on provision of health care may
be reduced and allow greater expenditure on desirable alternatives.
The balance of trade may improve if sugar is a significant import and
is replaced by domestically supplied materials.
Against this there will be groups who are disadvantaged. Consumers

Economics Today · September 2011 15

Measuring economic
growth: GDP vs GNP

Andrew Reeve, Head of Sixth Form,

The Grange School, Northwich explains the
meaning of two key macroeconomic concepts

Which is the wealthiest nation in the world? Which nations are currently experiencing high
levels of economic growth? Are all nations within the Eurozone currently in the same part
of the economic cycle?

There are many questions that economists are asked and in order to answer them, there needs to be some
mechanism of measuring the level of economic activity within an economy. There are also broader questions,
such as are living standards in South Sudan, now the world's newest independent country, higher than in the
neighbouring north? Or, which is the least developed nation on the planet? This notion of development is a far
wider ranging concept and one which we will return to in a later edition of Economics Today.
In order to answer these questions, economists have devised a set of national accounts. These are published each
year in the ‘Blue Book’ and they can be downloaded from the national statistics website.
The circular flow of income shows the amount of money flowing around the UK economy. There are three ways
that one can calculate the value of the UK. Each has a different method, but they all arrive at the same answer.
The first is the Income Approach; adding up all of the income by the various different economic agents within
the economy. The second is the Output Approach, adding up the total value of goods and services within the
economy, and finally the Expenditure Approach. Let us look at the last one in more detail. Within an economy
consumers spend money (Consumer Spending C), Firms spend money (Investment I), Governments spend money
(Government Spending G) and then foreigners spend money on buying our products (Exports X). To avoid
double counting, we must take away our nations spending on foreign produced goods (Imports M).
We can show this sum in the following formula: C + I + G + (X - M)
The numerical answer to this formula is known as a nation’s Gross Domestic Product (GDP). GDP is measured in
money. In order to produce some meaningful comparison, it is useful to convert all nation’s GDP to the same
currency, generally the $US and calculate the GDP per head of the population. In addition to this, when comparing
growth rates in GDP, it is also necessary to discount the figure for inflation, in order to see if the economy has
grown or whether the increase in GDP is simply due to price rises. The resultant measure is therefore Real GDP
per Capita (per head) measured in $US. See the IMF website (www.imf.org) which shows the GDP per capita for
nations around the world and therefore allows easy comparison to be made. It makes clear that the G20 nations
in the more developed world have high levels of GDP per capita, whilst nations in central Africa and generally
across the equator, tend to have low levels of GDP per capita.
The latest edition of the Blue Book containing all GDP data for the UK is the 2010 edition.
The 2011 edition will be published in early October 2011. Here is a web-link for you to consult:
http://www.statistics.gov.uk/downloads/theme_economy/bluebook2010.pdf.

Key words
Ageing population · Health care provision
Dependency ratio · Pension funding

16 Economics Today · September 2011

Why two measurements –
GDP and GNP?
Having explored the concept of GDP, let us
turn to Gross National Product – or GNP. Why
do we need two variables? The difference
between the two relates to two things –
Location and ownership.
GDP measures all economic activity which
is located within a nation’s boundaries.
Therefore, all production and economic
activity which is based within the UK will be
counted in the UK’s GDP. This includes all
output from the Nissan factory based in the
North East and the Toyota factory based in be included in the UK’s GNP, but not its GDP back to the various home nations. In 2010,
Derby, despite the fact that they are not – indeed, they will contribute to the GDP of the Irish Government announced that GNP
owned by UK enterprises. the nation that they are based in. was a better measurement for the nation, as
it more accurately reflects the actual state of
On the other hand, Gross National Product The statistical difference between GDP and
the nation: in its 2010-2014 Recovery Plan it
considers ownership. In the case of GNP, GNP is called Net Property Income from
expects GNP to fall to only 73% of GDP.
what is important is whether the output is Abroad or NPIA. NPIA is made up of profits,
Therefore, using GDP as an official measure,
owned by UK firms. Therefore, GNP will not interest and dividends coming into the UK
would significantly overvalue the level of
include output from factories such as Nissan from the assets that UK enterprises own
economic activity.
and Toyota and Panasonic as these are abroad. GNP = GDP + NPIA (where NPIA can
foreign-owned organisations which are be positive or negative). For the UK, the opposite is the case in the
based in the United Kingdom. On the other sense that GNP is higher than GDP. In 2009,
Table 1 shows that in the case of Ireland its
hand, it will include the output of UK-owned the GNP for the UK totalled £1,423,136,000,
GDP is significantly higher than its GNP. But
organisations which have bases overseas. For whereas GDP totalled £1,392,705,000. This
in the 1970’s this was not the case when its
example, British Petroleum has bases all shows that there is a slight positive ‘net’
GDP and GNP were similar. However,
around the world which make profits that are inflow of income from assets abroad, and
throughout the 1990’s and into the new
repatriated back to the UK. Likewise, in the more significantly, the economy is far more
century, Ireland attracted many multi-
service sector, Tesco has expanded into balanced than its Irish neighbour in terms of
national organisations who have located in
America – Fresh and Easy and also into China. income arising from both home and overseas
the country. This has led to a significant
These overseas sections of the business will assets.
outflow from Ireland as profits are repatriated

Figure 1: Circular flow of income – developing gross domestic product

Goods and
Services
Injections
Investment
Government spending
Consumer Exports
expenditure

Withdrawals
Savings
Wages, rent,
dividends Tax
Households Firms
Imports

Factors for
production

Table 1: The GDP and GNP of Ireland 2009-2010, % change

GDP and GNP 2009 2010 % Change

GDP at Current Prices ¤160,596m ¤155,992m -2.9%
GDP at Constant (2009) Prices ¤160,596m ¤159,906m -0.4%
GNP at Current Prices ¤132,233m ¤128,207m -3.0%
GNP at Constant (2009) Prices ¤132,233m ¤132,584m +0.3%
Source: http://www.cso.ie/releasespublications/documents/economy/current/nie.pdf

Economics Today · September 2011 17

Budget deficits and the
problem of government debt
Neil MacKinnon is an economist with VTB Capital, an investment
bank based in London

A major theme for financial markets over the last year or so has been the increase in government debt levels and budget deficits in
many of the major economies as a result of the costs associated with the severe recession of 2007-2008 (lower tax revenues and
higher welfare payments) as well as the costs associated with the bail-out of banks arising from the bursting of the credit and housing
bubbles.
This has sparked a debate about the role of budget deficits and debt and has re-ignited long-standing controversies central to macro-
economic theory involving the nature of fiscal policy. For your reading material on this subject I would recommend Professor Paul
Krugman’s ‘Mr Keynes and the Moderns’ which was a speech he gave in June this year to commemorate the 75th anniversary of the
publication of ‘The General Theory of Employment, Interest and Money’.1 I would also recommend Professors Reinhart and Rogoff’s
contributions to understanding the impact of government debt.2

Why do budget deficits and government debt matter?

First, governments play an important role in modern economies simply because government spending accounts for nearly 45% of total spending
in the major economies. As a result, decisions to increase or cut government spending will have a key influence as to the direction of overall
economic growth. In turn, the government’s budget balance (the difference between tax revenues and government spending) has an impact on
economic growth too. If there is a deficit (i.e spending exceeds revenue) then the deficit has to be financed either by borrowing or through
raising taxes or cutting spending. Of course, it is worth remembering that households and companies that make up the rest of the economy also
have budget balances and for the economy as a whole one sector’s deficit is another’s surplus.

The problem of ‘crowding out’

In terms of the debate surrounding the role
of fiscal policy, some commentators argue
that higher budget deficits ‘crowd out’ the
private sector and force up interest rates
which in turn dampens economic growth. In
this scenario (usually at full employment)
fiscal expansion is regarded as ineffective.
Ricardian Equivalence is also used to argue
that tax payers know that they will be on the
hook to finance these deficits through an
increase in taxes and so decide to reduce
their current consumption. Again making
fiscal policy ineffective. Other commentators,
usually from a ‘Keynesian perspective’, argue
that when an economy is depressed,
increasing government borrowing offsets an
increase in private sector saving and does not
result in higher interest rates. Japan is
actually a classic case where bond yields are
the lowest in the world at around 1% even
though Japan has a government debt/GDP
ratio of 220% and a budget deficit that
amounts to 10% of GDP. Indeed, since the
2007-2008 crisis, rising budget deficits and
debt/GDP ratios in the US and the UK have
not seen any increase in longer term interest
rates which are currently 3% on 10 year
bonds both sides of the Atlantic.

1. http://www.princeton.edu/~pkrugman/
keynes_and_the_moderns.pdf
2. http://terpconnect.umd.edu/~creinhar/

Economics Today · September 2011

Financing debt in the longer term
Government deficits start to matter over the longer term (rather than just in any
particular year) when debt starts to accumulate thus raising questions about the
sustainability of its financing. This depends on a number of factors ranging from
the prospects for economic growth, dependence on foreign financing and investor
confidence in government economic policy as well as confidence in there being a
stable political situation. Economic growth matters because that generates the tax
revenues to pay bondholders (the individuals and institutions that finance the
deficit). The ‘rule of thumb’ for such investors is that debt financing becomes
unsustainable when economic growth falls below the interest rate governments
need to pay in order to attract financing. In this situation bond investors will be
fearful that governments will not be able to generate enough tax revenue to either
pay the interest on bonds or repay their debt. Likewise, where governments are
dependent on foreign finance (like America, for example) then currency policy is
important. China, who is America’s main creditor is already expressing concern over
the Fed’s apparent lack of concern over a weaker US dollar (a weaker currency
reduces the value of China’s US bond holdings). In addition, America faces a budget
deficit of around 10% of GDP and a debt/GDP ratio near 100% and current policy
discussions between President Obama and Republican leaders in Congress centre
on how to reduce the deficit through the appropriate mix of tax increases and
spending cuts, a process that is looking politically difficult with potentially adverse
implications for America’s credit rating.

The eurozone problem

In the eurozone, the situation in Greece, Ireland, Portugal, Italy and Spain has been centre stage. In many cases, the government debt/GDP
ratio is unsustainable and in the case of Greece stands at 150% and for Italy 120%. Greek two-year interest rates are above 30% and the Greek
government has had to rely on loans from the EU and IMF to fund itself. In addition, Portugal and Ireland have already received substantial
assistance. The financial markets believe that Greece is effectively insolvent and would have probably defaulted without such support
(i.e Greece would be unable to repay its debts). The history of sovereign debt crises is that in such circumstances the government, normally with
the assistance of an outside agency like the International Monetary Fund, ‘restructures’ the debt which reduces the country’s debt burden which
then allows access to capital markets and begins the process of economic and financial recovery. The eurozone crisis is complicated by the fact
that eurozone banks (mainly those in France and Germany) have significant exposure to the government debt of countries like Greece and Italy.
A debt restructuring typically involves bondholders (in this case the banks, suffering significant loss, or ‘haircut’ in the jargon, which might result
in a collapse of those banks. The outcome of the eurozone debt and banking crisis is likely to prove messy but the end-game will require
mechanisms to allow for debt restructuring as well as policies designed to recapitalise over-stretched banks. Once such policies are implemented
and the ‘slate wiped clean’ then there is a better chance for the debt-burdened economies to recover. Sticking with existing policies of fiscal
austerity which is causing economic contraction which just worsens the debt situation is not sustainable and may threaten the future of
monetary union in its current format.

Economics Today · September 2011 19

How does the Production Possibility
Frontier fit into Economics?
Rachel Cole, teacher at Cheltenham Ladies’ College
and a Principal Examiner, explains the nature
of a key economics concept.

Why the bulge?

Imagine a tiny country where there are
After spending three hours a week for a whole year studying Economics just two types of resource, or factors of
with me, one of my students still couldn’t understand why the Production production. And with these resources only
Possibility Frontier (PPF) or Curve (PPC) is shown bowing or curving two things can be made. For simplicity’s sake,
outwards. She could draw, analyse and apply every other concept in the let’s say there are six workers who are
course, and was on course for a top grade in the AS exam. The problem it specialised. Three have been to university
seems is that in teaching her I glided too quickly over one of the most and are very good at producing new ideas,
fundamental concepts in Economics; without her really understanding it, a and three left school at 16 and are very good
at growing food. It’s not that the three school
lot of the rest of the subject remained disconnected. This article is aimed at
leavers can’t produce good ideas; it’s just that
correcting this problem, so that she – and I hope you – can build your they are not very efficient at it, and the ideas
understanding of Economics on a logical base. they come out with are not always the most
refined and ready to use. It’s not that the
university leavers are unable to grow food,
but they are out of practice having lost their
strength from sitting too long at the com-
puter, and are not very efficient at growing
What is a PPF? food. We say the university graduates are
The Production Possibility Curve (PPF) shows the maximum amount of output that can be specialised in producing ideas, and the
produced with two types of resource. On each axis in Figure 1 there is a good or service that school-leavers are specialised in producing
might be produced, and the points on the diagram represent the various outputs when all the food.
resources are used in all the combinations of employment of the two resources. It is clearly a
To make things work well in this example, the
great simplification of an economy, but it illustrates a wide range of economic principles.
more the school leavers try to make ideas,
You will see that the way Figure 1 is drawn is with a curve rather than a straight line. The the less extra output per unit of input they
reason for the outward bulge is that some resources are specialised to some uses, for example provide. We call this marginal productivity.
some people are better at doing one thing rather than another, and that if a country exploits And the more the university graduates try to
these relative skills the total possible output increases. The more a country focuses on the produce food, so their marginal productivity
production of one output at the expense of another, the more it will have to use resources that falls. Other ways of saying this is that the
are not ideally suited to that use, and the increase in output will ‘cost’ progressively more rate of transformation falls as you focus
(in terms of opportunity cost, what has been given up). The curves that you will come across increasingly on the output of one rather than
almost always do this, but in simple cases they can be a straight line or even bowing inwards. another, or the opportunity cost of making
Having looked at this, we will then discuss how a PPF can be used in other contexts, in both one good rather than another increases.
micro- and macroeconomics. You will see that the PPF fits into almost any part of the syllabus. Table 1 illustrates what could be produced
All of the applications are very useful to an economist, and the PPF is invaluable in your if all the workers had to make various
economics toolkit. It does help to have a very clear understanding of the concept at a deep combinations of the two products. If you add
level. together the first four columns you will see

Key words
Check you know the meaning of the twelve key terms at the end of this article

20 Economics Today · September 2011

that at every output level the full amount of
resources are used (all six workers are being
used), that is, the country is at its production
possibility frontier. We only plot the points
where everyone is used, because that is what
is implied by ‘production possibility’ – that
is, it is the maximum.
In the grey columns (5 and 6) you will see
some numbers which show you how much is
actually produced. The numbers themselves
cannot be derived from the information
provided so far – they are based on how
much each person can produce in certain
situations, and each worker transferred to
another use adds a different amount.
Remember each resource is specialised to
one use or another, so changing their use
changes the total output.
From this table we can plot Figure 1. If all
the resources are devoted to making ideas
(point A) the output is 35 ideas but there will
be no food output. If all the resources are
devoted to making food (point D) there will
be 30 units of food but no ideas. At points B
and C, where the resources are used more
effectively, there is a higher level of total
output, and hence the curve bulges Figure 1: A PPF bowing outwards, for the output of ideas and of food
outwards. 35
A
Here there are just four output possibilities B
shown, (A, B, C, D) but there could certainly 30
be more if we increase the number of
workers. It is not a perfect curve because of 25
Production of ideas

the simplification, but as more resources are

applied the frontier would tend to smooth C
20
out.
What this example illustrates is that some 15
resources are specialised in their uses.
University graduates are better at producing 10
ideas, so if they are forced into agriculture Production Possibility Curve
they will not be so effective. Likewise, if you
5
try to get everyone in the economy to
produce ideas you will not get a very good D
output of ideas in total. The best com- 0
0 5 10 15 20 25 30 35
bination is if all six university graduates make Production of units of food
ideas and all six school leavers make food –
that is, you split your resources equally
between the two outputs. But this might not
be what the country needs. Maybe it needs Table 1: Production possibilities in an economy of six workers,
more food. So you take a university graduate with specialised skills
off ideas and put him to use in the fields.
AND AND AND
What if resources are not specialised? Here Number of Number of Number of Number of Output Output
the opportunity cost stays constant – you
University University school school of ideas of food
always give up the same amount of one good
graduates graduates leavers leavers in total in total
to get another. See Figure 2.
producing producing employed producing
If all resources are equally good at producing ideas food producing food
food and ideas then the PPF is a straight ideas
line, and there is no change in the
3 0 3 0 35 0
transformation rate, that is, the amount of
one that has to be given up for the other. 2 1 2 1 30 10
This is the best way to use PPFs which 1 2 1 2 20 20
applying them to other concepts such as 0 3 0 3 0 30
——— ——— ——— ———
comparative advantage. 6 6 6 6
——— ——— ——— ———

Economics Today · September 2011 21

Figure 2: A PPF where the resources are not specialised
What we can learn from this is that all the
points on the PPF are productively efficient 200
(because all the resources are being used and
there is no unemployment) but that not all
the resources are used in a way that is
Ideas Food
allocatively efficient, that is, used in a way
that provides the highest amount of welfare A 200 0

Output of ideas
for the society consuming the output. To find B 100 50
out where allocative efficiency is we need to 100
C 0 100
know how much the output is worth to
society. Is food more valuable than ideas?
That depends on many things, and what you
can’t see on the diagram is a kind of demand
curve that meets the PPF measuring the
usefulness (or ‘utility’) of the output, and
where this meets the PPF there is an ideal
0
point, called allocative efficiency. Allocative 0 50 100
efficiency can also be illustrated in the Output of food
following way, using opportunity cost.

How a PPF can be used in other contexts in Economics

One of the most often used concepts in decision economics is that of oppor-
tunity cost. The PPF can be used to show how the value of something is best
revealed by what is given up rather than in money terms. Here’s an example:
if I spend an hour with a student helping her feel better about Economics,
how much is that worth? It’s very hard to say – it might make her feel better
about the subject and her grade might go up (which could have a big effect
on which university she goes to and therefore how much she can expect to
earn) or it might have no monetary value at all (I might just confuse her Figure 3: Opportunity cost
further). So as economists, the best way to value this is to ask, what else
could I have done with my time? For simplicity we ignore what else could she
have done with hers. Let’s say I have six hours of free periods in the school
a
week and I could teach one-to-one for all six or cover lessons for all six, or a
combination of the two. There’s a hundred things I could think of doing with b
1 hour
the time I spend teaching the student but I can’t do all those things at once. c of cover
Benefit of being taught

So let’s choose the thing that would add most value to my school as the next
d
best alternative, the opportunity cost. Instead of teaching her I could have
covered a lesson for an absent teacher. If I had done this I could have saved e
the school let’s say £40. So the PPF looks like the diagram in Figure 3.
Notice that here the horizontal gaps between the points a and b, c and d, and
so on are all equal. This is because each extra hour of cover is worth the same. f
So the opportunity cost of each extra hour spent teaching is the same. But
the opportunity cost of spending more time covering lessons economics
increases, meaning it is not a very good use of my specialised resource
(teaching Economics) if I never spend any of my free periods doing it. The
first hour I spend doing one-to-one costs £40 in money given up, but gains g

an enormous amount – the vertical distance between f and g. But if I spend Output of six lessons covered
all my time doing one-to-one teaching, the students only gain a small amount
(the vertical distance between a and b). This shows that the opportunity cost
of getting workers to do more of things they are specialised in decreases the
more they do so, and there comes a point where you may not want specialised
resources to do what they are best at, because there is a high opportunity
cost of them devoting all their resources to that single use. Another way of
saying this is that a good manager finds what workers are particularly good at

22 Economics Today · September 2011

and focuses the workers time on these things, up to the point where the
increase in output matches what has been lost from producing something
else. The allocatively efficient point is when the amount the student benefits
from an extra lesson is exactly equal to the amount given up in the cost of
covering lessons (£40).
The PPF can be used to discuss efficiency, both productive and allocative,
and is therefore very useful for advanced microeconomics. Points on a PPF
are said to be productively efficient. This means that the economy is using
the minimum possible in terms of resources to gain that amount of output.
The economy is not wasting any resources, and it cannot make any more of
one thing without sacrificing the output of another, or there is an opportunity
cost. If an economy is operating inside the PPF and it moves onto the PPF,
there is no opportunity cost. Once on it nothing can be gained without losing
something else. This is also known as Pareto efficiency, named after a famous
economist, Vilfredo Pareto, an Italian economist who was particularly
interested in the choices that people make.
In macroeconomics, the PPF is useful in showing the size of an output gap.
If you draw the long run AS curve as an upward sloping diagram the point at
which it becomes vertical is called full employment. The output gap is Q1 to
Q2 in Figure 4, and the PPF is exactly the same concept as the vertical part of
the AS curve.

Figure 4: Output gap using Aggregate Demand and Aggregate Supply

Price
Level AS1

AD
0
Q1 Q2 National Output

Still in macroeconomics, the PPF is used in Keynesian economics to show that

a country might be in equilibrium whilst not at full employment, and it can be
used to show that a country can grow without all the effects being on inflation.
If an economy is operating at Q1 in Figure 4, then the AD could be made to
shift to the right, finding a new equilibrium closer to or at Q2. Output increases
(the country is being more productively efficient) although as the economy
reaches full employment (at Q2) prices will rise. The policies intended to
create this movement of AD are called demand management policies and
they are advocated by Keynesians in a recession, but when the economy is on
the PPF (at Q2) their policies would just cause inflation.
PPFs are a very effective way to illustrate absolute and comparative
advantage, and give a graphical argument for one of the main reasons to
trade – that is, trade increases the production possibilities for all countries
involved, depending on the exchange rates. For any two countries, making
assumptions about no travel or exchange costs, it is worth trading if their

Economics Today · September 2011 23

PPFs have a different slope – that is, the opportunity cost ratios are different.
A country has a comparative advantage if it can produce something at a lower
opportunity cost than another country, and this is a powerful argument for
trade. This has been fully discussed in an earlier article in Economics Today.1
In conclusion, don’t be fooled by how simple a PPF looks. It holds the key
to many fundamental concepts in Economics, and it is worth the effort to get
the idea clearly in your mind. It will take some effort to fully understand it,
but it keeps coming back to the course in Economics.

Key terms
Assets – something of value that is owned. The value lies in the fact that they can be used to produce goods and
services, either directly (e.g. a machine) or indirectly (e.g. by selling shares on the stock market to get the means to
acquire goods and services.
Resource – assets which a country has either naturally, produced or brought to the economy by investment or
imports. These assets can be used to make goods and services.
Factors of production – the resources used to produce goods and services. They comprise land, labour, capital and
enterprise, or the function of risk taking.
Specialised – where a resource is more effective at producing one type of output than another.
Efficiency – a measure of how effective resources are when put to certain uses.
Productive efficiency – when output is at its lowest possible cost per unit.
Allocative efficiency – when the output is at its maximum possible usefulness to consumers, relative to cost.
Productivity – a measure of output relative to the input, e.g. number of apples picked per worker.
Production – a measure of the output e.g. number of apples picked in total.
Production possibility frontier (or curve) – the maximum output that can be produced from a given set of resources.
Marginal productivity – the extra output produced when one more unit of a resource is employed.
Comparative advantage – when an economic agent can produce a unit of output at a lower opportunity cost than
another economic agent. It can be shown by the gradient of the PPF.

REMEMBER
THIS!
One student at my school learns Japanese and Mandarin. She’s very
good when she’s spent a day doing just one subject, but revising for
exams was terrible. She found that when trying to do a bit of both her
scripts got confused. How would you draw her PPF?
When PPFs shift outwards, what happens to the opportunity cost of
producing any one unit of output?
In this article we looked at comparative advantage, and how the PPF
can be used to illustrate whether a country enjoys this situation, as
seen by the gradient of the PPF. Discuss how a PPF could be used to
show absolute advantage, where one country can produce more
efficiently or at a lower cost than another.
Whereas Keynesians argue that an economy can be in equilibrium at
output levels inside the PPF, classical economists argue the opposite –
the country will eventually arrive back on the PPF. If you leave the
economy to market forces (laissez faire) the unemployment disappears.
1. See R. Cole, ‘Absolute and Comparative Advantage Look –
No Numbers!’, Economics Today, Vol. 15, No. 2, November
Where does it go to?
2007, pp. 35-37.

24 Economics Today · September 2011

Questions
In this regular feature Chief Examiner Robert Nutter of Watford Girls’ Grammar School, looks at
AS and A2 questions which in this volume will aim to reflect the order that schools and colleges
cover topics from the specifications. There are three AS (1-3) and three A2 (4-6) questions per
edition plus explained answers.

1 5

In the above diagram the production possibility frontier of a

country which only produces cars and shoes has shifted position From the above diagram which shows the costs and revenues of
from TW to TV. It can be deduced that the opportunity cost of a profit-maximising firm it can be deduced that the firm will
producing OZ cars has changed from shut down in the long run if price falls below

A. XY to WX C. WY to VX A. P1 C. P3 E. P5
B. VY to WY D. WX to XY B. P2 D. P4

2 In a country where government directives and planning are

responsible for the allocation of resources this can be said to 6 Production of cars
per person
Production of TV
sets per person
be a
Country X 500 1500
A. free enterprise economy.
Country Y 1000 2000
B. capitalist economy.
C. mixed economy. The above table shows the ability of two countries X and Y to
D. command economy. produce two goods, cars and televisions. It can be deduced that
country X has

3 Following a rise in price from £1.60 to £2 the daily demand for

the number of cups of coffee in a café falls from 150 to 120.
A. an absolute advantage in cars and Y a comparative
advantage in TV sets.
The price elasticity of demand for coffee is
B. an absolute advantage in TV sets and Y an absolute
A. 0.8 C. 1.50 advantage in cars.
B. 1.25 D. 2.25
C. a comparative advantage in TV sets and Y has an absolute
advantage in cars.
4 In May 2011 it was reported that the Office of Fair Trading may
ask the Competition Commission to investigate the UK’s four D. a comparative advantage in cars and Y has an absolute
advantage in TV sets.
largest accounting firms Price Waterhouse Coopers, KPMG,
Deloitte and Ernst and Young. These firms are responsible for E. a comparative advantage in the production of both
auditing all but ten of the FTSE 250 companies. products.
From this information it can be deduced that in this market
there is a four firm concentration ratio of
A. 90% C. 94% E. 98%
B. 92% D. 96%

Economics Today · September 2011 25

The UK Evidence A: UK house
prices, simple averages
Year Price (£)
housing 1930
1950
590
1,940

market 1970
1990
2010
4,975
59,785
251,634
Source: Department for Communities
Brian Ellis, a Chair of Examiners,
comments on a question on house prices

Evidence C: Evidence B: UK house prices, mix of housing, adjusted average

One market or many? Year Price (£) 1 year % change
In 2008-10, average house prices in
Newcastle fell by nearly 30%. In 2010 alone 2001 116,206 +8.4
there were falls of around 10% in many 2002 135,884 +17.0
northern towns. However in Reading, 2003 155,485 +15.7
Brighton and Cheltenham (in the south) 2004 172,788 +11.8
house prices rose by 10% in the same year. 2005 183,966 +5.6
The cheapest houses in the north have a 2006 192,648 +6.3
price below the average spent on a new car 2007 213,807 +10.9
in the most affluent southern areas. 2008 211,388 -0.8
2009 194,235 -7.6
With such variations, thinking of regional 2010 208,757 +7.4
markets rather than a national market
Source: Department for Communities
might make sense. London is different
because an influx of overseas buyers is less
dependent on the state of the British
economy. Size and style of housing create a Evidence D: Excess demand, excess supply, what next?
second variable. Properties vary from one In the early years of this century, UK inflation was close to its target (2.5% RPI then 2% CPI)
bedroom studios in run down areas to but house price inflation was much higher as shown in Evidence B. Besides having the use of
stately homes in manicured parkland. The a house, buyers made a profit. This profit was meaningless in the context of moving and
Department for Communities adjusts its buying another home, but there was a way to ‘cash in’. The buyer of a £100,000 house (in
main house price index (see Evidence B) to those days) might have found £5,000 deposit and borrowed £95,000. If the price rose to
allow for changes to the mix of housing £150,000, the buyer’s share of ownership (or ‘equity’) rose to £55,000 but his loan debt was
traded each year. unchanged. Taking on a bigger debt (say £140,000 in place of the £95,000) released cash
Since the recession, some frustrated would- which could be spent (and often was). Booming prices and easy finance made house purchase
be sellers have rented out homes rather very attractive. There was excess demand. Supply was held back, partly by planning regulations,
than sell them in a weak market. At the and could not keep up with demand. Some fans of free markets suggested deregulation of
same time, would-be buyers, unable to planning to allow supply to increase.
finance a deal, have rented rather than The credit crunch and recession meant some jobs were lost. Many workers who kept their jobs
buying. The percentage of owner-occupiers felt insecure. Demand for housing fell. Some people tried to move ‘downmarket’ to cheaper
has fallen by over 3% from its 2003 peak. Is houses in order to reduce their debt. Falling house prices shocked both lenders and home
the house rental market separate or part of owners. Making loans for house purchase had seemed secure as the lenders could force the sale
a broadly defined housing market? It is of a house to recover their money if repayments stopped. This ceased to be true when some
often a simplification to assume that there house prices fell below the outstanding loan. Lenders became risk averse, reducing the
is one market for a product. That certainly percentage of a house price they would lend and tightening rules linking repayments to income.
seems to be the case with housing. Falling prices left some owners with negative equity: their home loan was above the value of
their home. Some people in this situation gave the keys to their lender and walked away.
The falling prices created relative bargains for anyone wanting to enter the housing market.
Exam Board AS Unit A2 Unit
However, falling prices and worries over job security held some people back. Others were
1(3.1.2
AQA & 3.1.5) unable to buy because lenders were asking for deposits of 25% or more, say £50,000 for an
1(1.3.2 average home. Many young people had student debts to pay off, together with rising rents.
Edexcel & 1.3.8) This left them little ability to save anything; £50,000 was beyond their reach. Supply has been
OCR F581 greater than demand for some time, though the rental option has reduced the number of
EC1 empty houses.
WEJC (B & C)
CCEA AS1
Int. Bacc. Standard 2.1 and 2.4 Key words
Cambridge Average data · Excess demand · Negative equity · Regional prices
Micro (b and e)
Pre-U

26 Economics Today · September 2011

(a) What is meant by ‘excess demand’ (Evidence D, paragraph 1)? (4 marks)
(b) Explain likely causes of the long term house price increases shown in Evidence A, illustrating
your answer with a demand and supply diagram. (12 marks)
(c) To what extent might deregulation of house building (ending planning restrictions) have had
beneficial effects? (12 marks)
(d) Most predictions are that average house prices will fall slightly in 2011, because of weaknesses
in demand. Explain why demand is expected to be relatively low. (10 marks)
(e) Assess the suggestion that referring to ‘The UK housing market’ is a misleading oversimplification. (12 marks)

Economics Today · September 2011 27

over supply and so reducing house price The volume of UK house sales in 2011 is
increases. roughly half the 2007 level. The main reason
for this is weak demand due mainly to the
The most obvious beneficiaries of this would
reduced availability of mortgages and limited
have been people priced out of the market
consumer confidence. Supply is also low
and unable to buy homes. In addition, other
because some houses are being switched
people might have bought at lower prices.
to the rental market rather than sold. If
This would have reduced their mortgage/
demand for housing increased, it is likely that
repayment expenditure. A benefit from this
more houses would then be made available
would have been a higher material standard
for sale.
of living for owner occupiers left with more
discretionary income to spend on other Comment: links to basic ideas, such as factors
goods and services. influencing demand, give a sound structure.
Against such benefits we should set the
gains from planning regulation. Besides the (e) Assess the suggestion that referring to
highly subjective amenity value of green ‘The UK housing market’ is an over-
spaces and ordered development, there are simplification. (12 marks)
more tangible links to the quality of life.
More congested cities would probably be It is clear from Evidence C that the regional
less healthy. The transport infrastructure variations in house prices are extensive.
would probably be even less adequate if Common sense tells us that even within an
development had been unregulated. In other words, unregulated urban area there are variations between attractive locations and
development would have generated more external costs. Other others with less appeal. London and the south of England have the
people would have been disadvantaged by development. largest concentrations of population and a substantial impact on
The market mechanism ignores externalities; regulation offers one national averages. Rising prices in the south might have an impact
way of tackling them. To make a balanced decision, we must weigh on national averages which makes them inconsistent with experience
the benefits of deregulation against the costs. My personal view in in many parts of the north. This reflects a common problem with
this case is that regulation makes an important difference to the averages. As another example, average incomes fall during a
quality of life but that could be selfish as I have a home in a pleasant recession, but some individuals and groups will still have rising
area. People unable to buy their own home could easily have incomes.
different priorities.
Just as regions vary, so too do houses. This is partly a reflection of
Comment: The first essential here is some balance (points for and social trends. Many homes once only had outside toilets. Early in
against). There is no one ‘right’ answer to such questions but a the last century it became normal to build bathrooms and toilets
conclusion is an important part of evaluation. inside the house. By the end of the century, many new homes had
en-suite facilities and downstairs cloakrooms in addition to the
(d) Most predictions are that average house prices will fall family bathroom. Central heating has become a standard expectation
slightly in 2011, because of weaknesses in demand. Explain in most areas of the UK. The features of the average house have
why demand is expected to be relatively low. (10 marks) changed and there are very many houses which are not average.
Evidence B shows that variations in houses can be considered in
The first point to make here is that effective demand depends on
mix-adjusted data. This reduces one way in which a simple average
ability to pay as well as on desire for a product. The norm in house
can be misleading.
buying has been to take a mortgage to finance a large proportion of
the price paid. This has become more difficult recently. Mortgages If we took a fragmentary approach which considered each locality
are currently available to those with large deposits (£50,000 is and type of housing separately, we could reduce the extent to which
mentioned in Evidence D), and secure, healthy incomes. In the the data was misleading. However, it would be very difficult to form
second half of 2011 real GDP is still 3% to 4% lower than in mid-
an impression of overall trends in the housing market using
2008. Many people have less income now than three years ago.
fragmented data. Consolidating the available information into
Reduced ability to obtain and to repay mortgages places a constraint
overall averages provides a quick way to see the general trends in
on the demand for housing.
the housing market. Such an average would have little value and
Experience of falling house prices reduces confidence. If there is a could be misleading for the buyer or seller of an individual house in
risk of further falls, paying a predictable rent rather than facing one location. On the other hand, a quick impression is easier to
uncertainty can become attractive. The economic outlook is gloomy, obtain and sufficient for some purposes.
with more job losses expected, so there is uncertainty about future
incomes as well as about house prices. The most attractive time to Whilst it is true that average data can be misleading, in the housing
buy is when the market reaches its low point rather than before market and elsewhere, the extent to which this is a problem will
then, though spotting the low point might only be easy with depend on the purpose for which data is required. For anyone
hindsight. Lack of confidence is holding back demand in the housing seeking only a broad, overall impression of trends in the housing
market. market, average data should be sufficient. Where local decision
The relatively strong current demand for house rentals leads some makers want data to guide their choices and actions, national
people who move to rent out their old house rather than sell it in a average data could well be misleading and so is likely to be
depressed market. These people cannot use the equity from their inadequate to inform sound decisions.
(unsold) house as a deposit on a new one. In many cases they also
choose to rent for the time being. This reduces both supply and Comment: Words such as “will depend on” or just “if” can be
demand for housing. indicators of strong evaluative conclusions.

28 Economics Today · September 2011

Answers
1 A production possibility frontier shows the maximum potential
output of an economy at a given point in time. When the 4 If the four leading accounting firms audit the accounts of 240
out of 250 leading businesses this represents 96% of this
frontier was in its original position (TW) assume the country market. A four firm concentration ratio measures the share of
produces no cars, it could then produce OW shoes. If the the market controlled by the four largest firms. In this case the
country produced car production amounting to OZ output then four largest accounting firms control 96% of the market which
the opportunity cost of producing OZ cars is WY shoes. Once means that the answer is D.
the frontier shifts to TV the opportunity cost then becomes VX.
Hence the answer is C.
5 The profit-maximising price is P1 where marginal cost
(MC) = marginal revenue (MR). In the short run firms can

2 A planned or command economy is often associated with

Marxist ideology which rejects the ideas of free enterprise and
survive if their price exceeds the average variable cost (AVC).
The shut down point in the short run is when price = AVC which
market forces. The key decisions of what, how and for whom to is P5 on the diagram. As some fixed costs may not need to be
produce are decided by the state. Prices, wages, and rents are paid in the short run such as business rates the firm can survive
decided centrally by government committee and output is also as long as some contribution is made to these fixed costs.
planned to reach certain target levels. Since the collapse of the However, in the long run all costs, fixed and variable, must be
Soviet Union in 1990 few examples of command economies still paid hence the price (average revenue) must at least equal
exist, Cuba and North Korea are the most well known. Other average cost. Thus to survive in the long run price must not fall
former command economies in Eastern Europe are now below P3. The answer is thus C.
members of the European Union. The answer is D.

Price elasticity of demand measures the responsiveness of 6 A country has an absolute advantage in the production of a
product if it can produce it more efficiently than another. In this
3 quantity demanded to a change in price. It is calculated using
this equation:
case country Y has an absolute advantage in the production of
cars and TV sets. However country X has a comparative
advantage in the production of TV sets. This relates to the
% change in quantity demanded
domestic opportunity cost ratios between cars and TV sets in
% change in price
each country. The opportunity cost of producing a car in country
In the above example price has risen by 25% and as a result X is three TV sets whereas in country Y it is two TV sets. The
quantity demanded has fallen by 20%. The price elasticity of differences in the opportunity cost ratios mean that by X
demand is thus 20%/25% which is 0.8; although technically it is specialising in TV sets and Y in cars they could find a rate of
minus 0.8 because the positive price change (a rise) is being exchange that will produce gains from trade for both countries.
divided into a negative quantity change (a fall). As the resultant This rate of exchange could be one TV set from country X for
figure is below 1 then the price elasticity of demand for the cups 2.5 cars from country Y. Put at its simplest country X is not as
of coffee is price inelastic. The answer is A. efficient as country Y when producing both goods but it is less
inefficient at TVs or put another way the opportunity cost of
producing a TV is lower in country X (one third of a car) whereas
in country Y it is half a car. The answer is thus C.

Economics Today · September 2011 29

The publishers
and the iPad
Stephen Romer discusses the implications of recent technological
change in the newspaper and book publishing industries.

Sir, If I purchased one of these iPad Gizmos that you advertise, and
subscribed to the paperless Daily Telegraph, in what would I wrap the fish
heads and with what would I light the fire? The Daily Telegraph is more
than just a vehicle for the news.
Letter to the Editor, The Daily Telegraph,
30 May 2011.

Once upon a time, many years ago, something called the ‘internet’ was invented. It was a brave new world in which a fervent ideology was
preached: all content must be available free of charge. Newspaper publishers rapidly bought into the new philosophy, and no sooner was the
internet up and running than the newspaper reader could access most of the articles in most of the papers without being obliged to pay for the
privilege. The rate of decline in demand for newspapers accelerated.
Having acted in haste, the press barons found themselves repenting at leisure for it was soon apparent that granting free access had been a
major mistake. The economics of the early internet – everything is free – was only viable if you made the unrealistic assumption that content
had no supply price. Otherwise, it was an economic environment of pure fantasy.
Newspaper content does, of course, have a supply price. The gathering, editing and presentation of news is far from being a free good. There
are costs of production, and, logic suggests that, in the absence of revenue, supply will eventually fall to zero.

Thus, newspaper publishers became obsessed Would tablets be the answer to publishers’
with the question of how to monetise inter- prayers? Would the iPad and the comple-
net operations. Some, including Rupert mentary Paid Applications Market – or ‘apps’
Murdoch’s News International, erected pay- – come to the rescue? The press barons
walls to ration access to their papers (The seemed to think so. The Guardian and The
Times and The Sunday Times, for example). Daily Telegraph responded by launching iPad
But the results were, at best, somewhat apps, and News International introduced
mixed.1 in January 2011 a tailor-made iPad-only
newspaper, The Daily, priced at 99 cents
However, in 2010, a new opportunity seemed
per copy. The investment cost: about
to have presented itself when there was a
£20 million. As for The Times and The Sunday
1. For an exploration of newspaper internet sudden stepwise change in consumer
economics, see this author’s article ‘Can the Times, iPad editions were soon available to
Newspaper Industry Survive the Recession?’ in
electronic gadgetry. Specifically, the Apple
subscribers, or on a one-off basis. Take the
Economics Today, Vol. 17, No. 2, November 2009. iPad was launched, inaugurating a new
iPad version of The Sunday Times, for
generation of ‘tablet’ computers. For the
Exam Board AS Unit A2 Unit instance. At £1.79 (versus £2.20 for the print
publishers, it was time to forget about the
edition), it consists of the whole paper (all
AQA 1(3.1.2) old fuddy-duddy internet browser and its
dozen sections) and additional materials,
1(1.3.2 attendant frustrations – they could now
Edexcel & 1.3.3) including ‘interactive 360 degree pictures’.
concentrate instead on the tablet.
OCR F581
WEJC EC1(B)
CCEA AS(1)
Standard 2.1
Int. Bacc. New 2011: 1.1 Key words
Cambridge Technical change · Competitive and complementary goods · Supply and demand shifts
Microeconomics (b)
Pre-U

30
REMEMBER
THIS!
Newspapers and magazines have experienced difficulty in
making the internet work financially; tablet computers
offer new hope.

In this new environment, economists have G For success, apps must offer added value,
been asking some very searching questions. not only to subscribers but also to
Is the app a free lunch for the publishers? advertisers. Thus, the app has to be
Or is the app profitability circumscribed? And distinct from both the print and internet
what does it mean for book publishing? editions of the publication. In turn, this
Potential constraints on publishing profit- means new costs. A publisher putting out
ability include: an iPad edition will be confronted with a
bill for continuous investment because
G 30% commission is payable to Apple for the app must be developed for its launch,
app sales. This is bad enough, but and fine-tuned in the light of ever-
publishers are also unhappy that the email changing technology. There must be a
addresses of app subscribers (valuable for permanent staff on the payroll, servicing
marketing purposes) are not forthcoming the requirements of the iPad format.
from Apple under existing arrangements.
G The relatively small number of iPad users:
papers or magazines would require
millions of app sales if the iPad were to be HEALTH
the answer to the financial difficulties of WARNING!
the printed media. For any given publica-
tion, that would require, unrealistically, Avoid confusing supply-side and demand-side changes in
almost literally everyone in the world who markets: technological advance can lower production
has an iPad to subscribe. costs, causing shifts in the position of supply curves, or
G Any single publisher’s app faces visibility prompt consumers to substitute new products for old,
constraints: it is a grain of sand on a beach leading to shifts in the position of demand curves.
where there are hundreds of thousands of
apps. Will your app be noticed? What are
the advertising costs of app-awareness?

Economics Today · September 2011 31

eReaders and iBooks REMEMBER
Hay-on-Wye is a town of books. There are THIS!
about thirty second-hand and antiquarian
bookshops, and thousands of bibliophiles The iPad boom has reinforced rapid growth in demand
flock to Hay in May for the annual literary for ebooks, introducing a new era of uncertainty in
festival. “It’s the Woodstock of the mind,” publishing.
declared Bill Clinton, promoting his
Presidential memoirs at Hay several years
ago. In 2011, the festival was booming,
attracting big-name authors, large crowds,
and The Daily Telegraph sponsorship worth
£250,000.
But it was an extraordinary coincidence that
at the very moment books were being
celebrated by Hay’s hordes, news was coming
through that the traditional printed book had
been thrown into a severe – possibly terminal
the compatibility of formats in the world of But what are the economic advantages of
– crisis. Specifically, Amazon, the internet
ebooks. Although Amazon supplies Kindle ebooks and iBooks?
book retailer, reported that its sales of
software for iPads and tablet computers, the
ebooks had now expanded to the point at (a) Publishers face lower costs: there is no
consumer cannot use an ebook obtained for,
which they were exceeding the number of printing or paper to pay for, and the
say, the Sony Reader, on a Kindle or an iPad.
printed books – pbooks, as one might call traditional distribution costs – physically
them. And there are more serious disadvantages of shipping books from warehouses to book
the ebook phenomenon. Books furnish a shops, or to the consumer’s home
Evidently, the traditional pbook – printed on
room, it has often been said. But you cannot address – are also obviated. Moreover, it
paper, bound between covers and trans-
do much furnishing if your books have no is a fact of life in the traditional book
ported by the lorry-load to bookshops and
physical existence. The library of even the trade that some titles will inevitably be
warehouses – had entered a period of
most voracious reader of ebooks will amount over-stocked, leading to costs in terms
decline. And developments seemed to
merely to a virtual library. Can virtual of storage and ultimate disposal. In
suggest that this was only the beginning: in
browsing – or browsing virtually – compare contrast, no ebook ‘stocks’ exist as such.
2011 Amazon was planning to expand its UK
with the pleasure of looking through a
workforce by about 2,000 to service Weighed against these advantages for
collection of books assembled over the
increased demand for both the ebook and publishers is threatened growth in the
years? There is the aesthetic aspect of the
the Kindle, Amazon’s ereader. self-publishing of books (facilitated
book as an object, and its provenance. These
by Kindle Direct Publishing), making
The Kindle was launched in the US are product characteristics absent from the
the traditional publishing company
in 2007 (but three years later in 2010 in the ebook. Moreover, the replacement of the
redundant.
UK), quickly attracting several competitive traditional book by its Kindle/iPad counter-
rivals, including the Sony Reader. As with part has a further disadvantage insofar as it (b) There are, arguably, environmental
flat-screen TVs, personal computers and hastens the decline of bookshops, stealing benefits: the ebook does not require
consumer electronic hardware in general, the that civilised pastime, bookshop browsing. paper, the consumption of which
ereader is the sort of gadget where prices will
probably fall in the years following its
introduction. In turn, this promises to
reinforce ebook demand. Ebooks and
ereaders are complementary goods, and
there is, in principle, a negative cross
elasticity of demand: if the price of one (the
ereader) falls, demand for the other (the
ebook) should rise.
In mid-2011, the price of Amazon’s Kindle
was £111. An advantage is that the Kindle
user can search the Amazon catalogue and
download a book without the need for a
separate computer. You turn the pages of
your book by touching a button. The Kindle’s
battery is said to be good for up to a month.
The Apple iPad and the subsequent tablet
computing boom has given a shot
in the arm to the nascent ebook market. For
the various Apple devices – the iPad, iPhone,
iPod Touch Music Player – one can obtain an
iBook app and transfer the ebook between
these devices. There is, however, a limit to

32 Economics Today · September 2011

accounts for trees and advances the
onset of climatic Armageddon (although
books can be printed on recycled paper).
But electronic reading devices are not
without environmental costs of their
own. Consider, for instance, a report in
Computer Active magazine (28/04/11-
11/05/11) citing research which claims
that the environmental impact of
manufacturing each ereader and
recharging its battery is outweighed by
the environmental savings only when the
owner has read twenty-three ebooks on
that ereader – instead of purchasing the
twenty-three books in their traditional
paper format.
But will the typical owner of an ereading
device read twenty-three books? Or even
three books? Or is possession of Kindles
and iPads largely motivated by a desire
to display one’s status and wealth? Isn’t
reading essentially a solitary activity,
one in which no one sees you or your
choice of reading medium? Does serious
reading – getting through twenty-three
books – necessitate ownership of a tablet
computer?
By the way, if you are new to buying your suitcase exceeds the limit even
Or is the whole iPad phenomenon merely
ebooks, you might consider trying by a single ounce. The attraction of a
an example of that time-honoured
out the experience of ordering and Kindle or an iPad is that it weighs
category in microeconomics, Goods of
downloading by accessing one of the about the same as one book, but can
Ostentation? Consider the Apple iPad2,
excellent ebooks on Economics carry dozens of ebooks downloaded
launched in March 2011. It’s the last
published by Anforme. Of particular into it.
word in style: it is sleeker, faster and
interest are the three ebooks on
lighter than the original iPad. Retail Weight can have further relevance for
Inflation, Unemployment, and
price? £659. readers: whether prone or supine,
Income Distribution.
book reading for leisure is an activity
(c) The growth of ereading is beneficial from
(iii) Books are heavy, and this can be which often takes place when one is
the point of view of the Treasury. In the
relevant to consumer decision lying down. Reading while lying in
UK, pbooks belong to a category (food,
making. Suppose you plan to take bed or on the beach, War and Peace
children’s clothes) on which VAT is not
half a dozen books to read on your quickly becomes uncomfortably
levied. However, ebooks are not exempt:
beach vacation. These days, airlines heavy. You want to go on – the mind
there is 20% VAT to pay.
ruthlessly enforce weight restrictions is willing, but the body is weak.
(d) On the demand side, consumers may find on luggage, levying a surcharge if
that the ebook is advantageous because:
(i) it is usually cheaper than its printed
counterpart – lower prices reflect
lower costs of production [see (a)
above], although VAT [see (c)]
counteracts the overall price-
reducing impact.
(ii) There is an unambiguous advantage
if you order an ebook: you receive it
instantly, rather than waiting for the
postman to deliver – or for the TRY
bookshop to phone with news that
the book you ordered last week has THIS!
come in. What ebook should you With reference to the iPad and the ebook:
order? There is plenty of choice in
the ebookshop. In the spring 2011, (a) define; (b) illustrate; and (c) discuss, the impact
Amazon UK is said to have more than of technical progress on the position in markets of
550,000 titles to choose from, and (i) supply curves and (ii) demand curves.
Apple’s iBookstore has 150,000.

Economics Today · September 2011 33

What policies can be used to stop firms in
an oligopoly from colluding?
Ruth Tarrant, Head of Economics, Bedales School, explains how
competition authorities try to ensure competitive product markets.

What is collusion?
Collusion is a difficult economic concept to pin down. One simple way of thinking about Why does collusion happen?
collusion is that it is just a ‘non-competitive’ market outcome, where prices are higher than If we can get to the heart of why firms
they would be under competition and closer to those that you might see charged by a choose to collude, then this will give us
monopolist, usually achieved by restricting supply. This might result from explicit or deliberate some clues as to how we can design policies
collusion (perhaps a cartel) or tacit collusion, where prices converge on a price above the that can prevent, or at least reduce,
competitive equilibrium in a non-cooperative way (for example through the interdependence collusive activity. Collusion usually occurs
of firms in an oligopolistic market structure). Article 81 of the EC Treaty on Competition Law in an oligopolistic market structure,
focuses on tackling explicit rather than tacit collusion. where there is a relatively small number of
firms operating interdependently. In an
oligopoly, this interdependence can lead
to uncertainty and much lower profits
than could be achieved if firms worked
We should also distinguish between The exercise of market power by either
together.
horizontal collusion and vertical collusion. the upstream or downstream company
Horizontal collusion occurs when there is would normally hurt the demand for the We can see this scenario illustrated neatly
agreement (explicit or tacit) between product of the other… the companies using a Prisoners’ Dilemma game, as
firms at the same stage in the production involved in the agreement may there- shown in Table 1. In this game, two firms
process to charge prices above the fore have an incentive to prevent the operating in a duopolistic washing deter-
competitive level. It is horizontal explicit exercise of market power of the other.2 gent market can choose, independently
collusion that is usually focused on by of each other, whether to set a low price
In other words, the approach taken by
competition authorities, as the higher or a high price. In this example, the
competition authorities to vertical collusion
prices resulting from the increased market dominant strategy of each firm is to
is one of tolerance as they believe it is
power of the colluders reduces consumer choose a low price, and so the Nash
essentially ‘self-policing’.
surplus/welfare and creates a deadweight equilibrium is for both firms to set a low
loss. Another type of collusion that is occurring price. In this outcome, both firms will
more frequently is procurement collusion, receive a profit of £4m. However, if they
Vertical collusion, between firms at different
or bid-rigging. Companies bid for large had managed to collude in order to set a
stages in the production process, is a
contracts (often construction or public- high price, they would each have earned
different matter. As one economist has
sector work) where the contract is awarded profits of £8m. Clearly, collusion would be
summarised it, “a supplier and a dealer are
to the lowest bidder; companies work far more lucrative for the firms than
necessarily parties to a buyer-seller
together and share their bids with other competition. Such collusion is more likely
agreement, and they presumably discuss
bidders, resulting in some companies putting to exist if the firms sell very similar goods,
prices all the time”.1 The EU Competition
in deliberate overly-high bids that make the and if demand is relatively price inelastic
Commission sees it similarly:
bid of one company look very competitive. so that revenue will rise when the price
This bid-rigging is illegal. rises.

1. Hovenkamp, Herbert (2005), Federal Antitrust Policy,

3rd edition, p. 465.
2. EU Commission (1998), Communication from the Commission
on the application of the Community competition rules to
vertical restraints, COM(98) 544 Final OJ. REMEMBER
Exam Board AS Unit A2 Unit
THIS!
3(3.3.3 Collusion occurs when firms reach an agreement to fix prices higher
AQA & 3.3.5)
than they would be under competition – this is illegal.
3(3.3.9
Edexcel & 3.3.11) Higher prices result in lower consumer surplus and higher profits for
F583
OCR & F584
colluders.
EC3
WEJC (D & E)
CCEA A2(1)

Int. Bacc. Higher 2.3 Key words

New 2011: Higher 1.5 Explicit collusion · Tacit collusion · Prisoners’ dilemma
Cambridge Barriers to entry · Bid-rigging
Microeconomics (c)
Pre-U

34 Economics Today · September 2011

Box 1: Recruitment agencies
In late September 2009, the OFT imposed fines totalling just under £40m on six
recruitment agencies, who had colluded under the banner of the ‘Construction
Recruitment Forum’ to fix fee rates for the supply of workers to the construction
industry, in response to the entry of a new, innovative competitor (Parc UK) in the
construction recruitment industry. Two recruitment companies who were initially part
of the illegal cartel were granted leniency by the OFT for bringing the collusive
arrangement to their attention, thus avoiding the fines incurred by the other
recruitment agencies.

Do we need to
tackle collusion?
There is a considerable amount of money Methods for tackling collusion
spent by competition authorities on There are a number of approaches that competition authorities can take to reduce the potential
detecting, addressing and preventing for collusion, including making markets more competitive/contestable, increasing the
collusive activity because of the negative likelihood that any collusive agreement will break down, and deterring collusion by the use of
impact it has on consumer welfare. However, heavy fines for those companies that are caught. Each of these approaches will now be
collusive agreements often break down discussed in turn.
without any government intervention
whatsoever. There are a number of possible
reasons for this. If barriers to entry to the
industry are relatively low, then new entrants Making markets
may undercut the firms with the collusive TRY more competitive
agreement and gain market share at the THIS! There are a number of strands to the concept
expense of the colluders. Demand for the of ‘competition’. Generally, we expect
product made by the colluders may also fall, Visit the website of the
markets that are more competitive to be
perhaps due to changing tastes, develop- OFT (http://www.oft.gov.uk/) characterised by a greater number of firms,
ment of substitutes or falling consumer to find out more about what lower barriers to entry (and exit), and lower
spending due to recession. Also, the larger they do. concentration ratios for the largest firms in
the number of firms that are colluding, the the industry. Thus if barriers to entry can be
more likely it is that one firm will choose to lowered (which can result in a greater number
‘defect’ on the agreement. If we refer again of firms and reduced market share for
to Table 1 and the Prisoners’ Dilemma, then incumbent firms), the market is likely to be
a firm can increase its profit from £8m to more competitive.
£10m by choosing to break the agreement
One of the conditions required for collusion
and charge a low price while other firms in
to occur is the existence of high enough
the agreement continue to charge a high
barriers to entry, which prevents new firms
price. However, there is no guarantee that
from entering a given market (Box 1 outlines
collusive agreements will always break down
a price-fixing example where the arrival of a
– the UK Competition Commission has
new competitor into an industry actually
investigated illegal collusive activity many
caused collusive action by the incumbents
times over in recent years, providing good
with the aim of driving out the entrant). So,
evidence that many agreements don’t fail.
one option that could be available to
So, what can be done to reduce the risk of
competition authorities is to reduce the
collusion?
barriers to entry. There are a number of
possible ways of achieving this.
G Firstly, as has happened in the UK, the
government could make it easier for new
firms to set up by reducing admini-
strative burdens. A good example of an
industry where this has happened is in the
market for renewable energy, with
Table 1: Profits in a duopoly applications to build a new wind-farm
taking 26 months in the UK compared
Clean Clothes with an average of 42 months across the
EU 3. This reduction in administrative
Low Price High Price burden is much easier to introduce for a
£4m for £10m for Soft Wash relatively new industry as it doesn’t
Low Price discriminate against incumbent firms who
both firms £1m for Clean Clothes
Soft Wash have already borne the sunk costs
£1m for Soft Wash £8m for
High Price
£10m for Clean Clothes both firms 3. http://www.timesonline.co.uk/tol/news/environment/
article7105710.ece

Economics Today · September 2011 35

Box 2: Airline industry – British Airways and Virgin Atlantic
Following a lengthy investigation by the OFT that started in 2006, BA was fined for
fixing fuel surcharges on long-haul flights with Virgin, and 4 former BA executives
were convicted of illegal price-fixing. BA was fined £121.5m by the OFT and $300m
by the US Dept for Justice for collusion with respect to fuel surcharges and cargo fuel
charges. Virgin avoided fines after informing the authorities that the breaches had
happened. The OFT’s ‘leniency policy’ gives immunity from prosecution for a company
involved in collusion if that company is the first to give full details. Both Virgin and
BA were ordered to compensate passengers who had ‘overpaid’ for their tickets, with
the total compensation bill reaching £100m.

Box 3: Car insurance

associated with starting out in the
industry. However, it does run the risk of An investigation by the OFT into the risk of price co-ordination in the car insurance
allowing large market share to be built up industry, which finished in January 2011, resulted in 7 insurers and 2 software
very quickly by new entrants, which could companies promising the OFT to limit the amount of data that they share. Their
in the future lead to price-fixing issues. existing insurance premium calculation software runs in ‘real time’ which results in
competitors being able to see each other’s insurance quotes and future pricing
G Deregulation is also a means of
strategies before consumers actually purchase the insurance. There was no evidence
deliberately reducing barriers to entry.
in the investigation of insurance companies actually making use of this information
Greater deregulation could arguably have
to fix prices; the OFT in this instance acted to prevent collusion before it happened.
prevented the collusive activity in the
The requirements that have resulted from this investigation are expected to spread
airline industry outlined in Box 2. Until
to all insurance companies.
very recently, the airline industry in the
EU was highly concentrated, mainly due
to the very strict controls imposed by
member states on which airlines could fly
into and out of their country, which
created high barriers to entry and the
potential for collusion. The European
Common Aviation Area (ECAA), agreed
upon in 2006, is an example of how
member states of the EU have worked
together to liberalise European airspace
by allowing aircraft from a company of
any member state to fly to any airport
within the EU.
The EU-US Open Skies Agreement is a very
similar sort of process which should
encourage competition on transatlantic
routes; the first part of this Agreement
allowed any airlines to operate routes the 1980s, following the deregulation of the pay National Insurance contributions for
between the US and the EU, rather than the local bus market in the UK, the company their employees, for example. In addition,
very limited initial range of airlines (which Stagecoach used the large reduction in the Department for Business, Information
included British Airways and American regulation to build up enormous market and Skills (BIS) announced in late 2010
Airlines), often via ‘codeshare’ agreements. power in many local and regional bus that it would support small businesses by:
Interestingly, this agreement also actively services, which can result in much higher
• Improving access to finance.
encourages closer co-operation between prices for consumers than would be the case
airlines in terms of environmental issues, thus in a more competitive market. The extent to • Making it easier for small firms to
encouraging collaboration on industry-wide which deregulation can be effective, supply to the government.
issues but hopefully reducing the potential therefore, must depend on the actual size of • Support entrepreneurs starting new
for collusion in terms of price-fixing. the market. businesses.
• Helping new companies to access
However, deregulation in industries, such as G Another way of reducing barriers to entry,
the airline industry, that generally require existing markets.4
in general, is to reduce costs for new
economies of scale to be profitable, may only and/or small businesses. This can be So far, however, the government has been
have a small impact on the number of done by ensuring that small businesses remarkably vague on how they will achieve
entrants as other natural barriers to entry will can borrow at similar rates of interest to this last point, which is probably the most
still remain. It may also be the case that there large businesses, perhaps, or by reducing important point for helping to reduce the risk
simply isn’t enough market demand to ‘soak the tax burden for new/small businesses. of collusion in concentrated markets. Small
up’ the supply generated by new entrants. In The UK government has reduced the rate businesses may also feel dis-incentivised to
of corporation tax for small businesses, grow as they will lose the benefits to which
4. http://www.bis.gov.uk/assets/biscore/enterprise/docs/
b/10-1243-backing-small-business.pdf and raised the rate at which employers must they are entitled as small businesses.

36 Economics Today · September 2011

Reducing barriers to entry is not the only
tool available to competition authorities in Box 4: Washing powder
terms of making markets more competitive,
Unilever and Procter & Gamble were fined £280m in April 2011 for agreeing to fix the
but it is quite commonly used. Another,
price of washing powders in 8 European countries, following a 3 year investigation
perhaps more costly, approach is for
resulting from a tip-off from a third member of the cartel, Henkel. Countries affected
competition authorities to identify markets
by the higher prices included Italy, France, Germany and Spain, across brands such as
where the nature of the industry itself
Persil, Surf and Tide. The fine handed down to Unilever and P&G was reduced by
naturally lends itself to ‘too much’ sharing
10% after they admitted co-ordinating prices; all three companies say they are
of information. An excellent example of this
retraining their top-level product managers in EU competition law in order to prevent
would be the insurance market, where it is in
a repeat.
the interests of insurance companies to be
aware of trends and patterns in insurance
claims for all companies, in order to provide
the most competitive pricing. Box 3 outlines
Box 5: Memory chips
the fine line between perfect information
(which is a required element for true perfect A cartel with at least 11 members was fined in 2010 by the EU Commission for fixing
competition) and ‘too much’ information the prices of electronic memory chips that are used in computers; computer
and the implications that this had for the UK manufacturers had to pay uncompetitive prices for these key components, which
car insurance industry in terms of tacit pushed up prices for the end consumer. US chip maker Micron blew the whistle on
collusion. Early intervention by well- the cartel, which reduced its share of the fine to zero. Other companies that were
informed competition authorities can help very co-operative with the investigation saw their fines fall by up to 45%, as a result
to prevent illegally collusive situations from of a new approach by the EU Commission to encourage companies to acknowledge
developing further. price fixing and allow investigations to be completed more quickly and cheaply.

REMEMBER
THIS!
Collusive agreements often break down naturally without intervention by competition authorities.
Competition authorities can try to introduce more competition into an oligopoly, and reduce the risk of collusion,
by reducing barriers to entry.
Competition authorities can also increase the likelihood that firms involved in collusion will defect from the
agreement by reducing fines for them and increasing fines for their fellow colluders.

Increasing the chance of

a breakdown in collusive
agreements
Clearly, it is impossible for competition
authorities to totally eradicate the risk of
collusive behaviour, because of the potential
for significantly higher profits through
collusion rather than competition. This point
seems to have stuck with the competition
authorities in the UK and the EU, which
have, in recent years, adopted a different
approach.
Companies involved in collusive price-fixing
action can contemplate a leniency policy
where they face no fines if they are the
first company in a particular price-fixing
Box 6: Lift industry agreement to report their behaviour to the
competition authorities; examples of this
In 2007, the EU imposed a hefty £700m fine on 4 lift and escalator companies for leniency policy can be seen in Boxes 2, 4 and
price-fixing. The 4 companies, from Sweden, Finland, Germany and the US, fixed 5, in which one company in each collusive
prices and rigged bids between 1995 and 2004. According to the EU, the fines were agreement ‘blew the whistle’ on the
so large because of the ‘long life’ of the product in terms of servicing and maintenance arrangement, thus gaining a first mover
(and, more cynically, perhaps because key EU buildings including the headquarters of advantage at the expense of their rivals by
the EU Commission and the EU courts in Luxembourg were victims of the collusion). defecting on the agreement.

Economics Today · September 2011 37

Whilst consumers still lose out as a result of
price-fixing, competition authorities have TRY
seen a rise in the number of reported THIS!
arrangements, thus meaning that price-
fixing agreement are more likely to be Investigate other examples of collusion – identify the
brought to a swifter end. In addition, characteristics and market structure of the market involved,
significantly less time and money is spent by and outline the reasons for the breakdown in the collusive
the authorities on investigations into agreement. As a starting point, you may want to find out more
suspected collusive activity, freeing up funds about the current EU inquiry into claims that EU investment
for use elsewhere. The positive impact here banks (including HSBC, RBS and Barclays) colluded in the
is increased further by the ability of provision of complex financial instruments that led to the
competition authorities to reduce any fines financial crisis and EU debt crisis.
for companies who admit to price-fixing and The Prisoners’ Dilemma game shown in Table 1 is an example of a
provide information freely to the
‘one-shot’ game i.e. a game that is played just once.
investigation team once an investigation has
commenced, which again speeds up the a. Find out why this is unrealistic for most business scenarios.
enquiry. This new approach to tackling
collusion certainly seems to be proving highly b. What is the outcome in a Prisoners’ Dilemma game that is
cost effective and efficient so far, although it repeated i. Finitely; ii. Infinitely?
could be argued that it may reduce laudable c. Find out what is meant by the ‘tit for tat’ and ‘grim trigger’
collaboration between firms. The washing
strategies when the Prisoners’ Dilemma becomes a repeated
powder cartel in some European countries
was initially formed following legal
game. Can you apply either or both of these strategies to any
collaboration between the firms involved to of the case studies outlined in the article?
reduce the environmental impact of washing
powders; this collaboration strayed off task
resulting in discussions on price-fixing, and
there is now a risk that the important Conclusions
discussions on the environment may not be
Firms choose to collude rather than compete in order to increase their profitability at the
resumed any time soon.
expense of consumers. Whilst the market itself can be self-correcting and self-policing,
The second prong in the new approach to there remains a role for competition authorities to act collectively on behalf of consumers.
reducing collusion by making a breakdown in Their role must be multi-dimensional in order to be effective, by reducing the risk that
collusive agreements more likely is to collusive agreements may form in the first place, and by encouraging a faster breakdown
increase fines for those found guilty of of those agreements.
colluding to fix prices. Examples of
industries where heavy fines for colluding
have been handed down can be seen in Boxes
2, 4 and 6 in particular. The EU competition
commissioner has said on several occasions
that heavy fines for price-fixing should act as
a “deterrent” to all companies in all industries.
This deterrent works by reducing the value of with Chief Examiner,
the potential payoff for colluding (so, if the Robert Nutter
payoff matrix in Table 1 is used as an example,
then a fine may reduce the payoff for
colluding from £8m to £4m, the value of the
1. Compare the role of the UK Competition Commission, the EU Competition
payoff for behaving competitively).
Commission and the US Department of Justice anti-trust division when dealing with
However, the use of extremely heavy fines cartels.
may actually have the unintended effect of http://www.competition-commission.org.uk
increasing market concentration. In the http://ec.europa.eu/competition/index_en.html
recruitment agency example shown in http://www.justice.gov/atr/index.html
Box 1, two of the firms involved were so
damaged by the fines that they didn’t 2. In December 2010 the EU Competition Commission fined six LCD (Liquid Crystal
survive; in the computer memory chip Display) panel producers ¤648 million for running a price fixing cartel. Research the
example shown in Box 5, several of the firms background to this investigation and how the ‘leniency notice’ operated in this case.
found that their bottom line was severely hit 3. In November 2010 the European Competition Commission fined 11 airlines almost
by the fines which reduced their ability to 800m euros (£690m) for fixing the price of air cargo between 1999 and 2006.
carry out R&D and compete in terms of Investigate the background to this case.
product development, a major factor in
http://www.bbc.co.uk/news/business-11719507
success in this fast-moving industry. Clearly,
the level of fines needs to be carefully 4. It has been alleged that the member clubs of the FA Premier League act as a cartel
determined so as to act as a deterrent on the by negotiating television rights collectively with broadcasters rather than individually
one hand and allow competitive practices to by club. What is the evidence to support and oppose this viewpoint? Could collective
return on the other. negotiation of sports broadcasting rights be in the public interest?

38 Economics Today · September 2011

Presentation of
economic data
Peter Cramp of Nottingham High School explains different
methods of data presentation.

Introduction
Petrol prices have been one of the big economic news stories of the year. On 23 June
2011, the average price across the UK stood at 136.12p per litre, according to
www.petrolprices.com, a figure which would perhaps have been difficult to envisage
little more than two years ago, when the price was around 85p per litre. In July a
supermarket-led fuel price war began to break out but petrol prices were still high
and perceived to contribute to hardship for families, further squeezing their ability to
undertake discretionary spending at a time when pay was failing to keep pace with
inflation. In this article data on petrol prices is used to provide a context to illustrate
different methods of data presentation and their uses. Data handling skills are of
importance for all economists, and even students new to the subject are likely to
encounter data almost immediately on beginning their course.

Tables
Tables are often used as a way of
presenting economic data when con-
siderable detail is required. Table 1
shows data on petrol prices presented
in the form of a table. There is plenty Table 1: UK unleaded petrol prices, pence per litre
of detail shown here but imagine if
every year since 1995 had been Price Tax Non-tax Tax as %
included and the detailed breakdown contribution contribution of price
given for the February 2011 data had to price to price
been shown for each year too! The 1995 54.0 39.4 14.6 73.0
detail shown in a table can be of 2000 76.2 58.6 17.6 76.9
considerable use, but the detail can 2005 91.0 60.6 30.4 66.6
also be the greatest disadvantage of
2007 95.1 63.7 31.4 67.0
using a table for data presentation.
2011 (February) 132.9 80.1 52.8 60.3
This is particularly true when the table
includes data on two or more related 2011 (February) Duty VAT Product Retailer/
variables, because the correlation Breakdown of Delivery
between them may be hidden in the 132.9p price 57.95 22.15 47.8 5.0
detail of the table and not as readily Source: Data based on www.petrolprices.com
apparent to the reader as it might be.

Key words
Table · Bar chart · Line graph · Pie chart · Correlation · Cause and effect

Economics Today · September 2011 39

Figure 1: UK unleaded petrol prices, pence per litre (Bar chart)
Bar charts 140
Tax contribution to price
Bar charts set out data in columns or 52.8
Non-tax contribution to price
widths. The height of the columns or 120
their width is used to illustrate differ-
ences in values or quantities. Bar
100
charts have more visual impact than
31.4

Pence per litre

tables. This should be clear from Figure 30.4
1, which reinterprets much of the data 80
80.1
in Table 1. An immediate impression is 17.6
given of the rise in petrol prices 60 63.7
58.6 60.6
between 1995 and 2011 and the 14.6
contribution that tax has made to the 40
increase in price. 39.4

0
1995 2000 2005 2007 2011 (Feb)
Source: Created using information from www.petrolprices.com

Line graphs
The line graph shown in Figure 2 is
constructed from the same data as in
Table 1 and Figure 1. Of the three
formats, it is probably the clearest and
most useful for this set of data. It
Figure 2: UK unleaded petrol prices, pence per litre (Line graph)
shares the visual impact of the bar
chart, but improves upon it in a 140
Tax contribution to price
number of ways. For one, the time Non-tax contribution to price
intervals in the data are not consistent 120 Total price
(there are five year gaps early on in
the series, but shorter gaps between 100
2005 and 2007 and then again
Pence per litre

between 2007 and February 2011). 80

This is accounted for in Figure 2 by the
axis used for time in a way that was
60
not possible using a bar chart. The line
graph arguably also makes it even
clearer than the bar chart in Figure 1 40
that the tax contribution to the price
has exceeded that of non-tax factors 20
throughout the period shown, and
shows clearly how the gap has 0
changed over time. 1995 1997 1999 2001 2003 2005 2007 2009 2011
Source: Data based on www.petrolprices.com
Line graphs are excellent for showing
relationships between variables, such
Figure 3: Unleaded petrol vs. Brent crude oil prices
as correlation. There is clearly a
140
positive correlation between the tax Unleaded petrol (pence/litre)
on petrol and its price, a relationship Brent crude oil ($/barrel)
which in this case is one of cause and 120
effect (which is not always the case: it
is important to remember that 100
correlation between two variables can
be coincidental or the movement in 80
two correlated variables may be caused
by a third factor that influences them
60
both). In the case of petrol prices,
another important causal factor is the
price of oil. This is because oil is refined 40
in the production process for making
petrol. The positive correlation between 20
oil and petrol prices and the trend
increase of both is shown clearly for 0
the period from 2003 to October 2010 2003 2004 2005 2006 2007 2008 2009 2010
in Figure 3. Source: www.michaelmather.com

40 Economics Today · September 2011

Figure 4: Breakdown of 132.9p litre of fuel in February 2011
Pie charts
In a pie chart, each category is given a ‘slice’ Retailer/Delivery
5p (4%)
of the ‘pie’, the size of the slice being
determined by the importance of the category VAT
relative to the whole. This would be a useful 22.15p (17%)
way of showing the data for the breakdown of
a 132.9p litre of petrol in February 2011,
details of which are in Table 1. The resulting
Duty
pie chart is shown as Figure 4. 57.95p (43%)

Conclusion and points

to consider Product
47.8p (36%)
The most important factor in data presenta-
tion is clarity: the method chosen should be
the one which presents the data most clearly Source: Data based on www.petrolprices.com
to the reader. This should be the case
whether you are reading, analysing and inter- Figure 5: CPI inflation in the UK
preting data chosen for you by others (in an
9
exam paper, for instance, or when reading a
newspaper article) or whether you are 8
choosing data yourself (for example to make
a point in an essay or as part of coursework 7
or a presentation).
6
Data should be collected carefully to illustrate
the points that you wish to make, as long as 5
your use of data is not deliberately selective
in order to mislead the reader. The data 4
chosen for this article ‘tell a story’ about rising
3
petrol prices and illustrate the key factors
behind price rises, namely tax on fuel and the 2
price of oil. It is a story that could be carried
further to a macroeconomic level, to look at 1
the impact of petrol prices on general price
inflation. Inflation is one of the four key 0
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
macroeconomic indicators (along with gross
Source: ONS.
domestic product, unemployment and the
current account of the balance of payments). Figure 6: Contributions to inflation in June 2011 in the UK
For many students early in their sixth form Consumer Price Index, main contributions to the 12-month inflation rate of 4.5%
courses, data on these key indicators is likely
to be the first data you meet. Transport 1.29

The line graph in Figure 5 shows Consumer Food & non-alcoholic beverages 0.64

Price Index inflation data back to 1989, with Housing & household services 0.55
inflation having risen steeply in 2010 and Restaurants & hotels 0.54
2011, to stand at 4.5% at the end of the Alcohol & tobacco 0.41
series in June 2011. A significant factor in
Furniture & household goods 0.28
this rise has been petrol prices, as suggested
by the fact that transport is the sector that Miscellaneous goods & services 0.24
put the biggest upwards pressure on prices Recreation & culture 0.13
in the twelve months to June 2011, as Communication 0.10
illustrated in the bar chart Figure 6.
Clothing & footwear 0.10
So the data presented in this article have been Education 0.10
chosen not just to highlight the advantages
Health 0.09
and disadvantages of different methods of
data presentation, but also to show a chain 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6
from rising tax and oil prices, to rising fuel Percentage points
Source: Timetric data.
prices, to inflationary pressure. The data offer
considerable opportunities for further
analysis using economic theory. One example Finally, an opportunity for practice! Looking practice your data presentation skills by
would be consideration of the factors that at Figure 6, the second biggest contributory researching data on rising food prices and
have caused rising oil and petrol prices, using factor to June 2011’s inflation was ‘food and presenting it in an appropriate format.
a simple demand and supply framework. non-alcoholic beverage prices’. You could

Economics Today · September 2011 41

Rachel Cole, teacher at Cheltenham Ladies’
College and a Principal Examiner,
discusses why Thorntons is closing
some of its shops

In this new column we look at how economics crops up

everywhere in our everyday lives. It features ideas from
your course which can be used in what we hope is a
context you know well, and will help you to think about
Economics even when you are not sitting at your books
and files.

In this edition we will be looking at the announcement on 28 June enough profit, and there might be other ways in which the firm can
2011 by Thorntons, the chocolate retail chain, that it will be closing make more money.
many of its high street shops. After issuing a profits warning
And this does seem to be the case. Thorntons is still making money
Thorntons may end up with as few as 50 shops in the UK, compared
on its stores, but it wants to refocus its business. This brings us to
to the 227 before it began its restructuring.1
another area of the economics syllabus. Why do firms sell off parts
Why does a business close so many stores at once? Thornton’s chief of their business? Sometimes smaller firms are better than big ones.
executive Jonathan Hart announced “Our goal is to refocus the Sometimes the firm is suffering from diseconomies of scale,
business across all channels and seek to deliver industry competitive meaning that it finds there are communication problems, it is too
results.” He went on to explain that there is weakness in “high street large and unwieldy to control effectively, or that it is spreading
footfall” and that he wanted to increase online sales. Another itself too thinly and there is no ability to build up expertise
problem that Thorntons faces is that demand is highly seasonal: and skills in particular areas. This calls for rationalisation which is
demand is strong at Easter and Christmas, but at other times, the process of selling off parts of the business to make it more
particularly in the warmer weather, demand slumps. efficient.
Using this data, examiners might ask the following: why does the Another reason for the sell off is that many high streets are in decline,
firm make a loss in the summer and why does a firm sell off parts of and Thorntons is simply joining the trend. Footfall is falling, said the
its business (rationalisation). Another kind of question is to consider chief executive, meaning that the number of people walking up and
how the market for online and retail shopping outlets is made up of down high streets is less than in the past. A whole change has
separate segments (with different price elasticities of demand), with occurred in the way we shop, and this is partly because of the rise of
the result that different prices are being charged online and in store. a substitute (online shopping) and partly because of the global
This is perfect ground for a price discrimination question (June 2011 recession, which makes everyone much more cautious in their
Edexcel) although some would argue that this is product discrimina- shopping whether or not their incomes have fallen. At the same
tion, because the selling of a box of chocolates in a store is a much time, HMV shut 60 stores, Jane Norman (a clothing brand) went
more immediate service than buying online, and you get a chance to into administration, and Carpetright shut 27 (out of 586) stores.
taste and see the items you are buying. Unfortunately there will be knock-on effects to other high street
So first of all, let’ s look at why a retail chain may shut down some retailers, and it is likely to be part of the general pattern of decline
of its stores. In theory a firm shuts down, in the short run, when it is in many inner cities.
not covering its variable costs. Fixed costs can be completely ignored So it’s not going to be quite so easy to pick up last minute chocolate
in the short run, because the firm has to pay these anyway. In the gifts for your family and friends, as the high streets in many towns
long run all costs are variable, so it is still true that the shops will be will have less and less to offer. Some people will lose their jobs, but
shut down because revenue isn’t covering total costs. But in this it is possible that there will be more people employed in total as
case, making a profit is not enough of a reason to stay in business. online shopping is a growing market and resources will be increased
The market structure for chocolate businesses is not perfect there. This brings up mobility of labour questions – whether workers
competition, but oligopoly. Oligopolistic firms can expect to make can in fact transfer to the online areas of Thorntons operations. This
supernormal profits and they will not be competed away. So it might might not be easy if workers have low skills. But then, as they say,
be that while Thorntons is making some profit, it is not making life is not a box of chocolates.

Key words
Footfall · Price elasticity
Recession · Rationalisation 1. A profits warning is made when a firm announces that its profits in the forthcoming accounts are going to be worse than expected, allowing
markets to respond before the accounts are actually published.

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Economics Today Magazine

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SEPTEMBER 2011 · VOLUME 19 · NUMBER 1

䊳 What are the causes of

䊳 How does the PPF fit

䊳 Publishers and the

Economics Today · September 2011 1

2 Economics Today · September 2011

Economics Today · September 2011 3

4 Economics Today · September 2011

Economics Today · September 2011 5

Figure 2: Rail fares with subsidies

6 Economics Today · September 2011

Economics Today · September 2011 7

1. The Hill’s report on ‘An Anatomy of economic

Share of the total net income of the population,

after deducting housing costs

10 Economics Today · September 2011

11. The National Minimum Wage, The Low Pay Commission

Economics Today · September 2011 11

12 Economics Today · September 2011

Figure 1: US consumption of selected drinks 1977 to 2006

Ounces per day

1. http://www.ers.usda.gov/Publications/ERR100/ERR100.pdf Exam Board AS Unit A2 Unit

Economics Today · September 2011 13

Suggested approach to the questions

14 Economics Today · September 2011

Economics Today · September 2011 15

Andrew Reeve, Head of Sixth Form,

16 Economics Today · September 2011

Figure 1: Circular flow of income – developing gross domestic product

Table 1: The GDP and GNP of Ireland 2009-2010, % change

GDP and GNP 2009 2010 % Change

Economics Today · September 2011 17

Why do budget deficits and government debt matter?

The problem of ‘crowding out’

Economics Today · September 2011

The eurozone problem

Economics Today · September 2011 19

Why the bulge?

20 Economics Today · September 2011

the simplification, but as more resources are

Economics Today · September 2011 21

How a PPF can be used in other contexts in Economics

22 Economics Today · September 2011

Figure 4: Output gap using Aggregate Demand and Aggregate Supply

Still in macroeconomics, the PPF is used in Keynesian economics to show that

Economics Today · September 2011 23

24 Economics Today · September 2011

In the above diagram the production possibility frontier of a

2 In a country where government directives and planning are

3 Following a rise in price from £1.60 to £2 the daily demand for

Economics Today · September 2011 25

Evidence C: Evidence B: UK house prices, mix of housing, adjusted average

26 Economics Today · September 2011

Suggested approach to the questions

Economics Today · September 2011 27

28 Economics Today · September 2011

2 A planned or command economy is often associated with

Economics Today · September 2011 29

Economics Today · September 2011 31

32 Economics Today · September 2011

Economics Today · September 2011 33

1. Hovenkamp, Herbert (2005), Federal Antitrust Policy,

Int. Bacc. Higher 2.3 Key words

34 Economics Today · September 2011

Economics Today · September 2011 35

Box 3: Car insurance

36 Economics Today · September 2011

Increasing the chance of

Economics Today · September 2011 37

38 Economics Today · September 2011

Economics Today · September 2011 39

Pence per litre

between 2007 and February 2011). 80

40 Economics Today · September 2011

Conclusion and points