I would start by defining / describing the concepts of supply and demand and how they determine an equilibrium price in theory. The simplest model would see supply increasing linearly, and demand decreasing linearly, with the price being where they intersect. Factors influencing where these curves lie include cost of production, transportation, value / perceived value in use vs exchange (Smith's diamonds and water paradox), perishability of the item, etc. Classical economic theory would say that an increase in demand produces a new demand curve with an increase equilibrium price, while an increase in supply produces a new curve with a lower price. Low supply coupled with high demand leads to high prices, whether it be the artificially high price of diamonds produced by monopolistic behaviour, or a result of genuine scarcity, like the astonishing record set in 2019 of $343,000 for a standard-size bottle of Japanese whisky (
https://www.forbes.com/sites/george...iants-a-rivalry-of-price-quality-and-success/). This is a model, however, and reality may not fit with models, due to factors not included in the model or due to its underlying assumptions. More advanced models take into account the price elasticity of supply and demand. For example, for some essential products demand does not change very much with price. An example would be electricity where prices have increased massively over the last decade but demand has not fallen by nearly as much. If the price of water suddenly doubled overnight, that would not change our need for water and hence demand would not halve. Supply can also have elasticity.
There are plenty of examples that can be drawn from recent Australian / world history, and I would choose ones that illustrate different aspects of the models in operation and ways in which external factors lead them to break down. From the top of my head:
- Price changes in fruit and vegetables in response to weather events (drought, destruction of crops by plagues of insects - the Irish potato blight of the 1840s being a classic example, both of the operation of the market without restraint / regulation and the long-term response by introducing government regulation). Crops destroyed, supply drops, prices rise, leading to altered consumer behaviour and price drops, etc.
- Trend in increasing housing prices and how the limited / fixed supply of land / property in the most desirable parts of major cities has led to a boom in house prices, fed in part by government actions. First home owners grant, for example, was meant to increase affordability for new entrants to the market but taxation policy / negative gearing fuels investment by landlords fueling increasing demand.
- The recent coronavirus pandemic offers several examples:
- Oil prices have fallen massively due to decreased demand (especially with the airlines not needing much fuel (in relative terms)). The price even went negative briefly as the cost of storage was so high in the face of a glut in supply and reduced demand. OPEC decisions to reduce supply in order to force up the price have a lagging effect as cuts in production can't be done easily and politics between countries and national interest means that the idea of rational actors leading producers to act in their own interests and that supporting the collective interest is flawed.
- We had a recent massive spike in demand for toilet paper, following on from panic buying. Prices did not spike, however, despite that being the rational response of retailers. Profiteering by raising prices would have done considerable reputational damage, so there was a self-interest motivation to not increase prices. Regulations would also have limited the ability to alter prices. The massive increase in demand led to increased production and thus to an increase in supply, as the model would predict, but this was actually at increased cost for suppliers. Manufacturers increased production by increasing operations to 24/7, which increased their costs as labour is more expensive in overnight shifts. They likely had contractual (if not moral) obligations to implement the increased production, but are limited in their ability to pass the costs on. Demand has now fallen, last week's Woolworths sales of TP actually being below the equivalent week last year for the first time since the panic (the CEO has been sending updates that describe TP demand, so you could plot sales over time to illustrate a demand spike). After so many people have stockpiled, it seems likely that a sustained (but moderate) drop in demand is expected. Theoretically, this should lead to a decrease in prices but I doubt it will happen, just as the prices didn't rise with increased demand. It will harm the manufacturers, though, as it seems unlikely that covid will produce any long-term increase in demand, and so the manufacturers have effectively just brought forward production that would have occurred in the future, but have done so at increased (and likely unrecoverable) cost.
- There was evidence of profiteering in some cases, and also examples of altruism. For example, I remember seeing a story of a person (in QLD?) who bought TP online and wanted 48 rolls but ended up with 48 boxes, each of 48 rolls. The company recognised it was a mistake and offered to buy back what was not wanted (at the same price), but the consumer kept the excess and sold it to friends / neighbours / people at the local school at the same price. Economic theory would say that this person should have sold them at a profit - there was plenty of demand - out of self-interest, but instead chose to sell at a loss (if the costs of time of arranging the sales, transporting etc are considered) as part of being a good citizen and helping / supporting a community in need.
- These are two examples of the same flaw in the model - the underlying assumption that people act rationally and in their own economic best interests. The spike in TP demand arose from fear and panic-buying, neither of which was rational. Not raising TP prices by the larger supermarket chains was good for their reputations and is valuable as a tangible example of corporate good citizenship and concern for community welfare, but it meant forgoing additional profits and so was not the rational economic response of letting the market determine the price from the interplay of supply and demand. As for the altruistic Queenslander, s/he illustrates that people act from a variety of motives and in line with their values and beliefs, and not simply from economic self-interest.
- More generally, the pandemic illustrates how events can lead to a sudden shift in demand. I needed a webcam for online teaching but couldn't find one in a store as demand had skyrocketed... one person at Officeworks told me that they were selling faster than toilet paper!
- Government action and regulations have played a role in covid, not only altering demand patterns (by restricting travel, for example) but intervening to provide financial support to some businesses. The "free child care" initiative, for example, was meant to provide a financial lifeline to Centre operators whose financial viability was threatened by the drop in demand (as children were kept home). The market response would be that the demand decreases should lead to a drop in prices and ultimately to reduced supply by some operators closing down, etc... but the government sought to prevent this as demand will recover and the industry is vital to keeping parents working and the economy moving. In effect, they fixed a price through the subsidy and by preventing extra fees being charged to maintain viability of services and ensure that the supply remains for when the demand increases (and it is already increasing). They also supported demand by making it "free" for parents, though everyone pays through taxation, and acted in their own self-interest by presenting themselves as helping families in financial need.
- JobKeeper and JobSeeker programs are not only about keeping people employed and providing financial support, they are about ensuring ongoing economic activity and thus maintaining demand. After all, as in a depression, large drops in demand reduce business profitability, leading to job losses and further reductions in both demand and supply. Uncertain economic conditions coupled with anxiety / fear of the future lead people to alter their behaviour, reducing demand for goods and services deemed less important or even unnecessary. Priorities change to ensure that whatever is deemed most important / valuable is maintained. Crudely, this means the demand for Ferraris will fall more than demand for toilet paper, as one is a luxury and one is a necessity, but it also means changed buying patterns in essentials like food - buying less meat or cheaper cuts, for example, leading to reduced demand, and then falling wholesale prices, then reduced income for farmers, leading them to reduce their own spending, etc.
