Category Archives: Supply & Demand

New Zealand vegetables prices spike in March with bad weather

Tomato, lettuce, cauliflower, cabbage, and broccoli prices rose sharply in March 2018, boosting vegetable prices 9.5 percent in the month after adjusting for typically seasonal changes.

“Vegetable crops have been affected by a run of storms in recent weeks – lower supply (supply curve to the left) due to bad weather usually means higher prices,” consumer prices manager Matthew Haigh said.

“In February, we saw rising prices for lettuce, broccoli, and cauliflower, due to a combination of humid weather and cyclone Gita. As expected, that wet weather has affected vegetable prices in March too.”

Tomatoes rose more than 60 percent in March to $4.65 a kilo. In March last year, tomatoes were 83 cents cheaper at $3.82 a kilo.

 

Wages in the English Premier League – Demand-Pull Inflation

You are no doubt are well aware of the staggering wages that the English Premier League player receive especially when you consider other occupations.

What ultimately the salary explosion has been driven by the huge amounts of money that is now at the disposable of some of the top clubs. In economics this refers to the concept of demand-pull inflation where the supply has not kept apace with the demand for world-class players. Below is graph showing both demand-pull and cost-push.

Oil price rises a sign of a healthy global economy.

Oil prices have been irregular over the last four years with the price of a barrel of oil being over $100 in 2014. This price had been suggested as the new $20 due to scarcity of oil reserves. However by 2016 the price had dropped to $28 a barrel the talk was that there was a global glut. Today the price is around $70 and analysts have been perplexed as to what is behind this increase. According to The Economist three significant questions arise:

1. Why has the oil price more than doubled in the space of two years against all expectations?

The 2016 slump in prices ($28) was in part due to the weak demand and an abundance of supply – simple economics. But demand recovered quickly and in particular the Chinese economy quickly pepped up its economy with fastest growth rates. On the supply side OPEC were able to restrict output and stocks of oil in the US started to fall. This saw D > S = P↑. Usually when there is an increase in price it attracts other sources of oil which are more expensive to extract – eg shale oil in the US and the tar sands in Canada. This is in turn will increase the supply and lower the price. But small suppliers are finding it harder to increase output as the financiers want more focus on profit rather than output. It can take months before oil actually comes on-stream.

Source: The Economist 20th January 2018

2. Why have stockmarkets been pleased with higher oil prices when it is usually associated with economic crisis?

The overall impact of higher oil prices has been to reduce aggregate demand in the global economy. With higher prices one might expect that the profits would be pumped back into the circular flow and therefore stimulating AD. However the Middle East producers tend to be big savers of oil profits at the expense of oil consumers in the West. Also countries have become less reliant on oil – demand peaked in 2005. Oil exporters depended on high oil prices to fund their government spending as well as importing consumers goods – Venezuela is a classic example of an economy that has relied on oil revenue for over 80% of government spending. Most big oil producers in the Middle East need the price of oil to be above $40 a barrel in order to cover their import bill. But a rising price of oil is usually a healthy sign that China is growing as it is the world’s biggest importer of oil.

3. What will be the ‘normal’ price of oil?

The critical change in the oil market from 30 years ago is that there is now an abundance of oil. Back then it was seen as an asset rather than a consumer good – oil in the ground was like money in the bank. But new sources of oil such as shale and tar sands have amounted to the existence of plentiful reserves. It must be added on the demand side the gaining momentum of mass-market for electric cars have reduced the demand for oil. It is being suggested that not all oil will extracted as there will not be enough demand. It makes sense that the five big producers in the Middle East – Saudi Arabia, UAE, Iran, Iraq and Kuwait – which can extract oil for under $10 a barrel, to undercut high-cost producers and capture the market share. So it is better to have money in the bank rather than in the ground. Will oil prices plunge? Unlikely especially when oil exporters are cannot sustain low prices for very long – in order to fund their expenditure they need oil prices of $60 barrel.

Source: The Economist 20th January 2018 – ‘Crude Thinking’

 

The avocado market – prices up by 143%

The current avocado market has seen the wholesale price of a box of 48 avocados increase by 143%.

US$34.45 in September 2016
US$83.75 in September 2017

The reasons can be explained by simple Supply and Demand.

Supply

There have been droughts, storms, wildfires and strikes in various growing areas including California, Chile and Mexico

California – production down 44%
Mexico – production down by 20%

This has a huge impact on supply with the supply curve shifting to the left – S1 – S2 therefore increasing scarcity and putting up the price.

Demand

Annual consumption in the US has increase from about 0.5 kg in 1989 to 3.5 kg in 2016.

In 2016 total consumption was 1.15 billion kg. Demand curve shifts to the right – D1 – D2 therefore increasing the price.

A lot of demand has been driven by trends like avocado toast and the growth of fast-casual Mexican chains like Chipotle. There has also been higher avocado consumption in China and Europe as health-conscious consumers in the world’s most populous nations show an interest in the “heart-healthy” avocados.

Airline price discrimination

Price discrimination involves charging different prices to different sets of consumers for the same good or service. So when you are on your next flight there are going to be different fares for the same class of seat whether it be in economy, business class or first class. What variables at work to bring about price discrimination in airline routes?

  • What day of the week you fly – Monday and Friday are usually peak times for business so you should find that fares are expensive. Also because it is usually for business purposes it is assumed that firms will be paying for the flights and therefore are prepared to pay more.
  • Times of the day – morning and evening tend to be more expensive as this is peak time.
  • How competitive the route is – if there is a lot of competition fares will be cheaper to the extent that there maybe predatory pricing. There is a good piece in the video showing the fares for flights from Montreal to St Johns Newfoundland. Once low cost carriers entered the market Air Canada dropped their price below cost.
  • Reputation of each airline – better reputation = higher fare

The video below is a very good especially the fare structure on the New York to Los Angeles route.

Supreme and Economics

SupremeStudents have long been talking about brands and none other than that of Supreme. Supreme was created in the 1980’s and was originally a brand which associated itself with the skateboard industry. There are currently 11 stores worldwide with three in the USA and six in Japan as well as store in Paris and London. In January this year Louis Vuitton held a fashion show featuring LV and Supreme as the two brands joined forces. Since then pop-up stores featuring the collaboration were opened on June 30, 2017 in Sydney, Seoul, Tokyo, Paris, London, Miami, and Los Angeles. It was the London pop-up that was recently the focus of an article in 1843 magazine of The Economist.

At 10am on Day One of the sale, a queue of about 600 people stretched down the Strand and along Surrey Street. Martin, Richard, Alex and Adita were all there. Running the queue for Louis Vuitton was security specialist Lex Showumni. “This is my first experience with Supreme. I was told it was going to be crazy, a lot of people pushing and shoving, but we haven’t experienced that so far.” The Supreme faithful have their own, slightly dubious, process of queue-management based on attendance and standing. It mostly works, but some people were unhappy: a trader had left the head of the queue to withdraw £12,000 from an ATM. He returned without the cash having lost his number 1 spot; eventually, after some animated discussion, he slipped back in near the front.

Each customer was admitted to the store for 15 minutes and allowed to buy six items. Successful trophy hunters included Ari Petrou, with a flipped T-shirt (around £400), that he was definitely keeping. Jeremy Wilson bagged a coveted red-logo baseball shirt (£730) that he planned to resell.

Within an hour, three main secondary exchanges had been set up outside the official store: one in the Pret A Manger, the other beneath a tree, and the third next to a municipal toilet. One dealer, who asked not to be named, explained that he had paid ten people a set fee to get early places in the queue and would give them a cut of the resale value of anything they could get their hands on. “It’s business!” he laughed. Wodges of cash were exchanged and stashed in newly acquired Louis Vuitton bags.

Invariably the hype that surrounds the pop-up store and the limited supply creates a situation where people get extremely anxious and are prepared to pay significant amounts of money for what could be classed as normal consumer goods.

There are certain economic concepts behind this.

Inelastic Demand – people who buy Supreme are are not price sensitive to purchasing items – a flipped T-shirt (around £400) seems quite excessive. A higher price has little impact on the quantity sold. In fact it maybe a Veblen Good – see below.

Limited supply – there is an artificially low supply of the product to maintain its uniqueness and ultimately it becomes very scarce. This creates excess demand which drives up the price

VeblenVeblen Goods – Conspicuous consumption was introduced by economist and sociologist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status. So-called Veblen goods (also as know as snob value goods) reverse the normal logic of economics in that the higher the price the more demand for the product – see graph.

 

Where is inflation?

Since the GFC in 2007/8 the developed economies have been awash with stimulatory forces including quantitative easing, record low interest rates and increased government spending. This has led to accelerating growth levels driven by an increase in Aggregate Demand – C+I+G+(X-M). Business and consumer confidence has also increased and this has come about by the decline in financial and economic risk.

Supply ShockSo you would assume with stronger aggregate demand that the capacity constraints in the supply of goods and services accompanied by shortages in the labour market would lead to inflationary pressure. Yet in some countries core inflation has actually fallen and this creates a dilemma for central banks as although there is growth in their economy the inflation rate is below their target band. A reason for this could the supply side shocks (Aggregate Supply to the right – see graph). The following maybe the cause:

  • Globalization keeps cheap goods and services flowing from China and other emerging markets.
  • Weaker trade unions and workers’ reduced bargaining power have flattened out the Phillips curve (see below), with low structural unemployment producing little wage inflation.
  • Oil and commodity prices are low or declining.
  • And technological innovations, starting with a new Internet revolution, are reducing the costs of goods and services.

NZ Phillips Curve

Sources: Project Syndicate, Economicsonline.co.uk

AS & A2 Revision – How PED varies along a demand curve

Been doing some more revision sessions on CIE AS economics and went through how the elasticity of demand varies along a demand curve. Notice in Case A that the fall in price from Pa to Pb causes the the total revenue to increase therefore it is elastic – the blue area (-) is less than the orange area (+). In Case B the opposite applies – as the price decreases from Pa to Pb the total revenue decreases therefore it is inelastic – the blue area (-) is greater than the orange area (+). In Case C the drop in price causes the same proportionate change in quantity demanded, therefore there is no change in total revenue – it is unitary elasticity. Remember where MR = 0 – PED = 1 on the demand curve (AR curve).

China stops subsidising farmers

In 2000 the Chinese government introduced price supports for farmers with the floors raised annually to stimulate production even when global prices fell. There were three reasons for price supports:

  1. ensure production of key commodities
  2. provide a degree of food security
  3. improve the well-being of farmers

China starts to abolish minimum prices

The last three years has seen the Chinese authorities start to abolish minimum prices for the following commodities – cotton, soybeans, corn and sugar. Without the minimum price the supply on the domestic market has dropped – grain production fell for the first time in 13 years. Remember with the minimum price being above the equilibrium it encourages producers to supply more but the demand will drop at the higher price.

When the minimum price was in operation the Chinese authorities had been stockpiling significant amounts of food and have been able to compensate for the reduction in supply from the farming community. However once these stockpiles have been diminished the only other alternative will be to import food which will be a positive for farmers from Brazil, US and Thailand. This might be sooner than later as the Chinese government is facing capacity challenges as warehouses and silos are overflowing but still China is not able to meet its domestic needs. According to the US Department of Agriculture, China is sitting on 54% of the world’s cotton stocks, 45% of the world’s corn and 22% of the world’s sugar reserves, but many analysts think that a lot of this stock is starting to perish.

Self-sufficiency in feeding the Chinese population still remains a priority for Beijing but after 2014 authorities have stated that they need to make rational use of the global agricultural market and import various food products. However China still spends a lot on supporting its agricultural sector:

2016 – $246.9 billion = 2.2% of GDP. Four times the average of OECD countries.

Although money is still spent on price supports a growing share is going into ways to improve productivity with R&D etc. China is in a position that they could revert back to the price supports if they feel the pain of reform is too great, but analysts think that they will be more accepting of global supply.

Source: China Cut Agricultural Subsidies and American Farmers Have a Lot to Gain


EU example

This policy of subsidising farmers is not unlike that of the European Union – see previous blog post ‘CAP reforms unlikely to benefit New Zealand farmers.’ – with the introduction of the Common Agricultural Policy (CAP). At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide fluctuations that often occur in the price of agricultural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

CAP Int Price1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.


 

 

 

Oil and contango

There are very high levels of oil storage at present are the main reason for oil prices to go below US$50. Why are the storage tanks so full reports The Economist?

1. OPEC’s agreement with non-members such a Russia to cut production from 1st January attracted a lot of demand to take advantage of future price increases. This did produce higher prices which win turn encourages more supply as American shall producers started to pump more oil. American oil rigs have increased in number from 386 in 2016 to 617 in 2017 producing 400,000 barrels of oil a day more than the low levels in September 2016. Much of the oil has gone into storage terminals.

2. Before OPEC cut production it increased output and exports. A lot of this oil went into storage in the USA as refineries there were down for maintenance reasons.

3. Futures prices of oil are closely related to the level of inventories. It was hoped that the OPEC cut in production would push the futures market into ‘backwardation’ – short-term prices are greater than long-term (futures) prices which means that purchasers will use the oil rather than storing it. However with the release of US storage levels the immediate price of oil fell in comparison to longer-term rates – referred to as “contango” which makes it worthwhile to buy oil and store it. It is estimate that the price of storing a barrel oil is 41 cents per month compared to contango of 65 cents for the same period. Therefore you make 24 cents on each barrel. See video below from EKTInteractive.

So the more oil stored the lower the short-term prices go – the challenge is to break the loop. Maybe oil output cuts beyond June may force some to release their inventory.

Source: The Economist 16th March 2017