Nov

9

Food inflation and supermarket silliness

November 9, 2009 | 5 Comments | Stephen King

You have to love the silliness that surrounds supermarkets in Australia. The current silliness relates to food price rises. According to Frank Zumbo the supermarket “duopoly” is responsible for Australia’s food price inflation rate being higher than the Britain over a ten year period (even though the Australian rate was less than the British rate over the last five years). Even the Minister, Dr Emerson (PhD in economics) seems to have jumped on the bandwagon although other reported comments are more measured. Graeme Samuel has noted that other factors may be relevant, but it is much easier to bash the duopolists.

So let’s ask if the argument makes sense even if there is a competitive problem with the supermarket sector.

Suppose that Coles and Woolworths are supermarket duopolists that dominate the Australian food market. Indeed, let’s suppose that they fully exploit their market power and have been charging monopoly prices to consumers for the last decade. Then this effective monopoly CANNOT be responsible for Australia’s higher rate of inflation in grocery prices. The reason is simple. A monopoly sets a higher price than a highly competitive industry. But the price the monopoly sets for consumers is less volatile as underlying costs change than the price charged by a highly competitive industry.  Thus, if marginal costs double in a highly competitive industry, we would expect to see the consumer price to double. But the same doubling of marginal costs in a monopoly industry will lead to a lower price rise. As a rule of thumb (based on linear demand and constant marginal cost) the monopoly price rise will be about half the highly competitive industry price rise.

So if the OECD numbers quoted in the articles are correct and we assume that all else is equal, then the higher rate of food price inflation in Australia is evidence that our supermarket industry may be more competitive than Britain not less competitive. The problem is that the commentators confuse levels with changes. Monopolist’s charge higher prices but these prices change relatively less as costs change over time.

Now, I am not claiming that our supermarkets are more or less competitive than those in Britain. I have no idea. What I am pointing out is that the people arguing that a higher rate of price change reflects less competition are, at best, confused.

So, what could explain the differing rates of food price inflation. Well – lots of things, some of which Samuel points out. Of course, it could be the case that our supermarkets have become a lot less competitive in the last ten years – that would explain the higher rate of price rise relative to Britain. Of course, this interpretation would mean that our supermarkets had become a lot more competitive in the last five years, to explain the lower rate of price rise. Or it could be the case that our supermarkets have been uncompetitive for the past decade, but were just stupid ten years ago and set food prices too low. Prices rose because the supermarkets stopped being stupid.

Hmmmm. I think the argument that it is something else rather than the “evil duopoly” is more likely.


Comments

5 Responses to “Food inflation and supermarket silliness”

  1. Matt C on November 9th, 2009 10:49 pm

    What about our quarantine restrictions?

  2. Magic G on November 10th, 2009 12:14 am

    Yes, and independents are even more expensive than woolies and coles.
    However, I thought that supermarkets intentionally vary their prices as a method of market differentiation.  If I really want a product this week, I’ll buy it even if it’s quite expensive.  If I don’t need it and I’m price sensitive, I’ll wait till it’s on sale.  It’s the monopolist’s dream to be able to charge a different price to each customer.

  3. Andre Sammartino on November 10th, 2009 9:15 am

    But were is the claim of ‘price volatility’ in the OECD numbers or the surrounding analysis?  Are you suggesting that monopolists are so information-rich regarding the future that they can set prices once a decade and just sit back and rake in the rents?
    Might the impact of virtual duopolist in the supermarket retailing domain be reduced incentive to supply?
    Put simply, with less scope to win shelfspace, and with a genuine fear that said retailers will squeeze margins at will, shouldn’t we expect to see less potential suppliers than in a more diverse retail domain (such as the UK, US etc)?
    With less suppliers how are any smaller/new retailers to compete on price?
     

  4. Dave on November 10th, 2009 9:39 am

    Hmm.  I thought the standard oligopoly theory was that the mark-up on marginal cost was equal to the HHI divided by the demand elasticity.  So, with constant elasticity and HHI, price inflation should match cost inflation, whatever the industry concentration.
    In assuming linear demand, you are assuming that elasticity rises as prices rise and so are assuming your answer.  If you assumed falling elasticity, you will get the opposite answer.

  5. Charles Camenzuli on November 14th, 2009 12:25 am

    SORRY BUT YOUR ARTICAL IS A WHOLE LOT OF GOBBLY GOOK.

    THE CURRENT DUOPOLY IS KILLING OFF OUR SMALLER STORES AND THEN LEAVING THE MARKET TO THE DUOPOLY TO CUT UP AND CHARGE AS THEY WISH. REFER TOTHE SSRA EXAMPLE BETWEEN FAIRFIELD AND GREYSTANES, THEY UNDERCUT THE LOCAL STIORE UNTIL THEY CLOSE DOWN AN THEN OVERCHRGE IN SOME EXAMPLE AT 143%.
    GROW UP AN DSTOP APOLIGISING FOR THE BIG TWO. BRING IN GEOGRAPHIC PRICE DISCRIMINATION.

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