ALCOHOLIC BEVERAGES’ MARKET
The consumers of alcohol respond to changes in prices of alcohol just any other commodity, such that an increase in price of alcohol generates a corresponding decrease in quantity demanded for alcohol (Baumol & Blinder, 2012). This is important for the policy makers who wish to curb alcohol consumption because it guides policy direction or effective policy measures to be taken to curb alcohol abuse (excessive consumption). An important aspect of the demand for alcohol to the policy makers is that an increase in alcohol prices leads to a decrease in alcohol-related harms such as chronic health conditions including liver cirrhosis mortality.
Based on this knowledge regarding demand for alcohol, policy makers are then in a better position to choose whether to implement alcohol taxation, a minimum price per unit of alcohol (price floors), ban on sale below cost of alcohol, or even establishing alcohol monopolies.
The market structure for a given product shapes the way in which suppliers of the product respond to price changes and adjust their output. Research evidence shows that industry/market structure of alcoholic beverages is oligopolistic in nature. This follows from the four/five firm concentration ratio whose rule of thumb provides that any industry with over 40% market share is considered an oligopoly while less than 40% is monopolistic competition (Tucker, 2011). Based on this rule, the industry for alcoholic beverages is oligopolistic since in 2004, research in the UK established that five businesses owned almost 70% market share in terms of goods produced measured as gross value added.
The oligopoly market structure lies between competitive industries (characterized with many sellers), and the monopolies (characterized by one seller). Oligopoly market structure has a few large sellers dealing with either homogenous or differentiated, highly substitutable products (Baumol & Blinder, 2012). The actions and decisions of an oligopoly firm depend heavily on what the rival firms do in response. The fact that the industry for alcoholic beverages is oligopolistic in nature implies that it takes a large change in price to cause a small change in output. Economies of scale are the major reason explaining why some markets do not have more firms involved. This simply means that some industries have high fixed costs hence may only have enough demand capable of sustaining a relatively small number of firms. It follows therefore that if a policy option induces any cost increase, it will be met with producers’ effort to try and recoup their economies of scale.
Individual firms in alcoholic beverages industry thus have two major options as strategies to help them get ahead in this oligopolistic market structure. These include: non-price competition and acquisition of other firms. Firms can implement these strategies either separately or combined hence avoid potential losses or maintain the same prices after introduction of a pricing policy (either ban on sales below cost or price floor) (Hall & Lieberman, 2010).
The non-price competition strategy involves advertising, product differentiation, and creating barriers to entry as competition activities, none of which relates to adjusting prices to sell more products. Advertising activity is where producer and retailers in oligopoly industry make use of media outlets to communicate value of their products to both existing and potential consumers. Product differentiation is where producers make their products unique through quality (Hall & Lieberman, 2010). Barriers to entry involve activities that make it difficult for new entrants. For example, alcohol producers can take advantage of limited shelf space to initiate contracts with retailers which leave so little shelf space with a deliberate intention to make it unprofitable for another producer to enter the market.
The second strategy through which firms in oligopolistic industry can compete is through acquisition of firms. This strategy allows producers to and retailers to either integrate vertically or horizontally, or merge with other businesses. This is especially the case when producers find it optimal to engage with other businesses instead of diversifying their operations.
In order to explain how individual producers in this industry might be affected by the price floor implemented in Scotland, it is assumed that the industry is initially operating efficiently as indicated in figure 1 below, such that equilibrium is established at the point of intersection of the supply and demand curve. The Supply Curve is also the same as the Marginal Social Cost (MSC) while the Demand curve is also same as the Marginal Social Benefit (MSB). In this scenario, MSC= MSB implying that the total surplus representing the sum of consumer surplus and producer surplus is maximized at PEQE. This market is free from government interference.
Consumer S= MSC
Figure 1: Original equilibrium when markets are operating efficiently.
If however the Scottish government intervenes in the alcohol market and sets a price floor (minimum price – Pmin) of 50p per unit of alcohol, which is higher than the original market equilibrium Price, the effect on individual producers will be that they will face a lower level of quantity demanded of alcohol Q1. At the same time, the producers will have a surplus supply of alcohol resulting from a fall in quantity demanded.
Q1 QE Q2 Quantity
Figure 2: Showing market situation in which government has imposed minimum price for alcoholic drink.
Figure 2 above shows that the government is able to achieve the intended policy outcome (which is to reduce alcohol consumption) using minimum pricing policy. The resulting surplus production is represented by Q1Q2. The introduction of price floor by the Scottish government has the effect to refrain firms (individual producers) from limiting the ability of new entrants into market. In other words, the price floor may lead to increased competition. In circumstances where the impact of price floor is to cause major brands to compete with value (or own-) brands or increase their price, the value brands may end up losing shelf space as retailers may decide to focus on branded products which sell better than value products at the same price.
In circumstances where an increase in price generates small reductions in alcohol supply, greater profits are likely to accrue especially because the increase in price is greater than the resulting decline in output. The small reduction in alcohol supply is due to fact that fewer people may be willing and able to buy at the increased prices. However, the bargaining power of retailers will determine who between the producers and the retailers will enjoy the increased profits (Hall & Lieberman, 2010). If bargaining power of retailers is weak, then producers will be in a position to increase their prices to retailers and benefit from the increased profits. If on the other hand, the bargaining power of retailers is strong, retailers will demand the same price from producers and keep the increased profits.
The reason why policy makers have opted for a price floor over a tax on alcohol is because of the differences in policy outcomes when each of the two policy measures is considered separately (Hall & Lieberman, 2010). Taxation policy has the ability to produce the same impact and desired outcome by government which is to control the production and the consumption of alcohol in the same way the price floor policy did. When a tax is imposed on alcohol production (i.e. on the producers), it increases the price of the consumer hence leads to a decrease in quantity demanded of alcohol. If the tax is imposed on alcohol buyers, it will result into a reduction in demand and cause a fall in quantity supplied too.
Taxes usually affect all drinkers of alcohol. Therefore, taxation has been considered by some economic analysts as being ‘blunt instrument’ which targets all alcohol consumers instead of targeting only those consumers who cause harms. Taxes are usually passed to all drinkers who may choose to pursue one of these three options: either pay more to consume the same amount, reduce the amount they drink, or substitute for cheaper beverages or other products (Hall & Lieberman, 2010)
Minimum pricing on the other hand has the ability to circumvent the retailers’ ability to absorb price increases. It means therefore that introduction of minimum pricing policy will cause the price of all alcohol being sold below the minimum price per unit to go up (Hall & Lieberman, 2010). The price effect of the minimum pricing policy tends to be relatively stronger for alcohol that is low-cost. Consequently, this policy has significant implications for those people in the low income groups and the young and hazardous/harmful drinkers since they are the more likely to buy cheaper drinks. It is for this reason that policy makers have decided to go for minimum pricing policy despite the fact that the tax policy would have helped government to obtain additional revenues from tax increases depending on the level of price increase and price elasticity of demand.
Baumol, W. J., & Blinder, A. S., 2012. Macroeconomics: Principles & policy. Mason, OH: South Western, Cengage Learning.
Hall, R. E., & Lieberman, M., 2010. Microeconomics: Principles and applications. Mason, OH: South-Western, Cengage Learning.
Tucker, I. B., 2011. Microeconomics for today. Mason, OH: SouthWestern.