Supply and demand Impacts to the market

Supply and demand

How market disruptions and individual decisions impact the market

by Ben Campbell, Ph. D, Associate Professor and Extension Specialist, UGA Department of Agricultural and Applied Economics

Supply and demand are such simple concepts; yet understanding what drives these two concepts is extremely complex. Just when we think we have it figured it out there is a market disruption (big and/or small) that moves the goal line and makes us have to rethink pricing, marketing, etc. in the short- and longrun.

Some key concepts to note:

1. Supply: the amount of a good or service a firm will try to sell in the market; law of supply-the higher the price, the more the firm will try (would like to) sell in the market, 2. Demand: the amount of a good or service a consumer will buy in the market; law of demand-the higher the price, the less a consumer will purchase, 3. Equilibrium: where supply and demand meet; generally, this would be where we see a large number of firms pricing at or near; 4. Margin: the difference between what price a good/service is sold for (price) and the cost of getting the good to market. In a world with no disruptions the market would move to and stay at an equilibrium point where price and quantity would remain static over time. However, a world without disruptions does not exist so supply and demand (and consequently the equilibrium and a firm’s margin) are constantly changing.

Let’s look at some examples.

coronavirus pandemic quarantined people at home many turned to landscaping to fill their time. As more and more people began to landscape, the demand for pine straw and other landscaping materials (e.g., plants) increased drastically, driving prices higher. In many cases a higher price in Georgia would result in importing pine straw from other places to take advantage of the shortage in Georgia caused by the increased demand. However, we saw increased demand throughout the U.S. which resulted in prices moving higher with no mitigation from imports. Coupling this with rising input costs (e.g., freight and labor shortages, gas prices increase, weather, etc.), which would tend to lower supply and drive-up price, prices increased to a new higher equilibrium. Moving out of the pandemic we would expect demand to decrease from their 2020 levels. However, on the supply side we would expect input prices to increase and producers to look to bring more pine straw in production (such as acquiring new acres to harvest) to take advantage of the shortage in the market. Given this scenario, lower demand and increased supply will drive down price while increased input costs will drive up price. The bigger of the two effects will dictate whether price increases or decreases in the future. Pine straw. As we moved into 2020 a plethora of market disruptions hit the market that have driven prices higher. These disruptions hit both the demand and supply side of the market. For instance, as the 4 Sod. Prior to the Great Recession of 2008-2009 the sod market was full of suppliers with many firms expanding production acreage. As the Great Recession took hold many firms (and acreage) left the market

4

(approximately 57% reduction). This decline in production resulted in a reduction in supply which would drive up the equilibrium price; however, during this time demand also was negatively impacted as housing starts and discretionary income were reduced. As the Great Recession ended, demand returned at a faster rate than production came back online; thereby resulting in firms having the ability to increase prices. Fast forward to 2016 and beyond. Many input prices have increased which would result in higher prices as some firms would reduce supply or try to increase their margin by increasing prices to offset increasing costs. As we headed toward 2020 there was booming GDP growth which was led by increased housing starts; thereby leading to increased demand. So as demand increased and input costs increased (e.g., increases in chemical, lumber, and labor costs, etc.), the equilibrium price moved higher. Moving into 2020 we might have expected a big dip in prices as the economy stuttered due to the coronavirus pandemic which slowed house builds; however, as consumer were quarantined at home, they began doing landscaping which mitigated some of the demand loss coming from slowed housing starts.

Plants. The pandemic caused a surge in demand for plants. Many producers sold all the plants they could get their hands on (including plants intended for market several years down the line). As prices rose in response to the increased demand, many producers expanded their production for 2021 to take advantage of the 2020 demand levels. However, a reduction in demand in 2021 due to consumers moving away from working from home and the increased supply would drive prices lower than 2020 levels. Over time we would expect that the market disruption caused by the pandemic will leave the system and supply and demand will return to pre-pandemic levels.

With respect to supply and demand, agricultural goods are not alone in how they respond to changes in supply and demand. For instance, when a hurricane is headed to the Gulf Coast there is generally a rise in gas prices as consumers increase demand for gasoline due to their perception that gas may be hard to come by or that prices will increase in the future. We also see the impacts of supply and demand when looking at the pandemic’s impact on toilet paper and cleaning supplies. Though many retailers did not increase prices, the secondary market (people buying then reselling) saw prices increase drastically.

Final thoughts

As firms make business decisions on pricing, it is essential that firms understand supply and demand, who their customer is, and the margins for each of the products they sell.

The overall supply curve is made up of each individual firm’s supply curve and the overall demand curve is made up of each individual customer’s demand curve.

Given this, some consumers (i.e., market segments) may be more amenable to paying higher prices while other consumers may be less able or willing to pay more for a product. On the flip side, some firm’s may have to charge higher prices given their cost structures and vice versa.

Understanding your cost structure and the market (customers) you are servicing will allow you to understand what you are and are not able to do when there are market disruptions. Taking it a step further, by understanding your market segments and how it relates to the margin for a product will allow a firm to decide whether a price increase can be passed onto consumers.

As input prices go up a firm may not be able to charge for rising input costs so they either accept the lower margin, find new customers that will pay a higher price, or eat some of the input cost and pass a small amount to consumers.

The decision of raising prices should not be thought of in a vacuum (short-term). It may be that charging a high price today because the market allows it may cause customers to move to competition, especially if as noted earlier a shortterm demand shortage will work its way out of the system quickly. Price increases may be warranted if the overall trend (supply and/or demand side forces) are moving prices higher over time or if a firm is dealing with a market segment that will absorb the price increase.

Thereby, looking at supply and demand we can get a general idea what should be happening with price. The individual firm decision of whether to increase price should be based on the market segments being targeted and the margins for a firm.