Topic 2.5 - Demand AND Supply CASE Studies, 2018 - st version PDF

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29/01/2018

TOPIC 2.5: DEMAND AND SUPPLY CASE STUDIES

Oil ‘glut’

Global Financial Crisis

Second oil price shock Strong global economic growth First oil price shock US Shale oil

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First Oil Price Shock (1973) • Before the Yom Kippur War, the price of oil was (in 2013 dollars) around $17 per barrel;

Supply (pre-embargo)

$17.25

• After the war, the Arab countries punished supporters of Israel by putting an embargo on exports to those countries (the US was Israel’s main supporter). • As a result, supply decreased, and the price of crude increased to over $54 per barrel.

Demand 58,613

Quantity (‘000s barrels per day)

Strong Global Economic Growth • During the early 2000’s, the global economy enjoyed strong economic growth;

Price

Supply

• In other words, incomes were rising strongly across many countries (but most importantly, the US and China); • This is a non-price demandside factor

P0

• Hence, the demand curve for oil shifted to the right. • The result? An increase in price AND quantity D0 Q0

Quantity (‘000s barrels per day)

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• As the initial chart showed, I could do a number of other examples, just from this market alone – Sometimes it is supply-side issues that might dominate (oil shocks, US shale oil), while other times it is demand-driven (growth in the 2000’s, the GFC); – This could, of course, be repeated in every single market over time. This is the power of the demand and supply model!

Example 2 Lamb supplies are sharply reduced because of a drought in the lamb-raising states, and consumers turn to chicken as a substitute for lamb. Describe using an appropriate diagram the events in the lamb market using supply and demand analysis. • Clearly been a decrease in supply due to the drought in these lamb-raising areas. So draw this in first; • But question specifically says that consumers ‘substitute away from lamb towards chicken’ as a result, so should we shift the demand curve to the left as well?

Price

S0

• Nope… • The consumers who substitute away from lamb are captured in the fall in the quantity demanded from Q0 to Q1 . The ↑ in price has induced a ↓in the quantity demanded.

P0 D0

Q0

• i.e. there are no non-price factors influencing the demand curve (it is just the substitution effect we have talked about previously). Quantity

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Source: The Australian (07/11/17)

Let’s deconstruct this in terms of our demand and supply model:

S0

S0 Price

Price

Coffee and milk are complements

D0

D0

Quantity

Quantity

Coffee market

Full-fat milk market

= ‘less left over cream’ If that cream is staying in the carton and getting sold with milk, then it's not available to make butter with.

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Price

Butter market

S0

Cream = essential input into butter Supply curve for butter reduces (shifts left)

P0

D0 Q0

Quantity

PLUS…

i.e. preferences shifting to butter, hence demand curve shifts to the right.

Price

Butter market S1

P2

In summary: - Price definitely rises (both decrease in supply and increase in demand reinforces this)

S0 P1

P0 D1

D0 Q1

Q0

Q2

Quantity

Quantity of butter sold? - Technically ambiguous (supply will decrease it, demand will increase it) - Article does say later on though that local sales of butter have increased by 20% though, hence here Q2 > Q0

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A Heroin Drought in NSW Price

Around Christmas 2000 in N.S.W., a heroin ‘drought’ occurred. A paper written shortly after this noted: “... The cause(s) of the heroin drought are not known with any great degree of certainty but there are probably a number of factors at work. Firstly, the quantity of heroin seized by authorities has risen significantly ... Secondly, State and Federal police have arrested a number of significant figures involved in importing and distributing heroin in Australia ... Thirdly, the opium poppy growing regions of Myanmar (Burma) are presently experiencing a severe (water) drought...” Weatherburn, D. et al (2001) “The Australian Heroin Drought and its Implications for Drug Policy”, CRIME AND JUSTICE Bulletin 59 (Oct 2001)

S0

P0

DH Q0

Quantity

All of these factors, of course, are supply-side (non-price) factors. Hence we would expect to see (and did see) a marked increase in price, and a fall in the quantity consumed.

• However, we can also use this to look at related markets. Specifically, what happened in two other markets: 1. 2.

The market for syringes The market for cocaine

• Although specific price and quantity data on these are hard to come by, we can get a sense of the spillover effects from the following two charts:

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Syringes

Cocaine

Price

Price

S0

S0

P0

P0

D0 Q1

• •

Q0

D0

Quantity

Syringes are a complement good. Therefore, as the price of heroin rises and the quantity demanded falls, we see lower demand for syringes.

Q0

• •

Quantity

Cocaine is a substitute good. Therefore, as the price of heroin rises and the quantity demanded falls, we see higher demand for cocaine.

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