Nora Commentary 2 Final

Ski property faces meltdown as global warming chills the market

The property market in ski resorts is at risk of disappearing. Caused by recession, the weak pound, and climate change, Britons’ demand for ski property has decreased, property selling for 30% less than in 2007. Demand has remained strong in high-altitude ski resorts with guaranteed snow. Climate change decreases yearly snowfall, causing a gradual decrease in demand for European ski property.

 

A market has failed when it results in an over or under allocation of resources towards a particular product. Demerit goods are products which are over-provided by the free market and cause negative externalities of production or consumption. The polluting industries cause negative externalities (carbon emitted during the production of demerit goods). The negative externality (global warming) occurs when production creates external costs damaging to third parties. The external cost is added to the private costs of the producer, reflecting the full cost to society. The decrease in the value of ski properties is an external cost of the fossil fuel burning industries. For factories emitting carbon, there is a cost to society that is greater than the costs of production paid by the firm.

The marginal social cost (MSC) is greater than the marginal private cost (MPC) because of the extra costs to society caused by pollution. The article describes the extra costs, the vanishing of a whole market. The graph represents the carbon emitting firms who are only concerned with their private costs and produce at Q_e instead of at the socially optimal level of output (Q_so).  The socially optimal point (MSC = MSB) is not reached. Resources are over-allocated towards the polluting industry. The turquoise shaded area represents the dead weight loss to society, part of which is the fall of ski property value. 

In free markets, the profit-maximizing firms continues producing at Q_e . If the government is concerned with reducing the external costs of fossil fuel production, it can impose regulations on industries like taxing pollution. However, if taxes are too high, it will cause an under-allocation, if taxes are too low, the problem is not fixed. As opposed to this interventionist solution, carbon emission permits are a market based solution to over-pollution. Firms producing less carbon sell the superfluous permits for profit (creates incentives to pollute less). The diagram illustrates the carbon permit market. The demand curve represents the total demand for carbon permits. If an industry demands more carbon permits (wanting to emit more carbon), then the total demand for permits rises and the price of permits increases. Firms who pollute more face higher costs and therefore must charge higher prices for their goods, while firms who pollute less face lower costs and can sell their products for lower prices. Dirty firms will be competed out of the market; clean firms will be more successful and be rewarded by the market for their clean methods of production.

 

The main problem is that “Britons who own flats and chalets at ski resorts could face a threat to their investments – thanks to a long-term shortage of snow”. The ski property industry could save their business through innovation of the quality of their product. Buyers are “only considering resorts at high altitudes with large ski areas – more than 150km of runs – and summer activities”. Chalet sellers and renters could distance themselves from being fully dependent on the level of snow, making them dependent on the polluting industry, as they suffer from that industry’s spill-over costs (climate change). By offering year-round activities, “ski” property buyers will even be attracted to areas where snow is lacking.

By offering activities such as mountain biking, hiking, and horse riding, consumers will be willing to pay more for each quantity available of ski property (demand curve shifts to the right, causing P₁ to P₂, and Q₁ to Q₂). The decrease in demand caused by global warming is balanced by the increase in demand due to innovation of the product.

 

The ski property market cannot control the polluting industries, leaving the government responsible for the regulation. By differentiating, their products demand can be increased to an extent that revenue will increase, eliminating the decrease in value of ski property. Eventually, the government will have to take action, in the form of permits or legislations, to fix a market failure, which will influence all of society’s markets.

 

Nora Commentary 1 Final

 Holiday airfares close to last year but climbing

Many complain about the high prices of airplane tickets as holiday season approaches. Why is this? The concept of demand (the quantity of a good or service that consumers are willing and able to purchase at a given price in a given time period), price equilibrium, and price elasticity of demand (PED) explain this yearly phenomenon. As consumers are unresponsive to a change in price of tickets, producers increase price, hence increasing revenue. Approaching fall, the airfares rise by 50% because travelers are inflexible about the itinerary of their flight. Economically, the demand increases and becomes inelastic.

An increase in demand from spring to fall is depicted above. PED (responsiveness of consumers to a change in price) decreases: demand becomes inelastic. “For the holidays, the big airlines added a $20 surcharge each way on popular travel days closest to Christmas and New Year's. Furthermore, “several [fares] had risen 50% or more”. Airlines also charge an additional $15-$30 per bag. The same increase in price (P₁ to P₂) causes a proportionally smaller decrease (Q_f1 to Q_f2) in quantity demanded in fall than in spring. Thus, when increasing price in fall, the airlines increase revenue. Airlines should not increase their price in spring, because of the elastic demand, causing a shift from Q_s1 to Q_s2, hence a decrease in revenue.

 

Demand for airline tickets is almost perfectly inelastic in the fall because few substitutes exist, and it becomes a necessity to consumers. The airline prices increasing towards the end of the year has occurred similarly for the past years. However, the economic recession impacts the air travel market. “Airlines have been shrinking to match a decrease in travel. With the supply of seats more in line with demand, carriers have been able to raise fares close to where they were last holiday season.” The decrease in travel is shown by a decrease in demand (a shift of the demand curve to the left). A decrease in income or the expectation of a decrease in income causes consumers to travel less (decrease in demand). Compared to last year, the airlines decreased supply to avoid surplus, shifting the supply curve to the left.

 

The diagram shows the inelastic demands for airline tickets of this year and last year. The equilibrium price increases from P_e1 to P_e2. The equilibrium price is where demand and supply intersect, with no surplus or shortage of seats. If the airlines would not have decreased their supply in response to the decrease in demand, there would be a surplus of seats (diagram below) and the average fares could not have been increased without the airlines losing revenue.

 

The decreased supply and the inelastic demand around Christmas, allows the fares to be high (up to 20$ additionally). Last year, airlines had not decreased supply, yet recession was already in force causing a decrease in travelers. This caused a surplus of supply of seats, seen on the diagram, meaning that “airlines used discounting to fill seats”. The seats soon filled because of the law of demand: as the price of a product falls, the quantity demanded of the product will increase.

“Given the upward trend in fares, Grus says book now.” The price of airline tickets is expected to rise until new years. However, the itinerary for which demand is high only concerns a few days around the holiday. A few days before and after, the demand drops, and consumers are more responsive to a change in price (more elastic demand). This forces airlines to decrease their fares so that travelers buy remaining last-minute tickets. For airlines to maximize revenue, providers should increase price when demand is highly inelastic, as quantity demanded will not drop by a significant amount. On the other hand, airlines need to reduce supply of airplanes for the days that are off the mainstream itinerary. This would make supply level with demand, and airlines would not have to decrease their price to fill seats, therefore maximizing revenue.

With an economic understanding of how travelers react to the change in price of airline tickets, companies can “out-smart” the recession, and increase revenue even while demand for air travel is decreasing.

 

Oligopoly Page 125

1. Explain why prices tend to be quite stable in a non-collusive oligopoly.

A non-collusive oligopoly is when the few firms in an oligopoly do not agree upon the same price for their products. This means that each firm has to be aware of the reactions of other firms when making price decisions, since every move made by one of the rival firms, has a large affect on the demand of the other firms. This means if a firm raises its price the competitors would not raise follow. The firm whose price is now higher than the others loses market share to competitors, and faces a big decrease in quantity demanded. On the other hand, if a firm lowers its price the competitors would undercut the price, resulting in a “price-war”, which adversely affects the marginal revenue, causing losses for all firms. Firms have little incentive to higher or lower their price, which is why prices remain stable in a non-collusive oligopoly.

Demand above the current price is highly elastic, meaning that a even a small increase in price will cause a large decrease in quantity demanded. Firms in a non-collusive oligopolistic market will not want to raise price, since it will be ignored by other firms, causing a substantial decline in demand. On the other hand, demand under the current price is highly inelastic, meaning that a decrease in price will only cause a small increase in quantity demanded. This is why the demand curve is kinked, the firms, who are seeking to maximize profit, do not have incentive to change their price.

Monopolistic Competition Page 118

3. Explain whether or not a firm in monopolistic competition earning abnormal profits is productively and allocatively efficient.

Productive efficiency is the point where a firm produces at the lowers possible cost per unit (MC = AC). Allocative efficiency is the socially optimum level of output (MC = AR), where the cost to the firm equals the price which is the benefit to society. Just like a monopoly, a firm in a monopolistically competitive market will produce at the level of output where profit is maximized (MC=MR). Marginal revenue is below demand, meaning that at all levels of output (except the first unit), there is an under-location of resources. The lack of competition causes the firms to produce less than is socially optimal. Society would want more to be produced, but the firms restrict output to maximize profit. For a firm to be productively efficient, it would have to produce at the lowest average total cost. However, firms in monopolistic competition have some price making power, allowing them to produce at the profit maximization point.

For a firm in a monopolistic competitive market to earn abnormal profits its average costs must be lower than its average revenue. The firm will produce at output q to maximize profits, but will not produce at q₁ (productive efficiency) or at q₂ (allocative efficiency).