Your electronic devices are going to cost more

John Hopkins (Swinburne Institute of Technology) wrote in The Conversation earlier this week:

The manufacturing world is facing one of its greatest challenges in years — a global shortage of semiconductors — and there doesn’t appear to be an end in sight any time soon.

According to Acer, one of the world’s largest laptop manufacturers, companies will still be affected by this shortage until at least the first half of 2022.

Semiconductors are an essential component of electronic devices, found in everything from cars and factory machinery to dishwashers and mobile phones. They harness the conducting properties of semiconductor materials (such as silicon), through the use of electric or magnetic fields, light, heat or mechanical deformation, to control the electric current flowing into a device.

Hopkins also outlines how we ended up with the shortage:

Like many current global challenges, this shortage initially began as a result of the COVID pandemic. Staff at semiconductor foundries in China and around the world were unable to go to work, plants were closed and production halted, which led to a lack of supply. The movement of that supply was also slowed down by tighter restrictions at ports and international borders.

At the same time, employees started working from home, children and students started studying from home, and many of us were confined to our homes for long periods. New equipment was needed to support these changes, establish makeshift offices and classrooms in our homes, and upgrade our existing home entertainment options. This prompted a sudden increase in demand for many of the devices that rely on semiconductors. 

These two changes (a decrease in supply, and an increase in demand) have led to the shortage of semiconductors, but the shortage will be temporary. To see why, consider the market for semiconductors as shown in the diagram below. The market was initially in equilibrium before the pandemic, with a price of PA and QA semiconductors traded. Then, during the pandemic, demand increased from DA to DB, while supply decreased from SA to SB, but the price of semiconductors initially stays at PA. At that low price, the quantity of semiconductors demanded in QD, but the supply is only QS - there is a shortage.

What happens next is important. The shortage means that some semiconductor buyers are missing out. To avoid this situation, the buyers can try to find a seller, and offer a slightly higher price to avoid missing out on some of the limited supply of semiconductors that are available. [*] In other words, the buyers bid the price upwards, and this process continues until the price reaches the new equilibrium price of PB, where there is no shortage and QB semiconductors are traded. [**]

Now, consider how the increase in the price of semiconductors will affect the market for electronic devices. Everything from phones to laptops to cars includes semiconductors, so an increase in the price of semiconductors increases the costs of production of electronic devices. This is shown in the diagram below. The price of devices is initially in equilibrium at P0, with Q0 devices traded. The increase in production costs causes supply to decrease from S0 to S1. The equilibrium price of devices increases to P1, where Q1 devices are traded. [***]

The global semiconductor shortage might seem an interesting by-product of the coronavirus pandemic. But, it is going to show up in the price of your next smartphone, laptop, or new car purchase.

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[*] In reality, the mechanism probably isn't quite this simple as there will be existing contracts for supply, etc. However, the buyers who least want to wait will find ways of accelerating their access to semiconductors, and that will involve offering a higher price in some way.

[**] As I have drawn it, QB is greater than QA, suggesting that the quantity of semiconductors increases. However, that need not be the case. The change in quantity is ambiguous. If the decrease in demand was a little bit smaller, the equilibrium quantity would have decreased, or could have stayed at the original quantity of QA.

[***] For simplicity, I haven't shown the increase in demand for devices here. However, that also leads to an increase in the price, meaning that prices of devices will increase even further.