Problem Focused Exercise: rain affects play?
1
The Scenario
The brewery industry in the UK had poor sales in the summer of 2007. This exercise
explores why, using economic analysis. It considers how the forces towards an
equilibrium price may affect a firm.
Task 1
Read the extract below and then answer the following questions:
(a) What was the factor affecting the brewery’s UK demand highlighted in the
article?
(b) The article does not say what happened to the price of beer during the
summer of 2007. What would you expect and why? In answering this question
draw an appropriate diagram to show how economics models such changes
and use this to consider the effect on the price.
(c) What would your expectations be for profits in this period and how does this fit
with the ‘profits warning’ from Scottish and Newcastle? The article talks of a
profits warning. What would you expect to happen to the share price? Try to
be precise in your arguments.
feedback page 3
Rain affects play
Based on: S&N is caught on hop by bad summer, The Telegraph, 8th
August 2007 and Scottish & Newcastle Interim Results, Released 7th
August 2007
The brewers of Foster's and
Kronenbourg, Scottish &
Newcastle, became the latest
company to warn that the
terrible British summer weather
could hit profits. Their
interim results released on 7th
August 2007 warned that the
company had ‘experienced
significant difficulties in two
of our three key summer trading
months’. The cold and rainy
weather meant drinkers stayed
away from pubs in June, with
the British beer market
shrinking by 17% – at a time
when usually such sales are
expected to rise. Given the
continuance of the poor weather
in July the company announced
it would find it "very
challenging" to meet this
year's sales targets.
(Historical note: Scottish & Newcastle Plc was acquired by a
consortium of Carlsberg and Heineken on 29th April 2008.)
Copyright: Embedding Threshold Concepts Project
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.
Problem Focused Exercise: rain affects play?
2
Task 2
The economic model suggests a change in price will occur.
(a) What happens if Scottish and Newcastle do not change their price? Show
this on a diagram (assuming for the moment that other breweries do not
change their prices either).
(b) All UK breweries were affected by the same factor in Task 1(a). How would
Scottish and Newcastle be affected if they kept their price the same, but
some of the other breweries did change their price?
(c) Why is the economic concept of equilibrium important in the analysis in both
tasks 1 and 2?
feedback page 5
Copyright: Embedding Threshold Concepts Project
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.
Problem Focused Exercise: rain affects play?
3
Feedback Task 1
(a) The demand curve for Scottish &Newcastle products has not shifted right as
would be expected with a
good summer. Worse, it has shifted left due to the
poor weather Britain suffered over the summer of 2007!
(b) What model/diagram do we use?
The bad weather affected all breweries, so we consider the market for beer, using
the model of demand and supply. Since the article is concerned with the
immediate effect of the bad summer, the short run, the supply curve is assumed to
be upward sloping, indicating less will be supplied by firms and prices will fall.
(The numbers in the diagram are only for illustration).
Price
Supply
X
£2.00
Y
£1.80
Demand
normal summer
(New Equilibrium
Price)
Demand
rainy summer
Quantity
90
100
First we decide on what has shifted: the demand and/or supply curves. Here it is
demand that is initially affected and the demand curve shifts to the left by the
amount shown by the arrows on the diagram.
Then we consider how the equilibrium has changed. The reduced demand puts
pressure on price to fall to stop sales declining too far. This means that we move
from equilibrium at X to the one at Y (which means that supply has also changed,
but because of a movement along this curve).
We then consider what this new equilibrium means in terms of price and quantity by
considering the movement on the axis: Here this means that we are no longer at the
initial equilibrium with a price of £2.00 and a quantity of 100. There is a new
equilibrium at a price of £1.80 and sales of 90.
Copyright: Embedding Threshold Concepts Project
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.
Problem Focused Exercise: rain affects play?
4
(c) What are profits?
Profits are equal to price multiplied by quantity sold.
What happens to profits in this case?
Since both the price and quantity have fallen we can safely expect profits to fall.
What effect would this have on share prices?
We would expect a fall in profits to lead to a fall in the share price, as this should
reflect the value of the firm. However, share prices are trickier to predict because
of the timing of announcements. By the time of the article in the Telegraph, investors
may have already seen that it was a poor summer, realised what this was likely to do
to profits and so some may have already sold their shares. Indeed, share prices
actually rose slightly on the day of this announcement – things were not quite as
bad as investors expected!
Copyright: Embedding Threshold Concepts Project
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.
Problem Focused Exercise: rain affects play?
5
Feedback Task 2
a)
Price
Supply
£2.00
Z
X
Y
£1.80
Demand
normal summer
(New Equilibrium
Price)
Demand
rainy summer
Quantity
75
90
100
What happens if Scottish & Newcastle and other breweries do not reduce their price?
We need to look at the diagram: The shift in the demand curve is the same, shown
by the large arrows, but price remains the same at £2.00. We move from point X to
Z.
We then consider what this means in terms of price and quantity by considering the
movement on the axis: This means the fall in quantity is larger than in task 1(a) – to
75, compared to 90. Prices are not adjusted downwards to the new equilibrium, so
more sales are lost.
(b) If Scottish and Newcastle kept their price the same, but some of the other
breweries change their price, the reduction in Scottish & Newcastle’s demand and
hence their decrease in sales would be larger. It is important for many firms to
consider what their rivals may do to prices.
(c) There are always pressures on companies to change their prices when they are
not at equilibrium to try and gain sales and restore profits at the expense of their
rivals. Scottish & Newcastle need to recognise the pressure on other companies
who are also losing sales – if some of them reduce their prices then Scottish &
Newcastle will be in a very difficult position if they do not reduce theirs – some
customers will desert them for the better value elsewhere as we considered in (b)
above (technically we would say that demand was elastic in this situation). This
increases the pressure on Scottish & Newcastle to reduce their prices towards
equilibrium, because of the otherwise possibly large decrease in sales (and profits).
Copyright: Embedding Threshold Concepts Project
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.
Problem Focused Exercise: rain affects play?
Reflection
1.
Did you indicate the quantities and prices on the
axis in your diagram? Why is this important?
2.
Did you understand why in task 2(a) we used nearly
the same diagram as in task 1(a)?
3.
Do you appreciate that there are strong forces
pushing prices towards equilibrium (including in this
example FEAR of what their competitors do may
do)?
Copyright: Embedding Threshold Concepts Project
6
Yes
Partly No
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.
Problem Focused Exercise: rain affects play?
7
Notes for lecturers
Objectives of the exercise and prerequisites
This exercise presents a scenario students may have heard/read about in the
media and may be particularly useful for business/business economics
students.
Learning Focus: Understanding the economic modelling of market changes
using demand and supply analysis. The concept of equilibrium and the
importance of this in analysing what happens in disequilibrium are stressed.
The role of profits in the price mechanism is introduced.
The Threshold Concepts that are pivotal to this learning are incentives and
the modelling concept of equilibrium. The role of expectations in economics
is introduced.
Prior Knowledge Required
Students need to have had a short introduction to demand and supply
analysis.
Sequencing and timing
1.
Task 1 asks students to read the extract and then answer three questions.
The task can be carried out on an individual basis but students may
benefit from working in groups. Students can be asked to give a
presentation of their findings to encourage participation (this can be
certain selected groups rather than all, in order to fit the time
scheduling).
2.
It is possible to set task 1 without task 2.
3.
The complete exercise is likely to take 20-30 minutes, without any group
presentations.
Copyright: Embedding Threshold Concepts Project
05/02/09
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for Employment and
Learning (DEL) under the Fund for the Development of Teaching and Learning.