A shift in the supply curve

Supermarkets in the UK are abandoning reliance on the price mechanism alone and have introduced rationing of lettuce. This is very unusual in the market economy, which can usually be relied upon to provide the goods and services you want at the prices you expect.

The reason for this move is the sudden fall in supply caused by poor weather conditions in Spain (a condition of supply). The graph below shows how this has affected the market.

The bad weather has called a fall in supply and so the market supply curve has shifted from S1 to S2. This has led to a rise in price from 40p to 1.40 as the market no clears at the point where the demand and supply curves cross.

Because lettuce is a primary product demand is inelastic (not very responsive) and the result is a very large rise in price following the reduction in supply. 

The UK supermarkets are now rationing lettuce to avoid even higher price rises. The shortage of lettuce is leading to panic buying. Consumers see lettuce and buy more than they need just in case there are none the next time they shop. This pushes the demand curve, D, to the right, forcing the market equilibrium even higher.

The actions of the supermarkets may seem unnecessary, but they are reacting based on their knowledge of consumer behaviour and market forces.

The Daily Mail covers the story here

This story has a lot of terms Year 11 will not currently understand, but they will soon. It has been written is an accessible way rather than a technical way. It is equally useful for IB and VCE students as it is about the basic market mechanism. IB students might search for similar stories from other sources in case they feel it is an IA candidate.

Negative gearing - does it lower rents?

'Negative gearing' is a scheme in Australia where a landlord can make a loss renting out a property and set that loss against their other income so that they pay less tax. For example a landlord collects $100 a month less than the cost of a properties mortgage and expenses. The landlord earns $100 a month from other work, but pays no tax on that income in compensation for the loss. Only three countries in the world allow this and Australia is one of them.

The 'tax incentive' allows people who buy property as an investment to earn higher profits from that investment in the long term. It is widely criticized as causing a less equal distribution of income as the benefits go to those who can afford to own more than one property. There are a substantial number of investors who own multiple rental properties.

Those who defend the use of negative gearing claim that it helps lowers rents for those who cannot afford to buy their own home. This is because it allows landlords to rent at a loss.

The economics of this can be explained using demand and supply.

 

Figure 1

Figure 1 shows that as the cost of buying a rental property is now lower, the supply curve of rental homes shifts to the right (S to S1). The market equilibrium rental price falls from 0P0 to 0P1, while Q1 - Q0 more homes are rented out at the new market rent, P1. It seems that renters share in the good fortune of the tax break given to investors.

The problem is this isn't really all that happens. It is a complex situation and we will focus just on the housing market. The fact that landlords can now recoup part of their loss on an investment means they can afford to pay more for any given property. This raises the demand for housing and, given that the stock of homes is very limited (inelastic supply), we can expect this to drive up the price of homes. Figure 2 shows how the effective subsidy for landlords shifts the demand for homes from D1 to D2, that leads to a rise in the price of homes to 0P1 from 0P0. The inelastic nature of house supply means that the price rise might be quite significant compared to the demand shift.

 

Figure 2

The result of this rise in the price of buying a new home means that landlords costs are higher than they would otherwise be, wiping out at least part of the gains from Figure 1 (S1 does not shift as far to the right). Further the higher price of buying a home means more families have to rent as they cannot afford to buy. So the demand for rented accommodation in Figure 1 shifts to the right, resulting in higher rents.

It is therefore not at all clear that negative gearing helps renters. It certainly reduces the tax bill of landlords however and that makes it difficult for weak politicians to tackle the problem. There is no doubt in my mind that negative gearing represents an unjustified transfer from taxpayers generally to landlords and helps skew the distribution of income towards the higher income deciles of Australian society.

The ABC explain why the scrapping of negative gearing wont push rents up and some of the history of the tax concession in the article below.

The ABC article is here

This article is relevant to VCE students for Unit 4, budgetary policy and for the goal of equity of income distribution. It is relevant to VCE and IB students as an application of supply and demand analysis using elasticity and an example of government failure in their intervention in a market.

The market for foreign students

Australia likes to sell its education services to other countries. The fees they pay help to cover the costs of staff salaries, fund new facilities and research. For Australia the fees represent exports and so help maintain the external balance.

In recent years there has been a sharp drop in the number of foreign students attending Australian Universities and in 2011 this caused Monash to reduce staffing by 400 posts.

Now things are improving with a rise in applications for student visa's. There are a number of factors that have caused this, and The Guardian article gives most of them and backs them up with some useful data.

For Year 12 students this would be a good exercise in applying supply and demand analysis, Year 11 students will need to wait a little but can come back to it in around week 6. Year 12 students can also ponder if there is sufficient information in the article to apply any concepts of elasticity of demand to the situation.

I will say no more for now, but will return to this article in a few weeks to provide some analysis.

The Guardian article is here