Nathaniel Ritchie ID:
Part A – Toilet Paper
Pre-Pandemic
Market is at equilibrium where the supply and demand line intersect, P* and Q*, resulting in no shortage or surplus or all goods produced are sold. This is where total economic benefit is at maximum. As shown in diagram below. The demand for toilet paper is very price inelasxtic as nearly everyone uses it, and there are no close substitutes resulting in a steep demand curve. The Supply is relativity price inelastic as it takes some time to adjust supply due to the complex chain to produce the good (Source).
Shock to market
Tastes and Preferences is a determinant of demand, this means a change in tastes and preference will alter the demand, if tastes and preferences changes to view a good with greater perceived benefit due to factor such as hype and media, the willingness to pay increases thus a shift right of the curve will occur (Source). This exactly happened with toilet paper in during corona. The hype of other people stockpiling (source) and the media stating shortages in markets are occurring (source) would drive more people to purchase more toilet paper than necessary. This shifts the Demand curve from Demand to Demand 1, To try and supply the rapid increase in demand, suppliers stopped production of some good to produce toilet paper (Source) thus a shift to the right of the supply curve, Supply to supply 1. This should rise price from P*1 to P1, and change quantity demanded from Q* to Q1, however this did not happen, price did not increase (Source) this shifts Q* instead to Q2. Supply is Q3, while demand is Q2, this results in a shortage of from Q2-Q3.
Consequences of shortage
One of the consequences of the shortage is the development of a black market. Since the current market price is P* anyone can buy at this price, however as there is a shortage only so many people can get the toilet paper. Those who purchase at P* can sell it on for P2 and gain the difference, this is what happened (source), however the size of the black-market can be reduced by government intervention (source). A shortage in toilet paper can result in people using their income to purchase other goods which are not essential which results in other shortages futhur putting strain onto the sytem(Source).
Long term/run
Demand for toilet paper is decreasing, however is still above what pre-corona was at (Source). The first step initial decrease in demand is because the hype and media surround toilet paper would be reduced so people will see the perceived benefit of purchasing the toilet paper to be less, thus less willing to pay less. This results in a shift left of the demand curve Demand 1 to Demand 2, resulting in a decrease amount of shortage and decrease in the black market, quantity goes Q2- Q1, price still stays at P* however Black market price goes from P2 to P3 (Diagram bottom left). Further in the long run, due to consumers typically don’t increase the use of toilet paper their inventory’s will fill up and will no longer need to purchase more toilet paper resulting In a shift left of demand shift left as suppler are reverting to pre-corona production and will reach market equilibrium as prior to corona From P1 to P*, Q1 to Q*.
Part – B
Market and Firm in profit producing situation.
The model on the left is world oil market currently in equilibrium where P* is the current price of oil, the model on the right is the oil producing firm. This firm has a comparative advantage in producing oil however is a price taker so the firm’s profitability is dependent on the markets price and cannot influence themselves. Currently when P* the firm makes a profit in the short run seeling current quantity, even if price drops to P1 the firm will cover average total costs and average variable costs. Even though the firm holds a monopoly in its country it however exports to the global market which is assumed as perfectly competitive due to oil having a very large number of firms producing and exporting, thus in the long term economic gain is at zero.
Market and Firm in loss situation due to coronavirus and price war.
The corona virus has seen consumer and industry consumption in of oil in the world to slowdown and even cease (Source) this reduction of demand results in a large shift left of the demand curve of the oil market which drives prices down, this in conjunction with a price war between two major oil producer saw a rapid increase in supply of oil (source) these both saw price shift from P* to P1, and saw quantity demand from Q* to Q1. This decrease in price means the firm is now in economic loss: shutdown zone, P is less than Average total cost (ATC) and Average Variable Cost (AVC). This shutdown positions the firm means that the price they are receiving per Q does not cover AVC, the cost to produce each Q of good, nor covers the ATC, the total cost of operating the firm per Q. The total cost if maintain firm is P1 – ATC * Q1 (Green and Purple), however if the firm is to shut down the cost of shutdown will be less and only ATC-AVC *Q (Purple shade). In order for the government to help out the firm, the government must cover ensure the firm is receiving a min of P that covers AVC per Q (Source)
Firms long run survival
If the government is to bail out, then the firm has a chance to operate at profit again post corona. Once corona is dealt with and economic activity ramps up then the consumption of oil will return as consumers and industries need it to operate machinery and to drive. This will shift the demand curve back to the right driving up prices and increasing in quantity demand. With the supply issue that is unknow if the countries fighting in the price war will continue, on the assumption that they cease and scale back production to pre-corona time, this will reduce quantity supplied resulting in a increase in P. If the new P is above the ATC line then business will be in positive economic position producing a profit. Due to the worldwide oil market assuming perfect competition in the market due to a wide range of firms producing and supplying the market, no firm is profitable in that sense. However, on a local level the firm in this situation is the only one in the country, ultimately having a monopoly meaning they have guaranteed profit in the long run from their own coutry.