Matt Nolan

Is Westpac admitting collusion

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Apologises for my long delay from the blog – I am afraid that it will continue for the next couple of weeks. I am on an economics adventure, trying to fight the beast of recession with sketchy logic and econometrics 😉

However, I had to say something about this recent Westpac article on bank funding (ht Rates Blog).

At the end Westpac says that it, and other banks, have been pricing at average cost instead of marginal cost – so they have been pricing based on the cost of credit to them, not the cost of sourcing additional credit to make loans.

Now, according to Westpac the average cost is higher than the marginal cost, and all banks have seemingly agreed to do this even though since the marginal cost of credit is below the current “price” an individual bank could “defect” and make some money. Is it me, or has Westpac blatantly admitted to collusion here?

Westpac has said that it, and other banks, have implicitly agreed to set interest rates at a higher level than marginal cost – which I presume must be closer to the collusive price than marginal cost as otherwise it wouldn’t stick.

Now I didn’t think the banks were colluding, but if Westpac is willing to go ahead and admit it then …

[Note: to be fair I think long run marginal cost, which banks would actually need to set fixed rate loans based on, will be higher than marginal cost – and this would explain much of the difference. However, this isn’t what Westpac said.  Also, I’ve ignored market power and the prevalence of fixed costs – again if they wanted to make these arguments go ahead, but do they really want to say that they used market power to keep prices above the marginal cost of credit 🙂 ]

jamesz

It’s not about the (plus) size

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Apparently American clothing stores are cutting their plus-sized clothing lines at the moment, even as the average American woman gets larger. Why? Because the mean size isn’t the important one. There’s an excellent explanation here:

…it has to the do with the fact that the distribution of weights is skewed to the right. The costs of production result in a focus toward the modal body size, not the mean or median.

Basically, it costs more to make more sizes. The manufacturer wants to make the fewest sizes to fit the most people. Lots of people fit the small sizes. Large people span a huge range of sizes, so not many will fit each big size. Hence, it’s profit maximising to produce only the smaller sizes.

Weight distribution of American women

Weight distribution of American women

Read more

goonix

In defence of the New Zealand wholesale electricity market

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Recently the New Zealand electricity sector has been taking a bit of a hammering. According to a Commerce Commission sanctioned report, consumers have been overcharged by $4.3b over a six year period (how’s that for a headline!). More specifically, the report concluded each of the four big generators – Meridian, Contact, Genesis and Mighty River – has been exercising the power the market’s design gives them to command unjustifiably high prices, at least during years when inflows to the hydro lakes are low as they were in 2001, 2003 and 2006.

New Zealand has two markets in electricity – the wholesale market and the retail market. The wholesale market is where generators sell their production to retailers (often the seller and purchaser are one and the same). These prices vary significantly depending on the conditions of that particular period (for example, how dry Southern Lakes are or whether a generation unit is out service). That’s why, as a consumer. it’s clever to be informed with details like Business Energy costs.

The second market is the retail market, where retailers sell electricity to consumers. Prices here are typically very stable, with consumers seldom exposed to the vast variation that takes place period-on-period in the wholesale market.

In the long-run, the prices in the wholesale market feed through to the retail market. In other words, if a generator/retailer found themselves short of generation and thus had to buy excess generation on the wholesale spot market at relatively high rates, they would eventually pass through these additional costs to their consumers in the retail market.

The report is essentially saying that generator/retailers were able to use their dominance in the wholesale market to push up prices during periods of constrained supply, which consumers then ultimately had to pay for in the retail market.

The report also says that pricing in the wholesale electricity market is, in the absence of dry periods, typically competitive. A very important point made in the report is that no market is ‘textbook’ perfectly competitive and this is certainly the case in electricity, given its unique characteristics (in particular the need for supply to continuously meet demand).

Indeed, I would say that the wholesale electricity market is working almost exactly as intended. Pricing is commonly competitive except at times of tight supply, when generators are able to reap higher rewards that incentivise continued investment in generation (which is extremely expensive) so that ever-growing demand can be met into the future. And the Commerce Commission determined that the generators’ actions were a “lawful and rational exploitation of the opportunities the market gave them”. I doubt you’d be able to make nearly as impressive a headline out of that though…

Matt Nolan

Low prices and anti-competitive action

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Over at Anti-Dismal, Paul Walker states the following when discussing anti-competitive action against Intel:

The whole point of market power is to raise prices, and thus profits. But how can Intel be accused of anti-competitive behavior when it was giving “hidden discounts” to computer makers? A real anti-competitive monopolist, with real market power, acting in a truly anti-competitive way, would be in a position to raise prices, not lower them.

However, they are being attacked for predatory pricing – which means the “high prices” we are discussing have to be compared to the appropriate counterfactual.

At some level prices have been falling because of improving technology – so looking at the CPI figure is not exactly what we want to do.  We want to look at what Intel is supposedly doing to cause the complaint of predatory pricing.  Now Intel is suspected of predatory pricing because it is giving kickbacks (and so effectively lower input costs) to people who use their chips.

If doing this is sufficient to prevent the entry of some competitors (because of significant fixed costs of entry – something that seems descriptive of the micro-chip industry, both from setting up factories and getting downstream firms to integrate your product), and thereby keep prices higher than they would have been in the case with competition, then it is a legitimate complaint.

Another way of viewing it is – has Intel set itself up in such a way that it credibly commits to the threat of a new entrant.  If we can make this case predatory pricing could exist.

Now I am not saying that the this is necessarily what is happening – but in a global industry with only 2 (maybe 3 😛 ) firms it is definitely worth looking into.  Personally I believe that there could be economies of scale, or that it makes sense to have a “benchmark chip” which Intel currently has patent over.  But there is a genuine case for an anti-trust case study here.

Matt Nolan

How dare they compete!

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Another article on alcohol retailing provides this “beautiful” quote (FYI this follows on from a previous post):

The end of loss-leading was welcomed by Glengarry product manager Liz Wheaden, who said the practice had the potential to lower customer expectations at the same time as it “destroys” brands.

Loss-leading made customers come to expect to be able to buy a product cheap, Ms Wheaden said.

While her company had never used loss-leading, the practice had forced Glengarry to offer more variety and improved customer service to compete.

How dare supermarkets push other retailers to cut prices, increase choice, and improve service. Have they no shame!!

goonix

Shopping for electricity – Powershop

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Recently Meridian established a new retailer in the electricity market, called Powershop. The marketing tells me that:

Powershop is a revolution in the way you buy power. We’re the world’s first online energy store, a retail outlet where electricity suppliers compete for your custom. This brings you a whole new level of choice and control over the way you shop, helping you save money and power.

Effectively you buy electricity in kWh units. You choose how many units you buy and for what period. The price of the electricity varies, depending on how you buy it. For example, if you buy a ‘bulk’ pack, you can typically get a cheaper per unit price than if you buy units in smaller bundles.

At the moment, with Southern Lakes brimming, prices are far cheaper than competing retailers. For example, the cheapest retailer that I could access in Wellington was charging 21.6 c/kWh (taking into account their discount), as well as a daily rate of around 80 c/day. Compare this to Powershop, where I have been buying electricity at around 18-19c/kWh, without any daily charge, and you can see the potential for savings.

The obvious risk from buying through Powershop is hydrological. Meridian (currently the only ‘major’ retailer on Powershop) generates the vast majority of their electricity through South Island hydro generation. If there was a dry winter, I imagine that prices over this period would be higher than that charged by a fixed-price, variable volume contract typically offered by other retailers. Thankfully Southern Lakes are brimming, so that shouldn’t be a problem…

…so long as the power can get from the South to North Island. Just this week the HVDC link that connects the islands tripped, meaning that the islands became electrically separated. As such, Meridian wouldn’t have been able to get their generation north. The threat of such an event occurring again means that Meridian will have to price this into Powershop rates.

At the very worst, if winter prices raised significantly due to hydrological/transmission problems, one can always switch back to another retailer, as Powershop has no contract term (switching costs are pretty low in my experience. I think I’ve changed retailer three times in as many years).

One nifty, if somewhat surprising, trick that I’ve been able to perform on Powershop relates to refunds. The other day I purchased a large block of electricity for just under 20 c/kWh. Later in the day I saw that the price of this unit had fallen to just over 18 c/kWh. I was able to refund the initial purchase and buy the cheaper power.

My experience with Powershop has been entirely positive and I’d recommend it if you can be bothered devoting a little time to your electricity purchasing (hell, even if you can’t be bothered with the transaction cost, you can set a default electricity product to purchase when you run out).