Friday 27 August 2010

Minimum alcohol pricing and economic rents

I'd noted yesterday that it's likely that the rents from minimum pricing get eroded unless there's some other imperfection in the system. Let's walk through it now.

If you want to work out who profits by minimum pricing, you have to figure out whether there's an asset in fixed supply in the system. Suppose we had a completely free market in alcohol in all respects but one: a minimum retail price of $1 per standard drink. And suppose further that the cost to the consumer for low end product, absent the rule, could be as low as $0.50.

In that world, do the alcohol producers get to pocket $0.50 per standard drink? Unlikely. They're still having to compete with each other for customers. Now, if there are some who actually prefer bad alcohol at high prices to good alcohol at high prices, like the perverts I see around here who will take instant coffee over espresso when both are free, then there could be some rents to producers. But even in that case they'd be competing on other margins as well: product packaging or other ancillary bundled goods, for example. Didn't one of the "ready to drink" brands have a promotion a while back putting $20 notes into random cases of product? Is it possible to ban every potential tweak on that model?

Do the shoppes get to pocket $0.50 per standard drink? No. They're not going to be buying much product at $0.50 per standard drink that they'd then get to on-sell at $1 per standard drink because they're competing with other shoppes. That competition means that product actually worth $1 per standard drink will wind up retailing at about $1 per standard drink, and the low quality product will be driven from the market. In the alternative case of the folks with perverse preferences preferring the cheaper products, the stores will compete for those folks' custom through more advertising, better facilities, lower margin on complementary goods and so on. And if they don't, some other shoppe that does will enter the market and do well.

So in the world where there's only minimum price regulation and the market is otherwise competitive, I have a hard time seeing big rents to anybody. Costs get bid up instead. But we're not in that world in one critical way that's set to become more important: restrictions on who can sell alcohol. All signs point to a bunch of local retailers being expropriated by the state without compensation as licences fail to be renewed. That makes the surviving retailers local monopolists with some pricing power. The producers again don't get the rents - they're competing with each other for space in the shoppes. But the remaining licence holders can earn rents, presuming that the drop-off in demand is more than offset by the revenue increase - likely, as the price elasticity of demand is -0.42 or so. That will bid up the value of those shoppes that get to keep their licences, presuming that the license transfers with the sale of the shoppe. Basically, an oligopoly model with competitive fringe will apply: the supermarket duopoly (Liquorland owned by Foodstuffs, if you recall) constrained by fringe internet and remaining small shoppes for wine and beer; the big liquor outlets constrained by fringe remaining small shoppes and internet for liquor. Small liquor shoppes keeping their licences will be taking some local monopoly locational rents limited by their customers' access to transportation or the internet.

A couple of predictions then:
  • It isn't going to be the big guys who lose their licences. Foodstuffs and Progressive are well organized and I'm sure have lobbyists. The little immigrant-owned liquor shoppes in South Auckland - they're set for the chop. And there might be some weirdo hits to the big guys in small towns that have had dry-county leanings for some time.
  • The value of the licences increases, so minimum price regulation pushes up the price of shares in Foodstuffs and Progressive as they own a lot of licences.

I've not adjusted my portfolio (University Superfund plus iPredict) as result of these predictions, so don't take them as stock advice.


  1. I've wondered if, as a student, I might benefit from more expensive alcohol if skews the sex ratio in favour of females at social events and venues. I am not sure about the relevant elasticities but one thing I am sure of is the effect on budget constraints (that is relatively unimportant to me personally). It is true that these affect males and females alike, however the budget constraints of females can shift outwards with in-kind transfers.

  2. Hmm, I'm not sure I follow all the technical terms, but I have a feeling this has something to do with why I like my daughters to take their own alcohol to parties.

  3. @Henry: I'm not sure what the mechanism is that you're proposing here. That women are more likely to go out if the men are more likely to be sober? Or that buying a girl a drink will somehow be more effective towards other ends?

  4. Males would buy fewer drinks for females under a minimum price regime. Therefore, females should have more appreciation for the drinks that are bought for them. Males are worse off overall, but the costs are mostly borne by those who currently spend most of their discretionary income on cheap drinks (a group I do not fall into).

  5. @Henry: I think you need to formalize that model a bit more to see the assumptions on which it's hinging. If appreciation is a function of spending, you're requiring some form of quality-blindness as folks could always spend more now, right? And, of course, it's never quite been clear that buying drinks is all that effective a strategy. At least according to Roissy anyway.