Is it the End of the British Breakfast?

JAM

Now I wanted to start this with a clever pun about jam or marmalade and the British Breakfast. Alas, I have yet to find one, but this story is arguably humorous enough in itself. I awoke this morning to a story on the BBC about a vote in parliament that will take place on deciding the minimum sugar content of jam and marmalade. If trivial micromanagement is a phrase that comes to your mind, I agree. I was arguing with myself over whether this was the government simply making a non-issue an issue, or if there was a genuine problem which required the government to spend time taking this into consideration.

Well according to Tessa Munt “it is the end of the British Breakfast as we know it” (let me quickly moan about her choice of calling it the British Breakfast, even the globally it is known as English Breakfast – Twining’s even have a tea named after it); now this is possibly a little farfetched. Now let me just establish what is going to happen in regards to this law passing through, British manufacturers will be able to reduce the amount of sugar in jams and other preservatives. It was set at 60% now to be lowered to 50% providing a slimmer version of British Jam. Now Tessa Munt has lamented that this will change the nature of British jam reducing its uniqueness and also making it more comparable to French jam.

Here is where things become more trivial, a DEFRA (Department for Environment, Food & Rural Affairs) spokesman stated:

“Reducing the minimum sugar content in jam from 60% to 50% will help British producers – large and small – to trade more easily across the world, boosting our economy and allowing jam-lovers everywhere to enjoy delicious British jam.”

Now there is a big claim here that reducing sugar content will somehow make British jam a more competitive export, and as such will “boost” the economy. Now I see the possible argument that by the use of less sugar, producers will reduce the cost of production by some extent as in place of the sugar is likely to be cheaper substitute preservatives. The question is to what extent will this happen, changing the sugar content in jam and marmalade effects how runny or set the jam is, but ultimately it has been stated that this new minimum will have an almost unnoticeable effect.

I have attempted to find statistics, but I have not come across any data considering the size of the jam and marmalade export market. I am sure it has some significance as there are the royalty approved “Tiptree”, but gut instinct doubts a considerable effect on the foreign market, as it is doubtful that due to this change British jam will no longer be as British. I think if the government is already going to waste time on the non-issue of these foodstuffs it may as well look at the decline of marmalade, and the rise of peanut butter, matching spending at £56 million.

I hope this topic won’t be hotly debated in the commons, if anything it’s a great argument against government intervention, just let the producers decide, and the consumers demand what they want. In my opinion it could not be simpler.

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Oligopoly Vs. Monopolistic Competition Air Berlin Case Study

Case Study: Air Berlin

Theory of the Firm Analysis

Fixed Costs:

  • Airplanes
  • Labour (salaries)
  • Airport Facilities

Variable Costs:

  • Fuel
  • Landing Fees

Define Fixed Cost: A cost that does not vary with output

Define Variable Cost: A cost that varies with output

The airplane is a fixed cost as once it is paid for the only variance in cost is through its operation. In the article it is mentioned that they look to sell 8 airplanes in the interest of reducing fixed costs as to reintroduce capital into the firm. An airplane in the majority of cases is bought outright, and this is established by the firm’s ability to sell it.

The fuel is a variable cost due to the possible change in price of fuel supplied to the airlines. The price of fuel is dependent on the microeconomic relationship of supply & demand, as the more routes an airline runs the more fuel it will need to purchase. In the article it identifies that jet fuel prices are “highly volatile” suggesting that this cost changes dependent on output.

The second variable cost is the landing fees, as more airplanes fly the greater the landing fees, as more airplanes have to pay the fee. There is also the nature of the cost of landing fees which may change; this is identified in the article through competition with Lufthansa for a central hub.

Case for Oligopoly:

Main Factors:

  • Interdependency
  • Competition
  • Etihad (market power)
  • Sustained Losses
  • Abnormal Profit & Reserves

Interdependency is a clear signal of oligopolistic competition, this is identified in the article as the need to develop a new airport. To continue competition both Air Berlin and Lufthansa must expand and open new routes, which is why there is the development of another central airport in Berlin. Currently, Lufthansa have an advantage as they have more docks for airplanes at “Tegel Airport”

There is clear evidence of competition with Lufthansa, as Air Berlin is stated to be the second-largest airline in Germany. This means that domestically the two big players are Lufthansa and Air Berlin, but the article goes on to mention the involvement of Etihad Airlines. The article also identifies that there is the intention of competition in the long run against alternative airlines, as Mehdorn states that “We want to strengthen our profile as an airline company… we need long-haul flights.”

The fact that the losses of the firm are being sustained provides clear evidence that Air Berlin is part of an oligopoly. Firstly, losses being sustained shows that the firm is not part of perfect competition, in perfect competition the firm will stop production the moment losses are being made as it is “easier” to stop producing rather than leave the market altogether. Secondly, the sustaining of losses means that at point in time the firm was making abnormal profit to build cash reserves, a firm that operates with abnormal profit is at a point of monopoly, but Air Berlin still has its competitors.

Due to the various competitions in the domestic sector mainly between Air Berlin and Lufthansa it can be argued that a kinked demand curve is in play in the German airline sector (as displayed below).

Picture2The above graph shows that they are not competing on price, this is clearly identified in the article as there is only the mention of reducing costs, introducing more routes, greater output (new airport), and airline unions (i.e. One-world Alliance). Lufthansa is shown to have a lower marginal cost due to economies of scale, as Lufthansa is a considerably bigger airline globally and in Germany in comparison to Air Berlin.

In the long run Air Berlin may be able to cut its costs down so that there is a return to normal profit, and with the eventual opening of BER the firm will be able to effectively expand and possibly compete at the same level as Lufthansa. However further delays in the opening of the new airport may mean that Air Berlin will continue to eat into their cash reserves, as stated by the article the costs per month are approximately €5 million will slowly degrade the €100 million in cash reserve. In the article it is stated that Air Berlin is selling airplanes to reduce their fixed costs, while this is appropriate action in the short run, in the long run it may mean that the firm will fail to fully utilise its new facilities of the new airport.

Case for Monopolistic Competition:

Define Monopolistic Competition: The existence of monopoly for a given firm at a given period of time in the short run. The firms in the long run will compete on price and other factors (e.g. branding, quality, etc.) eventually losing monopoly power over time as firms begin to differentiate less.

Main Factors:

  • There are Many Airlines and Consumers, and no Firm Has Total Control Over Market Price
  • Existence of Asymmetric Information
  • Independent Decision Making
  • Limited Barriers to Entry & Exit in Long Run

It is clear that there are many firms in the airline industry within Germany, and that there is a spread of consumers across the different airlines. It can be argued that no firm has clear control over market price based on external information, airlines often compete on price for specific dates or near certain events, and since there is the involvement of international airlines there is no single firm with complete control over market price.

There is clear evidence of independent decision making by Air Berlin. The first independent decision was to make a move to a new airport to act as a central hub so the firm can expand; Lufthansa had not taken any action in particular to cause this move, and it is likely that Air Berlin would have done this regardless of Lufthansa.

There is to a degree an ability to enter and exit freely into the market, this is identified by Air Berlins ability to sell airplanes, reduce unprofitable routes, and as a result reduce marginal cost. There are many competitors in the airline industry, Air Berlin could sell all of its airplanes, docks, and facilities to an international airline, or even sell parts to Lufthansa. There is the possibility of a clean exit, however in the airline industry there are many barriers to entry due to the cost of airplanes and facilities.

Picture1

The diagram above shows the short run loss of Air Berlin, it can be noted that there is a shift in marginal revenue and therefore average revenue as the article states that Air Berlin begins to lose customers. There is also the issue of high fixed costs which drives the average cost curve above average revenue, as the cost of the new airport facilities is considerable.

However, in the long run it can be argued that Air Berlin shall return to a point of normal profit. This is because there is the intention to sell eight airplanes to reduce those high fixed costs. There is also the mention of introducing long haul flights and the reduction of unprofitable routes which is the reduction of the supply to meet demand. This is shown in the diagram below as the firm returns to a position of normal profit.

Picture3

Introduction to Theory of The Firm

Fixed Costs → do not vary with output
Variable Costs → vary with output

Revenue of a firm is always dependent on the output.

Materials         → Variable Cost (leather, stitching, etc.)
Capital             → Fixed Cost (sewing machines, leather tanner, etc.)
Labour             → Fixed/Variable Cost (depends on type and payment)
Transport         → Fixed Cost (short term)
Marketing        → Fixed Cost (does not vary with output)
Factory            → Fixed Cost (same size, does not vary with output)

Factory p1

Short Term: The length of time in which one factor of production is fixed (factory determines whether or not the firm operates in the short term or the long term).

Long Term: The length of time over which at least one factor of production becomes variable (i.e. need a new factory to increase output).

The Law of Diminishing Marginal Returns:

Picture2

 

This graph shows how output increases over the initial short term, but in the long term output decreases. This can be explained by several factors, such as there are only so many facilities, employees waiting to use machines, rate of productivity declines as employees may begin chatting to each other or the machinery is now inefficient.

The classic example is “too many cooks in the kitchen”, if the oven is used by one cook the other cook cannot use it, if one cook used all the fish the other cook cannot use it, etc. The limitation of output increases over time due to inherent problems.

If this graph meets the x-axis and goes below it, it identifies the result of less productivity. As at any point below the x-axis adding a greater amount of a factor of production subtracts from the total output.

As a consequence of The Law of Diminishing Marginal Returns:

Picture3

 

Shown above is the example of how adding a unit of labour increases the costs involved in production. The reason marginal cost is at the trough while marginal productivity is at the peak is because the cost of introducing more labour was small in comparison to the increased output. Therefore it can be stated that the cost is counteracted by the increase in output.

This is evident if the following example is given, at one unit of labour 100 baseballs are outputted, as there is an additional unit of labour introduced there is an additional 150 baseballs outputted, this counteracts the cost of hiring the additional unit of labour as the output has increased by 150%.

Picture4

For Marginal Revenue it can be noted that as price decreases, quantity increases. This is because for the producer to sell the next good they will have to reduce the price of their good, in the sense of revenue you have to lower the price to sell more. As there is more supply the price drops as the good is less scarce.

Profit Maximisation: This is where Marginal Revenue is equal to Marginal Cost (MR=MC, Q-P)

At point Q1 there is greater marginal revenue then marginal cost, this is still a point of profit but if you stop at point Q1 you forsake possible profit and this is highlighted by the blue triangle. This is why it is worthwhile for the producer to increase one of the factors of production to increase the marginal cost with the goal of reaching the point of profit maximisation.

At point Q2 there is a greater marginal cost whereas, there is less marginal revenue. This point can be seen as equally inefficient as point Q1, as again there is loss represented by the green triangle. However it can be argued that it is better to be on this side as through this you achieve a greater market share, which is a long term interest.

Notes:

Every firm will attempt to reach the point of profit maximisation, the price of the product does not matter to the firm, and the interest is in profit.

Definitions:

Marginal Revenue: The extra revenue that an additional unit of product will bring.

Marginal Cost: The extra cost that an additional unit of product will bring.

Picture5

The introduction of average revenue allows the producer to see where the price of the good should be in order for the firm to maximize profit. The average revenue can be identified as demand, and while it is in the interest of the firm to maximize profit the accurate pricing of the good is essential.

Average Revenue: Total revenue per unit of output. When all output is sold at the same price, average revenue will be the same as price.

 

10 Terms to Know For Microeconomics

Production Possibility Frontier (PPF):

A production possibility frontier represents where resources can be allocated to produce certain amounts of a good in comparison to another good. It represents the choice the market has in production between two different goods, limited by the factor that certain resources are scarce.

Unemployment:

When there is surplus of labour which does not get utilised by the market. There are two manners in which to define unemployment. The first being the classic definition which states that if the price of employment increases above equilibrium there is more labour supplied but less demand. The second definition is “cyclical unemployment” where there is not enough aggregate demand in the economy to provide jobs for everyone who wants to work.

Infrastructure:

Infrastructure is the physical structures that are required for the operation of society and enterprise; it provides the means for an economy to function.

Supply:

Supply is the total amount of a good or service available for consumption at a given price at a certain moment in time.  The basis of the law of supply which states that as the price of good or service increases, the quantity supplied also increases.

Demand:

Demand is a consumer’s desire and willingness to purchase a good or service at a given price at a certain moment in time. The basis of the law of demand which states that as the price of a good or services decreases, the quantity demanded increases.

Market Failure:

Market Failure is when there is the inefficient allocation of resources, the existence of a negative externality on either the consumption or production of a good or service, and the existence of a monopoly power.

Externality:

An effect to a third party which was not accounted for in the price of the original transaction of the good, this can be either positive or negative.

Consumer & Producer Surplus:

Consumer surplus is where a consumer was willing to pay a price above equilibrium but only had to pay the equilibrium price, and producer surplus is where a producer was willing to produce at a price below equilibrium but was able to sell their good at equilibrium price.  Represented by the graph below:

P7 - Social Surplus

Public Good:

A public good is typically provided by the government, and it is meant to be non-rivalrous and non-excludable. Meaning that anyone can have access to it, you do not directly pay for it, and one person using it does not affect your usage of it. Some examples are street lighting, beaches, benches, and air.

Indirect Tax:

An indirect tax is paid through the consumption of good or services, whereas a direct tax is on your income. Examples of indirect taxes are Value Added Tax, Sales Tax, and Excise Tax. They provide a source of government income, and are a manner in which a negative externality can be resolved.