Demand, supply, and hotel rooms

Last week in ECON100 we covered demand and supply. There's no shortage of real-world examples to illustrate markets, but this New Zealand Herald story from Tuesday is well-timed:

New Zealand hotel prices jumped by 6 per cent during the the past year, well ahead of the average prices paid around the world, according to new research.

So, hotel room prices have risen, and faster than the general inflation rate (so it is a 'real' price increase). The hotel price increase could happen primarily as a result of an increase in demand for hotel rooms, or a decrease in the supply of hotel rooms. The article also provides us with the answer as to which is more likely:

"The growth in domestic hotel prices comes off the back of a record-breaking year for international visitors to New Zealand in the year ending December 2015, with a 9.6 per cent increase in total arrivals on the previous year," Hotels.com said.

So, an increase in demand led to the increase in hotel room rates (maybe it was because of Lord of the Rings?). This is shown in the diagram below, where demand increases from D0 to D1, and the equilibrium price increases from P0 to P1. Notice that the equilibrium quantity of hotel rooms increases, but not by much (from Q0 to Q1) - that's because even when the price increases, there isn't much scope for more hotel rooms to be made available (perhaps some additional B&B rooms or AirBnB or similar, or perhaps some rooms that would have undergone maintenance have that maintenance deferred so that they are available, but the quantity will be small). Because quantity supplied doesn't respond much to the change in price, we say that supply is relatively inelastic (we'll cover elasticity in ECON100 in a couple of weeks time).

Will the higher hotel room prices endure? Steven will talk more about the dynamics of supply and demand in ECON100 this coming week (if he hasn't already). In short, higher prices mean higher profits for hotels. That makes the hotel industry more attractive for other firms (and existing firms might want to expand as well), so we might expect more hotels in the future (if firms believe that the increase in demand will persist). And indeed it appears that is what is happening:

"This is a promising sign for the local tourism industry and, with many major hotel development projects in the pipeline, we'll see increased supply in the long term, which will be welcome news to holidaymakers planning a trip in New Zealand," she [Katherine Cole, regional director, Australia, New Zealand & Singapore for the Hotels.com brand] said.

So, we should expect an increase in supply, as shown in the diagram below. Supply increases from S0 to S2, leading the equilibrium price to fall from P1 to P2, and the equilibrium quantity of hotel rooms to increase from Q1 to Q2. The lower price will certainly make holidaymakers happier, as noted above, and provided the increase in demand holds up, the hotel operators will be better off (compared with before the increase in demand) as well.