Alcohol unit pricing, cobweb theory and a return to Giffen curves

Alcohol unit pricing

Boozy evenings out are about to get more expensive

In last month’s Budget, George Osborne, The Chancellor, announced that unit pricing of alcohol would be introduced in the UK.

This was warmly welcomed by the Home Secretary, Theresa May, assorted senior police officers, hospital A&E nurses of whom my younger daughter is one, and anyone else whose life is made a misery by living in town with lively pubs on Friday and Saturday evenings.

I was interested in the views expressed by a large number of well-intentioned people that it was high time for action on excessive drinking. But who, I wondered, had been reading my blog entry of 20 March 2010? Initially, it was almost entirely ignored, but, three years later, it became as popular as the leading blog entry, The Original Shaggy Dog Story.

The blog in question had the catchy title of Giffen Curves and Cider.

Recently, I’ve been asked to explain again to several of my readers what a Giffen curve is, and why these curves are important in assessing the impact of health policies which seek to limit excessive drinking by putting up the price.

A Victorian economist, Sir Robert Giffen, noticed in 1850 that, as the price of potatoes went up during the famines in Ireland,  so the poorest citizens bought more potatoes rather than fewer. They did this because potatoes were their diet staple. Meat, fruit and vegetables were luxuries which they could no longer afford as the Potato Famine drove the price of edible potatoes higher. Eventually, all their money went on buying rotting potatoes.

Irish Potato Famine

Irish Potato Famine, Skibbereen 1847

Consequently, a Giffen graph would show a demand curve for potatoes rising as the price of potatoes rose, which is not normally the case. A notable exception is that of luxury goods, but these are not matters of life and death, and so are not comparable.

Giffen’s Irish observation might also apply to heavy drinkers who are dependent upon alcohol, many of whom are in poor health, possibly living on social payments. Scotland, in particular, has large numbers of these people. It is likely that they too will now start to reduce their intake of solid foods in order to afford the  more expensive beers and ciders, whose price has been pushed up by alcohol unit pricing. Consequently, unit pricing would actually damage their health.

As it turns out, cheap beers and cider will be disproportionately affected. Here’s the BBC’s estimate of the impact:

  • A £2.99 bottle of red wine, containing 9.4 units of alcohol, would be priced up to £3.76
  • Cheap, strong lager at 75p a can, with three units per can, would become at least £1.20
  • Bulk-bought strong cider, costing 87p a can and containing four units, would almost double to at least £1.60
  • Cheap supermarket whisky at £16.10, with 40 units of alcohol, would probably be unchanged in price

So, in answer to the questions I’ve been asked, here are the answers:

Q. Do Giffen Curves apply to luxury goods, too?

A. No. Rich people do not start concentrating expenditure solely on luxury items when the going gets tough. They simply limit themselves to a new Porsche once a year rather than every six months.

Q. But rich people want to buy expensive toys and holidays, and pricing is therefore deliberately set high to attract them.

A. There is quite a difference between price and value. In the case of the Irish potato famine the value of a sound potato was so high that the starving Irish had no choice. They had to concentrate all their expenditure on spuds. It was literally a life and death situation. The pricing of luxury goods is not comparable. The high price is actually partly intended to deter potential purchasers. If we all drove a Porsche, nobody would want them, so their value would be low.

Q. Are Giffen Curves linked to Cobweb Theory?

Divergent cobweb

Supply and demand diverging from equilibrium.

Yes, they are. Cobweb Theory explains why agricultural prices fluctuate. If potatoes are scarce in Year 1, farmers will plant disproportionately more potatoes for Year 2, because the scarcity had pushed up potato prices. However, this might then, in Year 2, cause a glut, with a resultant price collapse. So, the farmers will then plant fewer spuds in Year 3, and the price then goes up again. This is dynamic disequilibrium, frequently seen in the global wine market. In the Irish case, potato blight caused several famines which kept the price of potatoes high.

Q. Why is it called Cobweb Theory?

A. The dynamic disequilibrium produces a supply and demand graph which looks like a spider’s web. Even economists enjoy a chuckle. Incidentally, one of the objectives of the EU’s agricultural policy is to stop dynamic disequilibrium, just as England’s Potato Board tries to do here.

New prices

Likely prices once alcohol unit pricing is fully implemented

Q. What’s a unit of alcohol?

A. Ten millilitres. Beer with 3.5% ABV contains two and a half units. Stronger beer contains four or more. Cheaper alcoholic drinks’ prices will be disproportionately increased.

Q. Where did you learn about Giffen Curves and Cobweb Theory? I’ve never heard of either.

A. They were part of my A Level syllabus. It also helped that my grandfather owned a farm.

If any reader has a point of view about the issues raised in this blog, I’d love to hear from you, please. If you want to know more about the Irish Potato Famine of 1845-1852, Tim Robinson’s three books about Connemara are a fertile source of information. They’re published by Penguin Ireland, and are available from Amazon.

One more thing: I still don’t know why my earlier blog, Giffen Curves and Cider, suddenly became popular, but I like to think that they all work in HM Treasury.