SOCS0030: Introduction to Economics I

1. CORE QUESTION, PLEASE COMPLETE!

Pret À Manger’s battle with Covid

With a significant proportion of office workers switching to remote working, Pret À Manger, the fast sandwich option many of us often resorted to, has seen a dramatic shrinkage of its clientele. This exercise guides you through a simple model that can illustrate the consequences.

Throughout the exercise assume that the “fast office lunch” industry in London is competitive, where firms have access to the same technology with decreasing returns to scale throughout.

(a) (6 points) On two side-by-side graphs, plot the pre-Covid long-run equilibrium in the market for “fast office lunches”, as well as the cost curves for an individual firm in the market that determine their production. Make sure you label all the axis, curves, and points you mark.

(b) (6 points) What changes in your graphs when remote working rules come in as a result of Covid? In other words, how can you model the shock Covid brought to Pret À Manger in this framework? Feel free to add to the graph you drew in part (a), just clearly label and explain the bits relevant for this part.

(c) (6 points) What happens as a result of the shock? Describe the changes that occur to the price level, the industry- and firm-level production, and the number of firms? Make sure you detail all changes both in the short- and the long-run.

(d) (6 points) Assume now – somewhat unrealistically – that Pret À Manger uses a single input, labor, for production. Using your conclusions from part (c) and a third graph with labor on the horizontal axis and output on the vertical, explain why Pret À Manger laid off about third of its staff.

(e) (6 points) Another article in The Guardian says that, before the pandemic hit, Pret À Manger scrapped dividend payments to shareholders: it paid a dividend of about £10m both in 2018 and again in 2019, implying they made positive profits in those years. Does this mean they operated in a non-competitive industry?

2. CORE QUESTION, PLEASE COMPLETE!

Pricing and efficiency for utility companies

Suppose you own a local electricity company and assume that you have the only such a company in the area – i.e. suppose that you face no competition. You have calculated your cost curves for operating the network, and it turns out that your marginal cost curve is upward sloping throughout. You have also estimated the downward sloping demand curve for your services.

(a) (6 points) In a graph with monthly kWh of electricity on the horizontal axis and price on the vertical, illustrate the price you would charge per kWh if your aim was to maximize the overall surplus that your company provides to society.Indicate consumer and producer surplus in your graph.

(b) (6 points) Now imagine that you were not concerned about social surplus but only about your own profit. Illustrate in your graph a price that is slightly higher than the one you indicated in part (a). Would your profit at that higher price be greater or less than it was in part (a)? In other words, as a sole firm in the local industry, do you have an incentive to maximize overall surplus?

(c) (6 points) Next, suppose that you decide to charge the per-kWh price you determined in part (a) but, in addition, you want to charge a monthly “standing” fee. Thus, your customers will now pay that fee to be hooked up to the network — and then they will pay the per-kWh price for every kWh of electricity they consume. How much do you think your costumers are willing to pay a most? Will this affect the amount of electricity they will consume? Explain.

(d) (6 points) Suppose you collect the amount in standing fees that you derived in part (c). Indicate in your graph the size of consumer surplus and profit assuming you face no fixed costs for running the electricity network? Is this outcome efficient (i.e. total surplus maximizing)?

(e) (6 points) In reality, utility companies face large fixed costs (e.g. they have to set up and maintain the electricity network). Why do you think governments usually allow them to charge standing fees in addition to per-unit prices? (Hint: Think about their shut-down conditions and profits with fixed costs.)

3. (40 points) OPTIONAL QUESTION – ONLY PICK AND COMPLETE ONE OF THE TWO!

Either of these options will ask you to write a short essay of 600 words. The essay must be written in full sentences and must be well-structured: each paragraph should deal with one major issue or idea and that these ideas should be developed in a logical sequence. Please include a short introduction, which lays out your main message (ie. the question you will answer or the claim you will argue for throughout the essay). Wrap up your work with a short conclusion.

Note: This an essay. There is not a single good answer. Make sure you state any assumptions you need for your analysis and that your arguments are consistent with those assumptions.

OPTION 1: Price gouging during Covid-19

Read the article, “Disaster profiteering – Price gouging: a cautionary tale” written in The Economist.

Using a (graphical) model we learnt in class, illustrate and explain the problem described in the article, and New York City’s solution for it. Do you agree or not with this solution? If you don’t, can you suggest some better alternative?

OPTION 2: Price caps to fight inflation

Read the short article by Marton Dunai, “Hungary imposes fuel cost cap in effort to fight rising prices” in the Financial Times.

Using a (graphical) model we learnt in class, illustrate and explain the Hungarian government’s intentions with regard to capping the fuel price. Thinking about the actual price that consumer’s pay and the potential effect on consumer welfare, what are the risks of such a price cap? What data would you look at to see if the price cap fulfilled the government’s hopes or if the critiques turned out to be right? Now look at some of these data and describe what you’ve found.