What is a cartel? (5 marks)
The companies in a market might collude to set the prices by making explicit or implicit agreements between them on the market price, sharing the market geographically, or controlling the quantity supplied in the market. The agreement between the companies in a specific market might create an oligopoly behaving like a monopoly. The companies might set the price, and all the agreement partners might obey the agreement. If the companies can create a large market power, they might behave like one monopolist. Cartel is the situation of existence of an explicit or implicit agreement between the companies in a market to control the produced quantity or the market price (Harrington, 2016).
The companies make an agreement on setting a price, sharing the market geographically, or controlling the quantity supplied by each company. The main goal of making an agreement for the companies is to be able to influence the market price in order to increase their profits. As known, if there exists a market type in real life close to the perfect competition market type, all the companies receive fair profit through selling their products at the market price. The perfect competition provides good conditions for everybody in the market equally because all the information is available for everybody, and there is freedom of entering the market and exiting the market. The companies want to develop an advantage over the agents in the economy, and the easiest way to do this is to hide information by using the financial, political, and advanced technological power. If the companies have enough power, they can hide some information from the other agents, and they can create a high-level of power to influence the market price. If the oligopolistic companies can have this power, they can set the price at a level where they can maximize their profit (Harrington, 2016).
The companies can manage to control the market price by dividing the market into several geographically and economically separated sub-regions. They share the sub-regions among the oligopolistic companies, and they implement similar pricing strategies. The oligopolistic market sharing behaviour might be broken through arbitrage between the sub-regions. Therefore, it is important for the companies to create barriers for preventing the arbitrage. The companies might use high-technology to hide information from the other agents. Many people cannot follow the high-technology information; therefore, the companies might use the advantage of the mixture of the individuals with the different levels of high-technology knowledge. The market can be segmented into the social groups or the income groups. Even, one company can market the same product or service at different prices to the people.
Another important way of an agreement is to control the quantity produced in the economy. The companies might influence the price by controlling the quantity produced in the economy. To cope with the rivals, they might increase the quantity in large amounts, and decrease the price to a very low level, or they can decrease the production to increase the price, and force the people to purchase it at a high-price level. These companies spend the effort to develop loyalty among the customers to their products, and even it is possible to observe that some companies include ingredients to develop an addiction. Increasing addiction attitude among the customers might assist the company to improve the loyalty to the product relatively easier.
Using economic theory (a diagram), explain how a cartel sets profit maximising price and output. (15 marks)
Graph 1: Demand and Supply in a Cartel Market
The graph above explains how the cartel market appears. It looks like a monopoly market. As known, in the perfect competition markets, the demand becomes parallel to the quantity axis in the long term, and anyone who is willing to sell the product in the market, he can sell it at the market price level. In simple words, the customers become very sensitive to the changes in the market price. If there is an uncompetitive power in the market, the demand becomes negatively sloped in the long term. In another word, it means that the customers' sensitivity to the changes in the market price decreases, and the companies might be able to create pressure on the customers by changing the quantity or the price in the market. The cartel agreement partners might have the power to shift the supply curve by changing the quantity produced in the economy. The companies might decrease the production to increase the price, and if the customers are relatively less sensitive to the changes in the price, and then the companies might succeed this relatively easier. The companies might implement killing price for pushing the other companies not engaged in the cartel agreement by increasing the quantity produced.
Another way of intervening the customers’ decisions, the cartel agreement partners might try to increase the addiction to their products among the customers. For being able to do this, the companies try to increase the slope of the demand. The only way they can do this is to make the people believe that they need these products. This is called as improving loyalty among the customers in the science of business. The companies use many different ways including advertising and including addiction-creating ingredients in their products. The main aim is to make the customers feel that they need the product. When they can do this, the market demand becomes relatively steeper, and the customers' reaction to the changes in the price becomes relatively less.
Consequently, the cartel companies try to create barriers for the other companies not engaging in the cartel agreement and develop loyalty among their customers to their products.
Relating to your answer in part (b):
What is meant by competition policy and why is it necessary in a market economy? What was the outcome of the Competition and Markets Authority’s investigation into price fixing by hotels? (10 marks)
The competition policy is the set of rules aiming at protecting the competition in the market. Some powers, like the cartel case, might break the price competition in the market, and that might cause an imperfect competition market like oligopoly or monopoly. The imperfect competition causes inefficient use of the resources, and the resource would be wasted due to the advertising, and other promotion activities. Also, some companies might increase their profits by doing marketing activities not related to the efforts for increasing the quality of the products or decreasing the production costs. Subsequently, the customers cannot have the best products in the market, and they might need to pay high-prices for the low-quality products.
In the case of the Hotels, the hotels, by fixing the price, they do not spend the effort to increase the quality of services, and the lack of competition allows them to behave freely in the market. Consequently, the market for hotels cannot give the desired quality in the market. On the other side, the customers have to pay a high-level of rate for staying in regular rooms. That might decrease the demand for the rooms in the country, and the tourism industry might be damaged because of the uncompetitive market structure.
The hotels might receive high profits unfairly in the accommodation sector, and these hotels might increase their market power in time. Subsequently, they might develop an oligopolistic structure in the market. The uncompetitive market type might cause inefficiencies in the market, and the tourism industry might receive negative influence from the inefficient market type. Considering that there are many other sub-industries involving the tourism industry such as food business, agriculture, entertainment business. The authority responsible for protecting the competition in the markets monitors the behaviours of the companies. They are responsible for protecting the efficient use of the resources. They can intervene the markets through implementing legal procedures about the companies. In the hotel case, the authority is suspicious about the pricing strategy of the hotels. The similar pricing strategies implemented by the different hotels indicate that there is an agreement between the hotels.
Explain why cartels have a tendency to break down. Suggest one significant characteristic of the demand for hotel rooms that makes this more likely in this case. (15 marks)
There are two agents in the hotel case of fixing the rates for the rooms: tourism agents, and hotels. Most of the hotel room bookings are completed through the tourism agents. Therefore, if the hotel owners and the tourism agents have the power of fixing the prices in the market.
The tourism agents are the intermediates between the hotels and the customers. The customers can book hotel by only looking at some photos of the hotels and reserve the room in the tourism agents’ offices, or on the online site of the tourism agents. Therefore, the information provided by the tourism agents plays an essential role in the decision-making process of the visitors.
On the other side, the tourism agents provide information about the visitors to the hotels, and they have the ability to lead the visitors to some hotels. Therefore, the tourism agents play a key role in the customer-hotel relation. The main characteristic of the tourism agent is to be an intermediating institution in the tourism industry. Considering that the tourism agents can sell tourism packs including hotel, food, museum visits, etc., they have the power to manipulate the visitors and the touristic business owners.
The hotels provide the accommodation for the visitors, and the most of the demand for their rooms come from the tourism agents. The hotels are interested in increasing their prices while keeping the same amount of rooms reserved. Therefore, they might develop tendency to increase the prices by making deals with the tourism agents. Sometimes, decreasing the number of rooms rented a little, they might receive relatively more benefit.
The customers are the ones who are influenced directly from the cartel agreements. The cartel agreements are difficult to observe by the customers, and they cannot intervene the mechanism. Therefore, they receive the prices given.
On a chart, show what has happened to the UK pound (sterling) against the US dollar between July 2015 and February 2016. (5 marks)
Graph 2: Euro to British Pound Average Annual Exchange Rate from 1999 to 2015
The graph above indicates that the Sterling has lost value after 2007 to 2009 sharply against the Euro. Similarly, Sterling has lost value against the other national currencies. The reasons behind the fall of Sterling are the followings: 1-The sharp decreases in the interest rates in the UK, 2-The decreases in the house values, 3-The balance of payments has a deficit, 4-The Euro is getting relatively stronger against the other national currencies, and that is creating a pressure on the other currencies, 5-The Central Bank of UK prints electronic money, and that increases the monetary risk, and 6-The risk of quitting the European Union is essential factor (Pettinger, 2008).
Graph 3: Change in the Sterling from 2007 to 2009
The graph above indicates that the Sterling index has lost value sharply after 2007. The risks explained above are the main reasons behind the fall of Sterling.
Using economic theory (diagrams), explain this change in the sterling exchange rate.
(15 marks)
The fall of Sterling can be explained through the demand and supply of money, and risk level of the economy. The UK has experienced bad times after the global financial crisis, and the value of the imports increased while the exports were decreasing. Also, the domestic demand inside the country has fallen. Therefore, the demand for the money has decreased for the money parallel to the decrease in the domestic demand for the goods and services. The decrease in the demand for houses causes a less demand for the credits. Also, considering that the demand for the houses is another essential fact. The demand for the credits mainly depends on the demand for the houses.
On the other side, for stimulating the economy, the Central Bank has implemented an expansionary monetary policy by increasing the amount of the electronic money. However, the demand for Sterling was low, and the extra supply of Sterling has created relatively more pressure on the interest rates (Pettinger, 2008).
Graph 4: Money Demand and Money Supply
The graph above indicates how the money supply and the money demand mechanism works. The money supply is negatively sloped because the demand is a negative relation between the quantity and the interest rate. The money supply is a vertical line because the money supply is determined by the Central Bank, and no other factors can intervene the money printing. When the domestic demand decreases and the demand for money decreases, and the demand shifts to the left as shown in the graph. On the other side, the expansionary monetary policy shifts the money supply to the right. Therefore, the equilibrium moves from E1 to E2, and from E2 to E3. As can be followed from the graph, the interest rate decreases while the quantity of money expands (Arup, 2010).
Considering that the UK economy still could not recover from the negative influences of the global financial crisis, the demand will not increase in the short run. Especially, if the citizens of the UK decide to leave the European Union, the risk level of the British Economy might increase. The increasing risk in the economy might cause a loss of trust among the agents in the economy, and the demand might decrease more. Taking that the rivals of the British producers in the international markets have relatively more advantages regarding low labour costs like China and other Asian countries, the deficit in the international trade might increase as well. Taking all these factors into consideration, the British Economy management might have more difficult times relatively to stimulate the domestic demand, and recover from the crisis in the short and middle run (Henderson, 2015).
Use a simple numerical example to explain why a depreciation of the pound is of benefit to the UK hotel industry. (5 marks)
Assume that 1 Sterling equals to 1 USD, and assume that Sterling is losing value against the USD, and 1 Sterling equals to 0.80 USD. That means Sterling lost 20% value against the dollar. Or 1 USD equals to 1.25 Sterling. Consider that an American is visiting the UK. Let us say that one room rate is 100 Sterling at the beginning which equals to 100 USD at the beginning. After the loss of value, the room rate is still 100 Sterling, but it is only 80 USD. Therefore, the room rate is comparatively cheaper for the American citizens or for everybody who earns in USD. The decrease in the price for the people who earns in USD increases their demand for the rooms in the UK. The domestic demand does not change on the other side. However, if the room rates are relatively lower in the other countries because of decreasing inflation in the other countries, the demand might not increase so much in the UK. Therefore, the inflation rates in the different countries are important. If the inflation rate is higher in the other countries while the UK inflation is stable, Sterling might gain more value compared to the other currencies, and the demand for the hotels from the foreigners decreases. We need to consider how the inflation rate can change in the national economies. For increasing the inflation rate, the domestic demand plus the international demand for the national products need to increase, and that means a recovery. Therefore, if the UK can stimulate its economy, and then the inflation rate will increase in the UK, and the businesses selling products and services to the foreigners will benefit more from the situation.
Explain what is meant by a recession, and using economic theory (diagrams), explain the causes and consequences of the UK’s 2008-09 recession. (20 marks)
The recession has started on January 23, 2008, in the UK. The first symptom was the decreasing demand and the bankruptcy of the large financial institutions in the countries under the UK. Similar to the US, the UK government has started implementing a bail-out strategy for saving the large institutions in the country. If the large companies would shut down, then the unemployment rate could raise quickly, and the social problems and the loss of trust against the management of economy could create a relatively worse situation. However, in the following month, February 2008, has been the month the unemployment has risen rapidly. The companies did not shut down, but they were forced to cut working hours. The Central Bank decreased the interest rate to create a stimulation in the economy; however, there was not enough demand for the money and the credits. In March 2008, the growth statistics indicated that the British Economy shrunk by 1.9%. The unemployment continued raising up to 2.2 million people. In June and July 2008, the rising in the industrial production was a good sign for the recovery. The economists expressed their expectations by explaining a W-shaped development; down-up-down-up. The developments in the following months until the end of the year showed us that the UK Economy could not recover from the crisis. The economy was shrinking while the unemployment was increasing (Wearden, 2009).
The crisis started in the mortgage market in the UK similar to the US Economy. The people could not afford the repayments, and they lost their houses. The crisis expanded to the financial institutions, and the people lost their jobs. The income level decreased in the economy, and the domestic demand and the foreigner demand, export, decreased. Subsequently, the crisis deepened and deepened.
Graph 5: Aggregate Demand and Aggregate Supply
As can be seen in the graph above, the aggregate demand decreased. The aggregate demand includes the domestic demand and the exports. The decrease in the demand caused a decrease in the production. The aggregate supply at the new equilibrium is relatively more sensitive to the prices because the economy produces less than its full potential. Thus, the production becomes very sensitive to the changes in the price, and the low domestic demand, and the low exports could not increase the inflation, and the prices did not go up. As a result of this, the producing companies started decreasing their production levels, and that caused an increase in the unemployment. The increasing unemployment caused more decrease in the individuals income, and this crisis cycle deepened the crisis worse (Arup, 2010).
Use economic analysis to explain why the hotel industry would be particularly badly affected by a recession, for example in comparison with the food industry. (10 marks)
The hotel industry is mainly dependent on the demand of the foreigners for the rooms. The sharp decrease in the domestic demand and the demands of the foreigner due to the crushing developed economies caused a crisis in the hotel industry. The decreasing demand spread to the production in all countries, and the individual income decreased for many people.
The hotel serves the rooms for rental, and the elasticity of the demand is comparatively higher. For instance, the food sector was influenced less negatively from the crisis because the price elasticity of the food is comparatively lower. Even though, the individual income decreases, people have to purchase food for surviving. Therefore, the demand for the hotel rooms decreased more compared to the demand for foods. If the demand’s price elasticity is higher, then the customer might decrease the demand relatively easier. The hotel rooms were less important for the people who were losing their income.
References
Arup, C. (2010). The Global Financial Crisis: Learning from Regulatory and Governance Studies. Law & Policy, 32(3), pp.363-381.
Harrington, J. (2016). Detecting Cartels. [online] John Hopkins University. Available at: http://krieger2.jhu.edu/economics/wp-content/uploads/pdf/papers/wp526harrington.pdf [Accessed 17 Jun. 2016].
Henderson, E. (2015). Quasi-Nationalisation in the UK Banking Crisis: A Problematic Policy Option. Financial Accountability & Management, 31(4), pp.463-481.
Pettinger, T. (2008). Reasons for Falling Value of Pound Sterling | Economics Help. [online] Economicshelp.org. Available at: http://www.economicshelp.org/blog/135/economics/falling-value-of-pound-sterling/ [Accessed 17 Jun. 2016].
Wearden, G. (2009). Timeline: UK recession. [online] the Guardian. Available at: https://www.theguardian.com/business/2009/oct/23/uk-recession-timeline [Accessed 17 Jun. 2016].
