merger between Delta and NorthWest

Shizhi

Microsoft Bids $44.6 Billion for Yahoo

Microsoft Bids $44.6 Billion for Yahoo

By MIGUEL HELFT and ANDREW ROSS SORKIN

Published: February 1, 2008, in New York Times

SAN FRANCISCO — In a bold move to counter Google’s online pre-eminence, Microsoft said Friday that it had made an unsolicited offer to buy Yahoo for about $44.6 billion in a mix of cash and stock.

If consummated, the deal would redraw the competitive landscape in Internet consumer services, where both Microsoft and Yahoo have both struggled to compete with Google.

The offer of $31 a share represents a 62 percent premium over Yahoo’s closing stock price of $19.18 on Thursday. It would be Microsoft’s largest acquisition ever.

Microsoft said the combination of the two companies would create efficiencies that would save approximately $1 billion annually.(Comment: There are substantial economies of scale to enjoy as scale of production increases. For example, duplicate research in two companies on online research can be combined to one. As more resources are devoted to developing online search, it is likely to be of better quality and can compete with Google better.) The software giant also said that it had an integration plan to include employees of both companies and intends to offer incentives to retain Yahoo employees.

Steven A. Ballmer, the Microsoft chief executive, said that he called his Yahoo counterpart, Jerry Yang, on Thursday night to tell him that Microsoft intended to bid on the company, and that they had a substantive discussion. “I wouldn’t call it a courtesy call,” he said in an interview.

Mr. Ballmer said he had decided to pursue a takeover because friendly deal negotiations would most likely be protracted and would probably become public.

“These things are hard to keep quiet in the best of times,” he said. He said his conversation with Mr. Yang was constructive, but suggested that a deal may not come easily.

Yahoo said in a news release Friday that its board would evaluate Microsoft’s bid “carefully and promptly in the context of Yahoo’s strategic plans.”

In a letter to Yahoo’s board, Mr. Ballmer wrote that the two companies discussed a possible merger, as well as other ways to work together, in late 2006 and 2007. Mr. Ballmer said that in February 2007, Yahoo decided to end the merger discussions because its board was confident in the company’s “potential upside.”

“A year has gone by, and the competitive situation has not improved,” Mr. Ballmer wrote.

As a result, he said, “while a commercial partnership may have made sense at one time, Microsoft believes that the only alternative now is the combination of Microsoft and Yahoo that we are proposing.”

Mr. Ballmer met several times in late 2006 and 2007 with Terry S. Semel, then Yahoo’s chief executive, people involved in the talks said. While the talks — originally focused on the prospect of a merger or a joint venture — were initially constructive and appeared to move forward, they quickly broke down, these people said.

After a series of secret meetings between both sides in hotels around California and elsewhere, Mr. Semel and Yahoo’s board decided against progressing with the talks, betting that its stock would turn around as it introduced a new advertising system called Panama, these people said. Mr. Yang, in particular, was adamantly against selling the company to Microsoft and championed the view of remaining independent, they added.

Mr. Ballmer constantly consulted with Bill Gates, the Microsoft chairman, about the progress of the negotiations, people close to the company said, and when the talks collapsed, he decided to wait to see the fate of Yahoo’s stock price. As the stock continued to fall, they said, Microsoft’s management became emboldened and began internal meeting in late 2007 about the prospect of making a hostile bid.

Despite their heavy investments in online services, both Yahoo and Microsoft have watched Google extend its dominance over Internet search and the lucrative online advertising business that goes along with it.

“No one can compete with Google on their own any more,” said Jon Miller, the former chairman and chief executive of AOL. “There has to be consolidation among the major players. It has been a long time coming, and now it is here.”(comments: Big firms are more able to engage themselves in various non-price competition in their bid to secure a greater market share. The merger between Yahoo and Microsoft will enable them to increase their market power and give them some advantage in competition against Google. For example, joint advertisement by two companies will be cost-saving.)

In recent months, Yahoo has struggled to develop a plan to turn around the company under Mr. Yang, its co-founder, who was appointed chief executive amid growing shareholder dissatisfaction last June.

Yahoo investors, however, remain skeptical. The company’s shares have slumped, and the closing price on Thursday was 44 percent below its 52-week high.

Yahoo’s shares closed Friday up 48 percent, to $28.38. Microsoft’s shares were down nearly 7 percent, and Google’s shares declined nearly 9 percent.

Microsoft, like Yahoo, has faced an uphill battle against Google. The company invested heavily to build its own search engine and advertising technology. Last year, it spent $6 billion to acquire the online advertising specialist aQuantive. Microsoft’s online services unit has been growing, but remains unprofitable.

Meanwhile, Google’s share of the search market and of the overall online advertising business has continued to grow.

Announcing its quarterly earnings earlier this week, Yahoo said it would cut 1,000 jobs in an effort to refocus the company and reduce spending, and issued an outlook for 2008 that disappointed investors.

The timing of Microsoft’s bid could allow the company to mount a proxy contest for control of Yahoo’s board should it try to dismiss the offer. Microsoft has discussed the prospect of mounting such a campaign, people close to the company said, and has until March 13 to propose a slate.

In his letter to Yahoo’s board, Mr. Ballmer wrote, “Depending on the nature of your response, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo’s shareholders are provided with the opportunity to realize the value inherent in our proposal.”

On Thursday night, Yahoo announced that Mr. Semel, its nonexecutive chairman and former chief executive, was leaving the board. Under Mr. Semel, a long-time Hollywood studio executive who ran Yahoo from 2001 to 2007, the company became more focused on its advertising and media businesses, but was unable to keep up with Google’s challenge in Web search and advertising and with the rise of social networking sites such as MySpace and Facebook.

A longtime board member, Roy J. Bostock, has been named nonexecutive chairman, Yahoo said.

Microsoft said it believes the Yahoo transaction could receive the necessary regulatory approvals in time to close by the second half of this year.

Miguel Helft reported from San Francisco, and Andrew Ross Sorkin from New York.

Oil and Candy

hello,

here are 2 article reviews plus some articles that might interest you. Enjoy!

Article 1

The article talks about the rising oil prices, zooming in on Russia as a major oil producer. Through demand and supply analyses, the writer identifies a decreasing supply of oil from Russia as a major factor for the increase in prices (As when SS decreases, P increases.) From the third paragraph, “The.. fall in Russian oil output… is adding impetus to the surge in the price of oil”.

The article goes on to explain that Russia is a key oil producer in the world, producing “almost 25 per cent of this amount[non-Opec countries’ oil production of oil]”, and thus a decrease in its supply of oil will have a significant impact on world oil prices. Also, besides Russia, other non-Opec countries are also supplying less oil.

Meanwhile, demand for oil continues to rise, and the increase in demand coupled with the decrease in supply raises oil prices tremendously. Many countries, including China and Japan, are worried that the existing supply is not enough to meet their demand for oil.

Article 2




















Article 3










Article 4




















regards,
hui min

video on The Economics of Walmart

http://www.youtube.com/watch?v=yRLH9utwb3wv

Wal mart is successful mainly because of its low price and orders of sale remain large. Wal mart is trying to lower production cost by providing their employees with little benefits, eg,health care with many workers are paided at minium wage. Compare to other companies with comparatively size, Wal-Mart has a more flexible business model that is able to adapt to market conditions quickly.

However, early this year, number of consumers of Wal-mart drops as quality of products sold in Wal-mart is questioned. The change in consumer's atitude as they would rather buy products somewhere else, which may be a little bit more expensive, but the quality is much better.

Xinyi

The silent tsunami

Apr 17th 2008
From The Economist print edition

Food prices are causing misery and strife around the world. Radical solutions are needed

PICTURES of hunger usually show passive eyes and swollen bellies. The harvest fails because of war or strife; the onset of crisis is sudden and localised. Its burden falls on those already at the margin.

Today's pictures are different. “This is a silent tsunami,” says Josette Sheeran of the World Food Programme, a United Nations agency. A wave of food-price inflation is moving through the world, leaving riots and shaken governments in its wake. For the first time in 30 years, food protests are erupting in many places at once. Bangladesh is in turmoil; even China is worried. Elsewhere, the food crisis of 2008 will test the assertion of Amartya Sen, an Indian economist, that famines do not happen in democracies.

Famine traditionally means mass starvation. The measures of today's crisis are misery and malnutrition. The middle classes in poor countries are giving up health care and cutting out meat so they can eat three meals a day. (comment: Concept of price elasticity of demand can be applied here. Meat are more price elastic than basic meal -- staple food such as rice. This is because: firstly, due to nature of good, staple food such as rice is indispensable as its carbohydrates provide people with energy. Secondly, there exists substitutes for meat as a protein source, such as legumes. Thirdly, Health care and meat are normally more expensive than meals -- mainly staple food like rice, thus takes a higher proportion of income. These three factors together contribute to a lower price elasticity of demand for staple food than for meat. Assuming prices for these two food types rise by the same degree, we would expect a less decrease in quantity demanded of staple food than the one of meat. The theory here goes in accordance with the reality where the people cut on the consumption of meat rather than staple food.) The middling poor, those on $2 a day, are pulling children from school and cutting back on vegetables so they can still afford rice. Those on $1 a day are cutting back on meat, vegetables and one or two meals, so they can afford one bowl. The desperate—those on 50 cents a day—face disaster.

Roughly a billion people live on $1 a day. If, on a conservative estimate, the cost of their food rises 20% (and in some places, it has risen a lot more), 100m people could be forced back to this level, the common measure of absolute poverty. In some countries, that would undo all the gains in poverty reduction they have made during the past decade of growth. Because food markets are in turmoil, civil strife is growing; and because trade and openness itself could be undermined, the food crisis of 2008 may become a challenge to globalisation.

First find $700m

Rich countries need to take the food problems as seriously as they take the credit crunch. Already bigwigs at the World Bank and the United Nations are calling for a “new deal” for food. Their clamour is justified. But getting the right kind of help is not so easy, partly because food is not a one-solution-fits-all problem and partly because some of the help needed now risks making matters worse in the long run.

The starting-point should be that rising food prices bear more heavily on some places than others. Food exporters, and countries where farmers are self-sufficient, or net sellers, benefit. Some countries—those in West Africa which import their staples, or Bangladesh, with its huge numbers of landless labourers—risk ruin and civil strife. Because of the severity there, the first step must be to mend the holes in the world's safety net. That means financing the World Food Programme properly. The WFP is the world's largest distributor of food aid and its most important barrier between hungry people and starvation. Like a $1-a-day family in a developing country, its purchasing power has been slashed by the rising cost of grain. Merely to distribute the same amount of food as last year, the WFP needs—and should get—an extra $700m.

And because the problems in many places are not like those of a traditional famine, the WFP should be allowed to broaden what it does. At the moment, it mostly buys grain and doles it out in areas where there is little or no food. That is necessary in famine-ravaged places, but it damages local markets. In most places there are no absolute shortages and the task is to lower domestic prices without doing too much harm to farmers. That is best done by distributing cash, not food—by supporting (sometimes inventing) social-protection programmes and food-for-work schemes for the poor. (Comment: If free food is to be distributed, supply increases and price drops, which harms the farmers by reducing their revenue and profit.) The agency can help here, though the main burden—tens of billions of dollars' worth—will be borne by developing-country governments and lending institutions in the West.

Such actions are palliatives. But the food crisis of 2008 has revealed market failures at every link of the food chain. Any “new deal” ought to try to address the long-term problems that are holding poor farmers back.

Then stop the distortions

In general, governments ought to liberalise markets, not intervene in them further. Food is riddled with state intervention at every turn, from subsidies to millers for cheap bread to bribes for farmers to leave land fallow. The upshot of such quotas, subsidies and controls is to dump all the imbalances that in another business might be smoothed out through small adjustments onto the one unregulated part of the food chain: the international market.

For decades, this produced low world prices and disincentives to poor farmers. Now, the opposite is happening. As a result of yet another government distortion—this time subsidies to biofuels in the rich world—prices have gone through the roof. Governments have further exaggerated the problem by imposing export quotas and trade restrictions, raising prices again. (comment: Supply and demand analysis can be used to explain the rising price of food. Subsidies to biofuels shift the supply curve of biofuel downward and as a result more biofuels are sold -- which means more food such as corn and grain is used to make the biofuels. Assuming that the total amount of food produced remains constant, less food is available to be sold for people to eat -- the supply curve of food for eating shift upward. Export quotas and trade restrictions imposed by the government further shift the supply curve upward. Given the price inelastic nature of demand curve for food for eating, this shift in supply curve will result in a big increase in food price.) In the past, the main argument for liberalising farming was that it would raise food prices and boost returns to farmers. (Comment: Some governments may impose a price ceiling as a part of their regulation of for a stable and affordable food price. If farming is liberalized and these price ceilings removed, the equilibrium price will be reached, based on demand and supply, which may be higher than the price given by the price ceiling.) Now that prices have massively overshot, the argument stands for the opposite reason: liberalisation would reduce prices, while leaving farmers with a decent living. (comments: deregulation of food price will allow more farmers switch to produce food due to profitability. As food supply increases, its price will fall, cat eris paribus.)

There is an occasional exception to the rule that governments should keep out of agriculture. They can provide basic technology: executing capital-intensive irrigation projects too large for poor individual farmers to undertake, or paying for basic science that helps produce higher-yielding seeds. (comment: this results in an outward shift of PPC as the quality of resources increases. This is desirable, at least in the short term, as people's desires are temporarily satisfied.) But be careful. Too often—as in Europe, where superstitious distrust of genetic modification is slowing take-up of the technology—governments hinder rather than help such advances. Since the way to feed the world is not to bring more land under cultivation, but to increase yields, science is crucial.

Agriculture is now in limbo. The world of cheap food has gone. With luck and good policy, there will be a new equilibrium. The transition from one to the other is proving more costly and painful than anyone had expected. But the change is desirable, and governments should be seeking to ease the pain of transition, not to stop the process itself.

Shizhi

US economy cartoon

Source:http://www.cagle.com/news/Economy08/

The cartoon shows what are the troubles the US economy has experienced. Recession, inflation and problems faced by the Federal Reserve System (FED) (the subprime crsis) are weakening the US economy. Moreover, there are some hidden economic bubbles such as the dotcom and housing bubble, which make the situations even worse.

America's food retailers

The article is about the need for US food retailers to cut cost incurred by food wastage.

Supply-chain management

Shrink rapped

May 15th 2008 NEW YORK
From The Economist print edition

America's food retailers should wage a tougher war on waste

WALK into almost any big supermarket in America and you will find a cornucopia of food. The mountains of fresh produce on display are a testament to shoppers' desire for choice and freshness—and retailers' desire to relieve them of their dollars. But behind the mouth-watering offerings lies a distasteful reality: billions of dollars' worth of food is dumped each year because of retailers' inefficiency.

The firms are not productively efficient, causing a surplus of food.

It is difficult to gauge quite how much waste—known as “shrink” in the industry's jargon—there is. Oliver Wyman, a consulting firm, puts the figure at 8-10% of total “perishable” goods in America. The Food Marketing Institute, an industry body, says such sales totalled $196 billion in 2006. That means food worth nearly $20 billion was dumped by retailers. In a report published on May 14th, the United Nations estimated that retailers and consumers in America throw away food worth $48 billion each year, and called upon governments everywhere to halve food wastage by 2025.

With food prices soaring and consumers tightening their belts, supermarkets' margins are under pressure. On May 13th Wal-Mart, America's biggest retailer, said its first-quarter sales rose by 10%, to $94 billion, but only after it slashed grocery prices by up to 30%. Its boss gave warning of harsher times ahead. Many retailers will need to cut costs, and tackling shrink seems a good way to do so.

Perishable food is a normal good, and it is relatively income elastic as compared to imperishable food. For example, fresh pineapple is more income elastic than pineapple can. The degree of necessity for perishable food is low, so it is price elastic. Thus, it is logical to increase price to increase total revenue. The US economy is weakening, so the demand for perishable food decreased. The price of food is soaring, therefore, there will be an increase in average variable cost and marginal cost. In order to maximise profit, the price should be higher. However, the price decreases by 30%. Therefore, the retailers may operate at a max-sale level so that they can minimise wastage.

Yet some firms are coy about the issue: Whole Foods, with sales of $6.6 billion and a reputation for fresh food, says its figures on waste are “proprietary”. Others point out that not all food is dumped. Kroger, a retailer based in Ohio with sales of $70 billion, gives 3,600 tons of fresh food a year to food banks.

Laudable though this is, it raises the question of why so much food is going to waste in the first place. After all, American supermarket chains have spent the past ten years or so installing inventory-management software, cold-storage systems and other supply-chain paraphernalia. Yet their shrink rates are still twice as big as those of European retailers.

One reason for this is structural, reckons Leigh Sparks of Stirling University in Britain. Food in America travels farther, increasing the risk it will rot in transit. Another reason is that American firms are less adept at capturing and using customer data to predict demand. And many American store managers believe high shrinkage is inevitable, given their enthusiasm for huge displays and the widest possible range of produce. “This feeds a vicious circle of more and more choice,” says Matthew Isotta of Oliver Wyman. And it can backfire if displays disguise rotten food or too much choice overwhelms customers.

The article suggests reasons for high shrinkage. Firstly, it is due to the longer period of transport. The perishable food has a higher chance to rot. Secondly, maybe the market in the US is not so competitive, so they become complacent and do not want to put in much effort to do marketing research. (they think their marketing research is good enough to gain a satisfactory profit in the market) Also, the belief "high shrinkage is inevitable" makes them unwilling to improve on reducing wastage.

A few firms have made a concerted effort to reduce shrink. One is Stop & Shop/Giant-Landover, a retailer with sales of $17 billion owned by Holland's Ahold. Launched in 2006, its initiative stressed that making its supply-chain leaner would enable the chain to offer customers the freshest possible products. This helped win over internal sceptics. “It really was a huge culture-shift for our people,” says José Alvarez, the firm's boss.

Stop & Shop looked across its entire fresh-food supply chain and reduced everything from the size of suppliers' boxes to the number of products on display, which fell by almost a fifth. Last year the chain cut shrink by almost a third, saving over $50m and eliminating 36,000 tons of rotten food, while improving customer satisfaction. Other retailers would do well to follow Stop & Shop's example—or watch as shrink takes an even bigger chunk out of their profits.

One way to reduce shrinkage is do supply-chain "rationalisation", so the retailer can cut unnecessary cost in this way. The retailers must do this because their profit may decrease as the price of food may continue increasing, leading to higher cost of production.

Yuhan

article reviews

enjoy the holiday ahead:)

yuting

Article reviews

Hello:) Inspired by the econs tutorial, i did two brief follow-up article reviews on ipod and reebok. Here they are

Yuting

VBC experience

I am not altogether sure how relevant this post will be, but since VBC (Virtual Business Challenge) is a Hwa Chong- initiated entrepreneuship game that intends to simulate the real business world, I would like to talk a little bit about it. Having played both the preliminary round and semi-final round, I think there is much to be learned from the economic's point of view. The following address is the link to a VBC forum where the leading team shared their invaluable insights over maket analysis. So just in case if you are interested.

(http://www.hcine2twork.org/vbc/main.php?topic=17).Okay, back to the original topic, this is done together with my other VBC teammate. The learning points of VBC:

1. Cartel
In the preliminary round of the game, there existed a cartel that basically co-monopolised all four makets. Since free trading of technology was allowed, the cartel was working well in the sense that once one of the cartel members buys develops technology, it can share with the rest in no time, which means that the whole cartel can enjoy cutting-edge advantage in R&D while only one fifth of the money is spent (five of them took turns to buy tech in the game). So together, they were able to monopolise the market and earn supernormal profit.

However, in the game/and most probably in the real world, ideal situation never occurs. I noticed that it is usually the case when one company develops a new tech and only shared with its cartel members after it had 'owned' the market for some time. So does it violate the agreement inside the cartel? I am not sure, but you may want to dig out more from law books. (maybe?)

At the same time, the idea of cartel may not work well in all circumstances.

Firstly, there will be an optimum number of members for the cartel. That is because the more the members, the smaller market share each company is to have, as well as the less profit it is to enjoy. Also, a large cartel means that it is more difficult to oversee all its members' activities, so violating the agreement due to tempetation to earn greater maket share (by lowering its price) may be possible. That is to say, a cartel will only work well when all its members are cooperative.

2. Optimum profit
Optimum profit is not gained when you own the market, but when you achive the point where MC=MR.In VBC, we were not required to draw graphs to see where MC=MR, but rather to find an optimum point for profit from price and quantity. I am not altogether sure whether that is what happened in the real world as some companies seem wish to expand itself continously. One possible explanation is that its start-up cost is so high that it has a far-reach downward slope for its LRAC/LRMC. That is why the type of companies I mentioned just now are mainly low cost industries like fast food industry.

3. Small companies
Even though for the both rounds, the markets were monopolised quite early in the game (around one third of the total game period).

However, that does not necessarily mean the end of the game for small companies like us. Indeed, in times when the markets are monopolised, most of the companies are facing the same situation as us, so whether to win or lose largely depend on how one switches its focus.

Econs notes teaches us that in such situations, small companies need to differentiate their products so that they enjoy a niche market that few companies can compete with them. That is the same for VBC. Since the big companies have already developed various technologies, it is almost impossible for us to compete with them technologicalwise, meaning the tech we develop may not win us back enough money to compensate the amount it is paid at the first place. So what we did was to adjust promotion rate to optimum (something like differentiate product).

Xinyi

Video on Price discrimination

A really nice video for those who are stunned by the many lines in your econs notes (like me) and have no idea how to draw 1 properly from scratch... and for those who didn't pay attention in lectures (*AHEM* not like me)...

http://www.youtube.com/watch?v=4NNGP9gWnSg

And I like his demand curves, very inelastic... sorry being sarcastic...

Almost forgot, Jia Guang = DiNo$@UrKiNg... I mean, I posted this message...

Article Review - Nokia Rockets Past Rivals

Nokia Rockets Past Rivals
By Jack Ewing
Soaring sales in emerging markets and growth in high-end phones are bolstering the Finnish company's already daunting lead -- but iPhone is on its mind.

http://www.spiegel.de/international/business/0,1518,530951,00.html

NOKIA ROKETS PAST RIVALS discusses the market power and influence of Nokia as a mobile phone manufacturer, and its potential rivals.

It is inferred from Jack Ewing’s article that Nokia is considered as a monopolist since it has had 40 percent market share by 2007. This percentile even increased in the first quarter of 2008.

Furthermore, this article explains how Nokia maintains as a monopoly power through barriers to entry. It is reported that Nokia’s basic phones sell for less than $40, which other firms cannot compete with.

Mobile phone industry is the one that involves very high fixed costs. Startup expenditures such as R&D, designing and advertisement are necessary for a mobile phone producer.

When a firm expands, it will enjoy economies of scale while the fixed costs will spread over a larger quantity, leading to a lower average cost.


Since mobile phone industry involves very high setup costs, as the diagram above shown, the LRAC will continue to fall as output increased over a wide range. Nokia as the largest firm in this industry, enjoys substantial EOS and a much lower average production cost than its rivals.

In addition, greater volume creates even greater economies of scale, and generates more money to invest in research and development. It will be very difficult for competitors to manufacture as many different models of phones as cheaply and still make a profit.

Nokia is earning more and more, it has a profit of $2.68 billion in the 4th quarter of 2007. The reason is suggested by the author: the mobile-phone industry appears surprisingly impervious to global economic uncertainty.

It implies that the demand is price inelastic, Nokia can easily make a larger supernormal profit by raising the price.

However, Nokia faces a fierce challenge from Apple’s iPhone.

” The wild card in the mobile-phone industry today is the Apple iPhone, which competes with Nokia's multimedia handsets, with sales of about 4 million units so far.”

Nokia attempts to maintain its monopolistic position by launching a handset this year that uses the touch-screen technology. This is to prevent Apple to seize a large market share by its unique product iPhone.

Moreover, I personally believe that Apple is not able to undermine Nokia’s position because the iPhone only aims for high-end market, while Nokia has different models over all prices.





APPENDIX:
Nokia Rockets Past Rivals
By Jack Ewing


Nokia's market share is soaring.
Nokia extended its already formidable dominance of the global handset business on Jan. 24, announcing it had achieved 40 percent market share in the fourth quarter of 2007. But perhaps the biggest surprise was that the Finnish company achieved this long-promised and psychologically important milestone while also becoming more profitable.
Thanks to soaring sales in emerging markets, as well as growth in high-end phones, Nokia boosted profit in the fourth quarter of 2007 by 44 percent, to $2.68 billion (€1.82 billion), on sales of $23 billion. At the same time, average selling prices grew, and the operating margin on mobile phones rose to 25 percent, vs. 17.8 percent a year earlier.
It was an impressive performance that pushed up Nokia shares 12.5 percent in New York trading, to $36.48. But Nokia executives want more. "We're targeting to increase our market share in 2008," Chief Financial Officer Rick Simonson told BusinessWeek, adding, "We're going to make sure that's profitable, sustainable market-share increase." Simonson wouldn't say how much Nokia plans to lift its share of the global market.

Handset Market Stays Steady
Any increase seems like an audacious goal, but Nokia may pull it off. Rival Motorola is cratering and reported disastrous results on Jan. 23. Meanwhile, thriving competitors such as Samsung Electronics and Sony Ericsson have a way to go before they can match Nokia in emerging markets, where basic phones sell for less than $40.
At the same time, the mobile-phone industry appears surprisingly impervious to global economic uncertainty, because consumers regard phones as necessities and scrimp elsewhere if they have to buy new handsets. Mobile phone sales grew a remarkable 15.8 percent last year, to 1.15 billion units, according to market tracker ABI Research. "I don't see anything in the near future that is going to negatively affect what they're doing," says Carolina Milanesi, research vice-president at market research consultancy Gartner.
Not that other companies aren't eyeing markets in Asia, Africa, and Latin America where mobile-phone use is exploding. On Jan. 24, Sony Ericsson announced four new low-cost phones for the Indian market. But Milanesi says it will take time for competitors to build up the marketing and distribution networks they need to challenge Nokia. "It's not just about having the right products, but also making sure you have a distribution strategy to get products into the hands of customers," she says.
Success with Siemens Joint Venture
In addition, Nokia's growing market share only increases its clout. Greater volume creates even greater economies of scale, and generates more money to invest in research and development. It will be very difficult for competitors to manufacture as many different models of phones as cheaply and still make a profit. "We've shown we're the only ones who can consistently be profitable in the low end," Simonson says.
Nokia also made progress in the turnaround of Nokia Siemens Networks, its joint venture with Munich-based Siemens. In the fourth quarter, the unit, which supplies equipment for mobile networks, broke even on an operating basis and even showed a profit of $96 million on sales of $6.7 billion, not including one-time items. For the full year, NSN had an operating loss of $1.9 billion, on sales of $19.6 billion, because of charges associated with job cuts and other costs of creating the joint venture.
The one big blot on the otherwise triumphant earnings report was Nokia's performance in the US. Because of its limited portfolio of phones designed for US mobile networks, pocketbooks, and tastes, Nokia has never enjoyed the same dominance there as in the rest of the world. Sales of Nokia handsets to North America plunged 13.6 percent in the fourth quarter compared to a year earlier, to 5.1 million units.
Keeping an Eye on the iPhone
Nokia has said it plans to redouble its efforts to boost US sales, but some analysts are skeptical whether the company can succeed. "Despite repeated declarations from senior management that Nokia will recover its position in the North American market, it has so far failed to do so," ABI Research said in a note.
The wild card in the mobile-phone industry today is the Apple iPhone, which competes with Nokia's multimedia handsets. With sales of about 4 million units so far, the iPhone hasn't yet overtaken Nokia's top-of-the-line N95, which has sold more than 5.5 million units since its launch in March, 2007. Still, iPhone sales are impressive considering the product still is not available in much of the world and can cost hundreds of dollars more than an N95, depending on the operator's plan.
Nokia is clearly paying attention. It will launch a handset this year that uses some of the same touch-screen technology that has won accolades for the iPhone, Simonson said, declining to give specifics. The company is also moving aggressively into music services as a way to counter Apple's iTunes. Says Simonson of the iPhone, "There is innovation in that device and we're very respectful of that." But on Jan. 24, at least, the market showed its respect for Nokia's powerful execution.

booming art market

The following article is on the issue of booming art market and how the art collectors and savvy entrepreneurs react to it.

With record Sotheby's sale, art market keeps booming
Collectors dropped a historic $362 million at Sotheby's evening contemporary art auction this week - a sign that for dealers and gallery owners, good times are still rolling.
By Herman Wong
May 16, 2008: 6:22 PM EDT

http://money.cnn.com/2008/05/16/smbusiness/art_sales_record.fsb/index.htm

http://money.cnn.com/2008/04/15/smbusiness/singing_in_rain_art.fsb/index.htm?postversion=2008041609


(FORTUNE Small Business) -- The sky may be falling on the economy, but the art market is flying high.

Sotheby's spring contemporary art auction on Wednesday evening was the most lucrative auction in the company's history, blowing past the high end of Sotheby's estimate with sales totaling $362 million, including a record $86.3 million for a 1976 Francis Bacon triptych that had been expected to sell for about $16 million less.

Such extravagant consumption is an optimistic sign for art dealers.

Change in targeting consumers groups from mainly U.S. and Japan in late-80’s to China, the Middle East, and Russia which field wealthy collectors, all of whom enjoy the effects of weak US dollar. Focusing on the international market brings in more buyers. Another factor leads to expand of art market is because of arts fairs held overseas annually bring in new clients and high-volume sales. According to New York City gallerist Josee Bienvenu, four shows in London, Mexico City, Miami, and Basel, Switzerland have been robust and attract more art dealers and art collectors.

"The secondary art reaffirms how the art market is doing overall," said Aldo Castillo, 51, a Chicago art dealer. Sotheby's results show that art has kept its value even as times are bad, he said, with buyers likely seeing it as a better investment as the real estate and stock market suffer losses.

While the modern and contemporary art markets are prone to wide fluctuations predicated by the economy and changes in popular taste from decade to decade, one sector of the art market - ancient art or antiquities is stable. Christie’s and Sotheby’s for instance have been auctioning ancient art for well over 100 years and ancient Egyptian, Greek, and Roman art have never suffered from a sudden down turn in value. Furthermore, antiquities continue to be a veritable bargain in comparison to modern art and a much sounder investment, generally appreciating between 8% and 10% annually in value. Only recently have antiquities begun to reach the new height as a result of booming art market. Over the years one may fall out of favor in modern master but one can still purchase an Egyptian statue or a Greek vase that will never go out of style.

New York dealers - closer to the epicenter of the Wall Street meltdown - were encouraged by the record prices but struck a more cautious tone.

The good sales news is a positive turn after the collapse of investment bank Bear Stearns, which depressed some collectors' enthusiasm, says James Cohan, a New York City gallery owner.
"I would hope that it would give the modest collector confidence in the market," Cohan, 48, said.
"[The prices] seem stratospheric," Cohan said. "We're playing in numbers that are telephone numbers, and so it's sort of stops being part of our reality." Cohan, who has a diversified base of buyers that include institutions and European and Asian collectors, says he remains "cautiously optimistic" about how he'll do this year.

Josee Bienvenu, 36, of Josee Bienvenu Gallery in New York City said that the art market has grown bigger and more diverse, making it less vulnerable to the kind of crash witnessed in the late 80's and early 90's. Still, she believes that after a year of frenzied buying the market will quiet down a bit.

In the short run, increase in demand for contemporary art work causes demand curve shift upwards and increase in equilibrium price. High auctioning price leads to high profits for painters. In the long run, the lure of profits attracts new suppliers to the market. The additional suppliers expand the supply of ethanol, causing the price of art work to fall. Overproducing of artists leads to some collectors’ concern of devaluation of piecework.


"People are going to be a bit more discerning," she said.

Some art sellers simply don't understand the commotion. Seattle art dealer Greg Kucera said the New York auctions only highlight that business continues as usual. Kucera, 52, said the fascination with an impending art market crash comes from the media.

"I keep being surprised that everybody thinks this is still a big story that art is doing well," Kucera said. "I just have the sense that it's kind of the news media's attempt to predict what's going to happen, rather than report it."

Xinyi

Video: Principles of Economics

Hi,

I've stumbled upon this video on Youtube. On a more serious note, I felt that the points listed helped me recap some of the (micro)economic concepts that have been covered in our syllabus so far. If I'm not wrong, the list includes some threshold concepts as found in John Sloman's Economics (2006), like:

1) Choice and opportunity cost: We should all be familiar with this. The opportunity is the cost of doing something measured in terms of the next best alternative forgone. There are (almost) always trade-offs for any economic decision; just like in an essay, the benefits and costs have to be weighed.

2) Marginal thinking and decision-making: This involves considering the marginal benefits and costs: once again, the concept of opportunity cost comes back into play. Marginal cost and revenue help firms to determine their profit-maximing and revenue-maximising outputs.

3) Reponse to incentives: This refers to how producers and consumers respond to changes in price - firms are incentivised to produce more; consumers will buy less. This also ties in with the concepts of price, income and cross elasticity of demand and supply. Another subtopic is profit-maximisation of firms, regardless of whether they are PC firms or monopolies (yes, money does make the world go round).

4) People gain from voluntary economic interaction: Both parties stand to benefit from mutual interaction, such as that between an employer and employee (the employer/firm earns revenue while the employee earns a wage); trade betwen nations (each nation may specialise in a certain industry, or producing and exporting a particular good like agricultural products; this means that each country can attain the necessary items without having to spend a huge sum of money to produce every single item it needs). At the level of a single firm, it is somewhat analogous with the specialisation and division of labour, and how firms choose to specialise in a certain product rather than a wide range.


5) Governments can sometimes improve market outcomes: You may think along the lines of government intervention like taxes, price floors and ceilings (which are concepts discussed in the topics on price controls, as well as under the monopoly market structure).

The video is here:



Jeremy Lim
P.S. I've forgotten to add that this video is solely for your amusement and is not to be taken seriously (obviously!).

article review on "trouble in the air"

This article is on the same issue of our recent DRQ, so I think it may be interesting.

Trouble in the air
Apr 17th 2008 From The Economist print edition
The merger of Delta and Northwest is driven by fear as much as hope

DARKENING economic clouds, oil at $114 a barrel, cut-throat competition and disappearing credit lines are confronting airlines with their biggest crisis since the dark days after September 11th 2001. It is a measure of the panic sweeping the industry that Delta and Northwest said this week they would push ahead with their $3.6 billion merger to create the world's biggest airline by traffic. Previously both firms had said that gaining agreement with their 11,000 unionised pilots over pay and conditions was an essential pre-condition to the deal. Yet even though Northwest's pilots remain bitterly opposed, due mainly to unresolved seniority issues, the two airlines have decided to take the risk of a potentially long-drawn-out and fractious integration of their operations because they calculate that a merger is their best chance of survival as the industry's woes deepen.
In the past few weeks, four smaller airlines in America—Aloha, Skybus, ATA and Frontier—have filed for bankruptcy. Maxjet, an all business-class transatlantic airline, went bust in December; its rival Silverjet is desperately looking for a buyer. Oasis Hong Kong, a pioneer of low-cost long-haul services, abruptly collapsed on April 9th. Alitalia may experience a similar fate unless a takeover by Air France-KLM, sabotaged by unions and Italy's newly elected prime minister, Silvio Berlusconi, can be revived. Nothing links these airlines, which span every conceivable business model in aviation, other than their inability to cope with the brutal economics of the business, especially the near-doubling of fuel prices in the past 18 months.
Delta and Northwest are not yet in such a hole, but having only recently emerged from Chapter 11 bankruptcy protection themselves, they know that time is not on their side. After a strong recovery by America's airlines in the past few years, profitability has fallen fast this year. And balance sheets are still weak, even at the big network carriers. IATA, the international organisation that represents the industry, observed last September that American carriers were “vulnerable to shocks”—and that was when oil was at $67 a barrel and the credit crunch had yet to bite. Adding to that vulnerability is the realisation by America's airlines that there is little, if any, fat left to trim if they stay as they are. The industry has reduced its workforce by 39%, cut wages by 30% and defaulted on pensions to the tune of $20 billion.
The first paragraph briefly tells us some reasons pushig the two airlines to integrate. One is that economic recession in the US that causes decrease in demand. Competition with other airlines further decreases the quantity of air tickets sold by the two airlines. Rise in oil price increases the cost for each flight. These are some vital factors for airline as we can see from the second paragraph that four smaller airlines have filed for bankrupcy. Smaller revenue minus larger cost will definitely result in a much lower profit. The two airlines are both making losses, that's why they need to merge to reduce the cost of production in order to survive during the tough time for this industry. As setting up an airline company involves very high cost, the company usually can enjoy substantial internal economic of scale. Both airlines expand their scale of production by merging, hence their total fixed cost can be spread over a larger output to achieve cost saving. Moreover, the two airlines can save through rationalisation which reduces repetition of some operation procedure and staff. As we can see from the third paragraph that the whole industry is saving wherever it can, cutting down cost is the only solution for airlines. The first paragraph also points out the main issue needs to be settled for a successful merger is "gaining agreement with their 11,000 unionised pilots over pay and conditions".

To make matters still worse, as carriers elsewhere in the world ordered around 7,000 new, fuel-efficient aircraft in recent years, those fragile balance sheets meant that American airlines sat on their hands. Delta has 117 McDonnell Douglas MD-88s with an average age of 18 years; Northwest soldiers on with more than 90 DC-9s with an average age nudging 40 years. These planes are up to 40% thirstier than their more modern counterparts, a crippling burden given the price of fuel. They are also more difficult to maintain—as last week's grounding of American Airlines' similarly elderly MD-80s highlighted.
Delta and Northwest have little scope to cut front-line staff or replace their ageing fleets any time soon—production lines at Boeing and Airbus are fully booked until 2012. But they think they can secure cost reductions of about $1 billion a year by centralising their back-office operations and cutting management jobs. They also hope to boost revenue by combining route networks and strengthening their appeal to lucrative corporate customers.
These two paragraph explains in more detail how the rise in fuel price gives extra burden to Delta and Northwest. Delta and Northwest have aircrafts with an average age of 18 and 40 years respectively. They are much more fuel consuming than the new and fuel efficient aircrafts being used in other airlines around the world. Moreover, the two firms need to spend a lot on the maintance of these old planes. These are the two main sources of their high cost of production. As they are not able to obtain new aircrafts before 2012, they intend to increase revenue by "combining route networks and strengthening their appeal to lucrative corporate customers" in the short run. I think ordering new fuel efficient aircrafts is definitely part of their long term plan to remain competitive in this industry.

Other American network carriers are watching closely. A similar tie-up between United and Continental, the second- and fourth-biggest, is under discussion, and American, the largest carrier, waits menacingly on the sidelines. Northwest's attempt to merge with Continental was blocked in 1998, but regulatory approval is more likely this time, given the lack of route overlap between Delta and Northwest. The prospect of a union-friendly Democrat in the White House next year is a further spur to getting deals done quickly.
The assumption in the industry is that consolidation will result in stronger airlines. That is probably true, but difficulties remain. As long as the barriers to new entrants remain absurdly low, intense—even suicidal—competition will persist at home. On international routes, “open skies” liberalisation is an opportunity, but the superior financial clout and modern planes of the big European network carriers, such as Air France-KLM and Lufthansa, are a threat. For hard-pressed airline managers with the urge to merge, relief is more likely to be fleeting than permanent.
The second last paragraph states some reasons for the merger is possible to be done quickly. In the last paragraph, the author points out that merger is only a "fleeting" solution for the airlines as both domestic and international competition remain fierce. The author says that "the barriers to new entrants remain absurdly low". Barriers to entry are a combination of obstacles that deter or prevent new firms from entering a market to compete with existing firms. If the barriers are low, basically a lot of new airlines can enter the market easily. This reduces the market share of the existing airlines and makes it harder for them to survive.

video on supply and demand in video game

http://www.youtube.com/watch?v=GhGkKdmFVrY

This video uses a game to illustrate the supply and demand, as well as monopoly concept. The auction house is like a market place where you can buy and sell goods. If you own all one product, you will own the whole market, and hence you can control the price. In the video, the player buys this entire one product on the market and then resells them at a higher price. Ten minutes later, the goods are sold and he makes a profit. I think this video may appeal to video game lovers when introducing economic concepts.

video on price discrimination

http://www.youtube.com/watch?v=nsVfuIfwMqQ

I think this video is probably done by a group of students doing a project similarly to our ILP. In the video, the students act as the tickets seller and customers in a cinema. There are several examples of price discrimination such as discounts to students, children and senior citizens. The video then concludes that cinema is not doing a favor for customers, but actually making more profits by practicing price discrimination.

Now I shall explain briefly how the cinema makes more profit. This is an example of third degree price discrimination where the monopolist charges different prices for the same commodity in different markets. The market for students, children and senior citizens are relatively more price elastic than the market for working adults. Without price discrimination, the cinema would charge a uniform price across all markets which may not be affordable to students, children and seniors. By considering the different demand in different markets and setting a different price, the cinema can now supply an extra market or make this market more profitable (by the theory of elasticity of demand, the producer needs to lower price in a price elastic market in order to increase total revenue). Therefore, the cinemas seem to offer discount to consumers. However, this is just another strategy to increase their revenue.

Another cartoon

The above cartoon is a pun upon the long-run average cost curve (LRAC) of a firm.

For the region of BMI below 18.5, the person is considered underweight. The "unhealthiness" level decreases as the BMI increases (which essentially means weight increasing, considering constant height). Thus it is better for the person to gain weight - i.e. increase in size / expand waistline. This corresponds to the region left of the MES of the LRAC of a firm. Similarly to the concept of the person becoming healthier if he gains weight, the firm likewise gets to enjoy internal economies of scale as it expands its scale of production, which result in the average costs of the firm decreasing with increasing output/scale of production.

The region of BMI 18.5 to 22.9 constitutes what is considered the "healthy range" for an average Asian. As can be seen from the cartoon, in this region, the "unhealthiness" value is at its lowest, and the "unhealthiness" level remains almost constant throughout. Thus people belonging to this range all possess the same health status (assuming no other defects or conditions etc. of course) - having a BMI of say 19, is not much different from having a BMI of 22. This corresponds to the flat portion about the minimum efficient scale(MES) of a saucer-shaped LRAC of a firm. Accordingly, for firms producing in this region, whether they produce more or less makes little or no difference to the average costs incurred.

For the region of BMI above 22.9, the person is considered overweight. When the BMI of the person balloons past this point, the "unhealthiness" level increases as the BMI increases. This corresponds to the region right of the MES of the LRAC of a firm. Analogous to the above idea of the person getting more unhealthy as he gains further weight, the firm will experience substantial internal diseconomies of scale that outweigh the internal economies of scale experienced, as it further expands its scale of production, which result in the average costs of the firm increasing with increasing output/scale of production.

Thus in fact from the interesting analogy made in this cartoon, we see that firms are actually very much like humans (living organisms) - there is an optimum size for them to take on (dependent on the industry, much like the optimum weight of a person depending upon his or her height), and being too small or too big brings about disadvantages.

Zhe Wei

British Airways will ground part of its fleet over rising fuel cost

Yo people,

This article demonstrates how British Airways, a major airline especially in the European market, seeks to minimise losses when facing increasing costs.

BA has previously reported earning supernormal profits in the past year, even giving out up to 35million in bonuses to its employees. However, this is changing very soon as fuel prices rise to $120 a barrel. Industry analysts warn that this will "wipe out BA's profits" in the next two years.

In a diagram, this corresponds to an upwards shift in a MC and AC curves.

To maximise profits (or alternately, minimise costs), we predict that the company will reduce output. This is consistent with BA's announcement to ground part of its fleet, especially the older and less fuel-efficient aircraft.

From the diagram, we see that due to rising costs (from red to blue), BA has gone from experiencing supernormal profits of P1abc to subnormal profits of P2def. Profit-maximising output has decreased and prices has also gone up.

However, the article instead reports BA slashing its prices, especially in transatlantic flights. We might conjecture that this is a promotional tactic in an effort to increase demand in the short run as the airline currently faces "sluggish demand".

Besides the above strategies, BA has gone one step further in seeking a long-term solution to the rising costs. It is currently taking the lead in undertaking negotiations to create a transatlantic airline alliance with American Airlines and Continental Airlines of the USA.

While such an alliance would not be equivalent to an outright merger, it is likely to nevertheless result in mutual benefit. Reference to previous airline alliances (Air France-KLM and Delta Air Lines, the Star Alliance, Wikipedia) suggest that the proposed partnership will entail greater choice in flights available, sharing of facilities such as operational staff and combined investments and purchases. This means that the benefits enjoyed by airlines participating in an airline alliance are similar to economies of scale - by purchasing airplane fleets together, for example, they might be able to enjoy a bulk discount. This is precisely an example of marketing economies of scale.

Hence, BA's strategy to negotiate for a transatlantic alliance is easily explained by how such alliances will defray costs and hopefully even increase demand (as more choices and improved service is available to the consumer).

- yongquan (:

Let's set up a photocopying shop! Part 2

How unfortunate, but I do not seem to be making much money out of this =(

Since I've been working on the set of How the Other Half Loves, I've had little time to handle photocopying and hence can produce very low output. As a result, my share of the market supply is even lower when put next to that of the monopolist. Consumers wouldn't bother with me and would stick to the trusted monopolist. Hmm.

Obviously there is no sense in trying to compete with the monopolist head on. The monopolist has plenty of Economies of Scale which I can't compete with. A photocopying machine of that size costs thousands(my check found one for $4500), so they have the advantage of being able to use indivisible capital. They also get marketing EOS since they buy copier paper in bulk and buy toners in large quantities too, while I buy copy paper in smaller packs that are more expensive per quantity of paper and spend great amounts of money on printer ink too(feeding Brother's monopoly on ink cartridges).
Also, the monopolist is getting business sent right to their doorstep, since the teachers pass all copy orders to them, effectively setting up a great barrier of entry for me. Hm.

Ah well. I'll just have to use this weekend to think up of means to compete with them. =D

Yi Sheng

Russian energy giant Gazprom

The article talks about the Russian energy firm, Gazprom, which enjoys a monopoly position in Russia, producing 86% of the nation's natural gas. Not only has it dabbled in the energy sector, but it has also diversified into other industries, for example financial and media sectors, holding major stakes in 75 such Russian firms, even possessing its own telecommunications network. Thus it is a monopoly - not only in the energy industry, but in fact a monopoly in the Russian economy as a whole as well! Diversification is also one of the internal economies of scale. This is substantiated by the fact that the taxes it pays alone constitutes 25% of Russia's budget.

Being such a large firm, it of course does not limit its investments in Russia alone, owning energy firms and pipelines in various European countries - and 14 countries are entirely dependent upon it for their energy supply. Thus the unique nature of the energy industry allows for 'local monopolisation' despite the entire market itself possessing a oligopolistic structure (Gazprom only controls 17% of world's energy reserves). This occurence is probably due to the energy industry being a natural monopoly in those countries - especially since the markets of those countries are relatively small and high start-up costs are involved.

Thus we can see that Gazprom involves strategic national interests and thus by economic theory, the government would nationalise it, take over it and operate it. But, the scenario here is slightly different. Gazprom is seemingly puppet-owned by the government, and its near-monopoly position is in fact due to the government's deliberate actions. These included: arresting and buying out the "oligarchs" who had seized some control of the raw materials in Russia in the past (when the Soviet Union collapsed) - thus removing competitors to Gazprom, and giving Gazprom greater control over the resources in the country; and awarding Gazprom five new gas exploration concessions recently without any competition, besides forcing the Japanese, Dutch and British who had a concession to develop a gas field in Siberia to give Gazprom a 50% share in their entreprise - thus setting up high artificial barriers to entry for foreign firms trying to penetrate the Russian market and hence ensuring Gazprom's monopoly position.

Thus it seems apparent that Gazprom was made into a monopoly on purpose so as to be utilised as a tool by Russian political leaders - to not only hold control over Russia's economy and establish their power, but also as a bargaining trump card over other countries - the examples in the article being Ukraine and Georgia having their energy supplies cut off when they had disputes with Moscow. This brings the idea of the power (a.ka. evils) of a monopoly to a new level - to the extent of exerting political control over other nations. This is also an interesting scenario whereby the government of a country, instead of seeking to reduce the power of a monopoly by employing the various measures to control it, let it flourish and gain in power, and then utilise its power to exercise political clout on other countries.

Taking a bigger picture into context, we can thus understand why many countries tend to have some nationalistic protections of their economies, limiting the extent of foreign investments in the country so as to protect their national industries. As mentioned above, this is probably due to the fear of having foreign countries or firms controlling too much of their industries or even the economy, giving the foreign countries or firms some degree of influence and power in the country. Very good examples would include the furore over Temasek Holding's purchase of Thailand's largest conglomerate Shincorp in 2006, and the Indonesian court ordering Temasek to sell either its stake in Telkomsel or Indosat (subsidary units of Temasek own 40% and 35% of Telkomsel and Indosat respectively), two national telecommunications companies in Indonesia. This is especially so, given that Temasek is owned by the Singaporean government.

Zhe Wei

another cartoon

This cartoon is actually intended for the issue of privatization of the water system, but I think I can relate it to monopoly. In the cartoon, the water vending machine is the sole supplier of water. The citizen can either purchase the water from the vending machine or go back without water because he does not have other alternatives (here we assume that all public water supply is destroyed or the nearest pump so far away that it can not be considered as an alternative for the citizen). However, this monopoly is artificially formed by deceiving the consumers as the free water supply is deliberately destroyed by the monopolist who claims that “the vandals took handle”.

There are also similar cases where the monopolist remains its monopoly power through illegal method or by deceiving consumers in our life. For example, some printer companies claim that only the cartridges of the same brand can fit into the printer and those alternative cartridges which are cheaper will cause serious damage to the printer and shorten its lifespan. By such, the company becomes the sole producer of the cartridges of its own brand. It can thus charge a high price as the consumers have to constantly purchase the cartridges in order to use the printer (highly price inelastic). However, these claims are sometimes merely the strategies used by companies to maintain its monopoly power. Nowadays, some firms have developed technology to recycle used cartridges or to produce “universal cartridges” of some different brands. These cartridges will do little harm to the printers but are much cheaper. As we can see from the above example, we as consumers cannot believe whatever the producers say. We have to listen selectively and critically.

cartoon

This cartoon is lampooning how oil price has increased over three generations. As we can see, the gasoline price was only 17 cents per gallon during the grandfather’s time, and then increases to 3 dollars per gallon (near 18 times)during the father’s generation. Within a year, the price further increases to 3.72 dollars per gallon: an increase of 24% (US gasoline price on 12/5/08 from http://tonto.eia.doe.gov/oog/info/gdu/gasdiesel.asp). Thus the son deduces from this trend that when he grows up, the gasoline will not be affordable as he says, “I’m doomed to ride a bike for the rest of my life”.

Now let's review the reasons accounting to the rise in oil price which was covered in tutorial 6. Firstly, we will look at the demand factors. The demand for oil is increasing dramatically partly due to the industrialisation of emerging markets like China and India. As oil is the main energy source which currently has no close substitutes, the global economic growth is inevitably accompanied with a rise in the oil consumption. Increase in demand is also caused by speculative buying as some people want to make a profit by selling at higher price later if the oil price continues to rise, or they want to save cost concerning price will climb up.

Now we will look at the supply side. Countries producing oil are usually politically unstable like Iraq. Turbulence in Middle East may cause the production of oil to be unstable. Moreover, as the oil reserves are depleting around the world, the drills have to go deeper into the ground. This requires better equipment which means higher cost of production. Despite all these, the supply of oil actually increases in the past years. Therefore, both demand and supply curves have shifted rightward. However, oil prices increases because increase in demand is the more significant driving force.

Furthermore, the oil industry is a near monopoly market. The high set up cost, high chance of failure and geographically limited oil reserves all act as the barrier to entry. The monopolist, OPEC, has control over the supply and hence the monopoly power to set price. OPEC can deliberately hold back supply and manipulate the price. As the market is highly price inelastic, OPEC can easily increase its total revenue by increasing the price. The consumers have to accept this price or walk away without the good as there are no alternatives that they can turn to.

Below is another cartoon which seems to talk about oil price at the first glance. However, it is also illustrating inflation as the actual barrel costs 100 dollars.

Article Review on Oil Prices

Hi,
6K and Ms How. The article called “crude threat” is about the impact of the increase in oil price on the global economy. It talks about both the current condition and what will happen in the future.

Buttonwood

Crude threat

May 15th 2008
From The Economist print edition

High oil prices may yet damage the global economy

A COUPLE of years ago, those who forecast that oil would reach $100 a barrel were seen either as doomsayers or publicity-seekers. Now some are predicting $200 oil—and are taken deadly seriously.

This paragraph suggests that there is a significant change in consumers’ expectations of the price of oil. This may further encourage speculative buying, resulting in an even larger and steeper increase of oil prices.

Had economists been told that oil would barely pause at the century mark before reaching the recent peak of nearly $127, they would no doubt have forecast dire economic consequences. But the global economy, although rattled by the high price of energy, is still chugging along. Meanwhile inflation has picked up, but headline rates in most developed countries are nowhere near the levels seen in the 1970s and 1980s.

The global economy is still making slow but steady progress. Also, the problem of inflation is not as serious as compared to the 1970s and 1980s. The surging oil price seems has a less impact on the global economy than expected.

There are three explanations for the oil price's muffled impact. The first is that nowadays developed economies are more efficient in their use of energy, thanks partly to the increased importance of service industries and the diminished role of manufacturing. According to the Energy Information Administration, the energy intensity of America's GDP fell by 42% between 1980 and 2007.

Here the author starts to explain the reasons for this phenomenon. There is a shift in focus of the economy of the developed countries from manufacturing to service industries. According to U.S. Census Bureau Economic Programs, the services industries account for 55% of economic activity in the U.S. Usually, manufacturing industries requires large amount of energy per unit of output and incurs large amount of energy waste at the same time. Therefore, the demand of manufacturing for oil is very large. However, energy required is much lower for service industries. In addition, the developed countries’ method of production is better. For example, there is less wastage of energy. This is illustrated by the 42% fall in energy intensity in U.S. (Energy intensity is a measure of the energy efficiency of a nation’s economy. High energy intensities indicate a high price or cost of converting energy into GDP.) Thus, there is a decrease in demand of oil in developed countries.

A second theory is that the oil-price rise has been steady, not sudden, giving the economy time to adjust. Giovanni Serio of Goldman Sachs points out that in 1973 there was a severe supply shock because of the oil embargo, when the world had to cope with 10-15% less crude almost overnight. Not this time.

The sudden increase in oil price in 1973 is because of insufficient supply. The demand for oil is very price inelastic. This change is sudden, so the consumers will not have time to adjust. Thus, the impact on the economy is huge. This time the increase in oil-price is mainly due to the demand factor. In other words, the supply is quite stable. The demand for oil is relatively more price elastic. Therefore, the consumers will have time to adjust their consumption patterns (use less oil-consumed method of production) and find alternatives of oil. Hence, the impact on economy is less.

The third explanation turns the argument on its head; rather than oil harming the global economy, it is global expansion that is driving up the price of oil.

The most important factor is the shift in favour of the developing economies. America has responded to high prices in familiar fashion: UBS forecasts that demand will drop by 1.1% this year and will be no higher in 2009 than it was in 2004. But demand from China and other emerging markets is more than offsetting this shortfall. With supply growth sluggish, the steady increase in demand is hauling prices remorselessly higher. Alex Patelis of Merrill Lynch reckons it would take a recession in emerging markets to drive commodity prices substantially lower.

It suggests that it is the economy which affects the oil price rather than the oil price which affects the economy.

The best-known pessimist on the oil price's link with global growth is Andrew Oswald of the University of Warwick. In March 2000, at the height of the dotcom boom, he argued that the world economy would slow in response to higher oil prices just as it did in the 1970s, early 1980s and early 1990s. Although his argument was brushed aside at the time, there was indeed a slowdown in 2001 and 2002.

Even so, his argument looks harder to sustain this time, given that a fourfold increase in oil over the past five years has been accompanied by some fantastic global GDP growth. Mr Oswald says the problem is that the lags are long, with few effects seen for at least 12 months. It may take as long as two years before a big impact appears, he reckons, during which time higher oil prices will have pushed up business costs, leading to a decline in profits and an eventual rise in the rate of unemployment.

Perhaps that transmission mechanism has not worked quite so quickly during this cycle because companies have been benefiting from the productivity gains of their investments in technology and from their outsourcing to Asian economies. But those gains may be starting to run out: profit growth, as a share of American GDP, peaked over a year ago.

In the future, the world economy growth will slow down as a result of higher oil prices. Yet the impact is not observed. This is because companies are able to enjoy internal EOS (lower cost of production as a result of their investments in research and development). Also, they are making huge profits in Asian markets. However, the profit may eventually disappear, as it is not enough to offset the increase in cost of production due to increase in oil prices. Therefore, companies have to lay off workers, consequently an increase in unemployment.

Companies are now facing a squeeze. Figures from Britain this week showed that firms had pushed up their output prices by 7.5% over the previous year but this rise, while startling enough, was nowhere near sufficient to compensate them for a 23.3% gain in raw-materials prices, the biggest since 1980.

Here is an example of increase in cost. In order to maintain profit/avoid losses, the suppliers have to increase price as the cost of production increases because of the 23.3% increase in price of raw-materials.

It will be even more difficult to maintain profit margins when consumers are under pressure. Again, higher oil prices are part of the problem. Goldman Sachs reckons that some $3 trillion of wealth was transferred from oil consumers to oil producers between 2001 and 2007 and the pace of transfer is running at $1.8 trillion a year. In general, producing countries save more, and spend less, than consuming nations. At the same time, of course, falling house prices in America, Britain, Spain and Ireland threaten to make consumers feel the pinch.

Since the consumers are more affected by oil prices than producers, wealth will be transferred from consumers to producers. In addition, the consumers are also suffering from the falling house prices.

Moreover, central banks may be unable to give consumers much help. With British inflation rising faster than expected, the Bank of England may join the European Central Bank, the Bank of Japan and the Federal Reserve in keeping interest rates on hold for the foreseeable future. So far oil has been the “dog that did not bark”; but it may yet give the global economy a nasty bite.

The impact can be lessened by the central banks as they are unable to lower interest rates. The developed countries have to keep interest rates on hold because of the rising inflation rates.

Yuhan