Why are they making my beer more expensive?

Pressure from parliament has led to supermarkets finding a way to collude and increase prices for alcohol sales. That is what I read from this article in the Herald.

Of course it is being framed this way so that it sounds like a winner:

The two big supermarket chains say they have stopped selling alcohol below cost as a “loss leader”, after claims the cheap deals lead to alcohol abuse

What a load of rubbish.

As long as the tax associated with alcohol consumption represents the costs and benefits (a hard issue as has been discussed in many places) then we don’t need to fluff around with this type of rubbish – as the price would represent market competition AND the social cost, thereby implying that the choices being made are in the social interest. But instead, in order to seem hard on something people view as a vice supermarkets have been pushed into a situation where they can collude in order to increase profits.

How? Well, it is true that alcohol is being treated as a loss leader. But its effectiveness as a loss leader depends on the price charged by the other firm. Under the guise of “the social good” the supermarkets have been able to agree to both increase prices slightly – keeping the relative “loss leader” advantage while making more money off alcohol sales.

It just goes to show – when people start getting the government to pressure firms based on the arbitrary morals they want to force on society, we will end up being taken advantage of by someone. I want my cheap beer back …

UpdatePaul Walker and Brad Taylor both have good posts on the issue.  Starting from this comment Agnitio brings up interesting points regarding how to view the socially optimal price in this setting – his criticism of my view is very good, even if I don’t agree with it yet (you can tell it is a good criticism because my defence isn’t very clear – the best I can do is say that it is a transfer from producers to beer consumers, but the GE impact is foggy).

  • The government are paternalistic and it’s a demerit good. They’re just trying to do what’s best for you by restricting how much alcohol you can buy. They don’t expect you to understand but don’t worry, Uncle John’s here to tell you what’s best 😉

  • @rauparaha

    To be fair it was actually the opposition going on about restricting liquor sales – the government should have nipped it in the bud though, as they were able to give supermarkets this opportunity 🙂

  • Ah, OK. That makes more sense since Labour is far more overtly paternalistic than National.

  • @rauparaha

    Dirty old paternalism – i like the cheaper beer, it gives me consumer surplus

  • What would Hayek say

    How about a complaint to the commerce commission for collusion and cartel behaviour.

    I recall an Adam Smith quote “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Wealth of Nations Book 1, Chapter X.

  • @What would Hayek say

    Good thinking :). It can be quite difficult to prove tacit collusion – but it would be fun to see them try 🙂

    That is a good quote BTW, I’ve always had a soft spot for it

  • steve

    I agree that this could be collusion. if I had more time I would write a letter to the Commission.

    BUT, i heard Paula Bennett (I think) discussing that it is illegal for them to sell below cost, because it is illegal to encourages alcohol abuse(or something along those lines, 10 points if someone actually finds the legislation). But therefore couldn’t they still be loss leaders, but only on premium products?

    Alcolohol abusers are likely to only buy cheap alcohol, i.e. cask wine, double brown, $6 bottles etc. therefore any loss leader such as premium wines or premium beer (so long as it is more expensive than the cheapest non-loss leader) is not actually breaking this law?

    Its all well and good to stop loss leaders on low cost liquor because it encourages alcohol abuse, but please don’t stop discounting those $20 bottles of wine down to about $12 – If they stop discounting those, then it really is cartel behaviour.

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  • Just to play devil’s advocate (I’m not particularily happy about this policy either, I love cheap beer)…

    As long as the tax associated with alcohol consumption represents the costs and benefits (a hard issue as has been discussed in many places) then we don’t need to fluff around with this type of rubbish – as the price would represent market competition AND the social cost, thereby implying that the choices being made are in the social interest

    My undestanding of a loss leader is that the supermarkets are effectively cross-subsidising beer to boost their sales of other products. If the MC of a beer is $1 and the additional social cost (and thus the excise tax) is $1, we have a total social cost of $2. If the supermarkets are selling beer for $1.50 would that not lead to excessive consumption from a social standpoint? The tax may be set at the socailly optimal level but the supermarkets either absorb part of it or raise the price of other goods meaning that actual beer consumption will not reflect the social costs and benefits.

    I realise that my example is overly simplistic, had to fit this comment in while eating lunch:D

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  • Trackback didn’t seem to work. My thoughts here

  • @steve

    Indeed – if they stop discounting the premium beers I’ll be at a loss 🙂

  • @agnitio

    Interesting – so the complementarity between alcohol and other products is seeing it being sold below the full social marginal cost.

    However, complementarity states that selling more of one product increases demand for another product – it increases the marginal benefit of consuming other things (in this case because the transaction cost of purchasing would be lower once you are committed to the supermarket). I’m not sure we can ignore this persee.

    If we are going to say that beer isn’t being charged at its full social cost, we are ignoring the foregone benefit for the other good – this is an opportunity cost isn’t it. So in your case when we take this into account the effective marginal cost may only be $0.50c – and so we shouldn’t try to push up the price of alcohol.

    That is the problem with trying to evaluate welfare in a partial equilibrium framework – we miss inter-relationships like this. That would be the way I would see it.

  • @Brad Taylor

    Thanks Brad, interesting

  • @Matt Nolan

    I think the complicated thing here is exactly what type of complimentarity we are talking about. Are we talking about beer sales increasing the demand for other products on an aggregate level (I certainly eat more pizza/corn chips/junk when I’ve been drinking!), i.e an actual complimentraity between two products. In this case it may be optimal to subsidise beer as you point out.

    Or the complimentarity that supermarkets observe on a individual level in that if you are get ppl too buy beer from you, you get all the other pruchases they were going to make anyways. In other words pricing beer cheaply doesn’t actually increase demand for some goods, it just reallocates it between firms (business stealing vs market exapnsion). In this case beer is being subsidised to increase the supermarket’s residual demand curve for other products without neccesarily increasing market demand for thsoe products. Here it may not be socially optimal to subsidise beer (even though it is privately optimal for the firm to do so).

    Obviously there will be elements of both effects going on which would make it an extermely complicated welfare analysis, certainly too much for me to do while eating this muffin:D

    Is this policy effective from today? might have to stock up on some cheap beer if it isn’t too late:D

  • @agnitio

    Indeed. So you are saying that firms are facing a “prisoner’s dilemma” situation where they over compete on the price of beer given its ability to increase firm level demand for other products.

    But I just don’t know if we can take the single firm private marginal cost of production for that product and say that if they are selling it for below that it is suboptimal – as the single product supply curve has to include “opportunity cost”, and if we don’t include that we don’t really have the marginal cost. In other words, the appropriate relative price does depend on the goods interaction with other goods doesn’t it.

    Note that in this case the prisoner’s dilemma ensure that firm profit is lower – they sell beer for less and don’t make anything extra in the other markets. So beer prices are definitely lower than they would be in the collusive case. But if we are taxing all externalities it could still be welfare optimal.

  • I’m not saying we should ignore the “opportunity cost”, more just that the prisoners dilema may be enough to lead to P<MSC (which includes the operational cost of production, opportunity cost related to demand complimentarity and the “social cost” of drinking) given that firms also take into account a busniess stealing effect (which leads to a prisoner’s dilemma).

    It’s definitely privately optimal for them to get out of this prisoner’s dilema, there is no doubt about that. I’m just interested in the idea that this collusion may be actually be socially optimal.

    Privately it definitely isn’t optimal for me 🙁

  • @agnitio

    Not optimal for me either 🙂

    My only issue is that if we have a prisoner’s dilemma there must be market power and profit taking – that is why we have a loss leader situation in the first place.

    So it comes down to exactly what we think is going on. I agree that a loss leader situation leads to a lower price – and therefore higher consumption. But if we had, say, a linear externality, then the tax captures the full social non-private cost of alcohol consumption.

    So this just leaves us with the fact that when the tax is removed they are selling it below marginal cost because of competition. As the price of other goods remain unchanged, this implies to me that the entire surplus from this consumption is going to alcohol consumers – and it is coming from supermarket owners. Which essentially makes this a transfer – the super-normal profits from selling other goods are being transfered to people who buy alcohol as a result of the loss-leader policy. Without providing weights I don’t know how to evaluate the welfare implication of that.

  • Nice post, Matt. The point I make here is basically about collusion,

    “But under the Commerce Act collusion is illegal. What are the Commerce Commission going to do about this? If Matt, and the rest of us, want our cheap beer back, then a complaint to the Commerce Commission seems in order.”

  • @Paul Walker

    Indeed. The only problem is it is tacit collusion that is supported by politicians – that is a notoriously difficult thing to move.

    I think I will have to do some field research on the price of beer this weekend to figure out what is going on 😉

  • maybe the supermarkets should file an authorisation if they think the social benefits of raising alocohol prices outwiegh the negative effects of collusion:D

  • @agnitio

    Why would that be in the supermarkets interest? It is in their private interest to collude afterall. Or does file an authorisation mean something different than I’m picking it up as?

  • An authorisation is basically getting the CC to sign off on something that is anticompetitive but has net public benefits.

    That’s what they were going to do to create Fonterra before the government passed special legislation. Another merger example would be when Whakapappa and Turoa ski fields merged.

  • Is this really a case of collusion, though? I thought there had to be intent in order to count as collusion, and there’s no evidence of that. It may result in the same outcome as collusion, but I doubt that makes it illegal. agnitio???

  • @rauparaha

    I thought tacit collusion was still illegal …

  • But it wouldn’t be tacit collusion: that’s just where they don’t explicitly agree to collude. It’d be an outcome like collusion that they didn’t collude to get to.

  • @rauparaha

    Huh? Are we talking about them both increasing prices based on government pressure.

    I would term that tacit collusion – I would say that the government pressure provided a focal point (or more likely reduced the chance they would get in trouble for collusion) and so led to them moving for the collusive outcome.

  • I totally agree that it might move them to the collusive outcome. But if there’s no intent to behave in an anti-competitive fashion then is it collusion?

  • @rauparaha

    Yes. Even if it is just an implicit movement that they do because “it works good” it is still anti-competitive. It can be anti-competitive even if they don’t realise it – for sure.

  • Interesting. I’m surprised that it is an offence with strict liability, though: it just seems too serious for that at first glance.

  • @rauparaha

    Sorry I don’t think I quite followed you here as I can be a bit slow at times 🙂 .

    I don’t think we can prove intent – so we couldn’t fine the supermarkets for tacit collusion in this case. However, the CC could become involved in working on the market structure as a result of the tacit collusion methinks.

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