The Strait of Hormuz blockade, trade passes in the Panama Canal, and the cost of imported goods

The New Zealand Herald reported last month:

The war in the Middle East has boosted demand to move vital cargo through the Panama Canal to such an extent that one vessel carrying liquefied natural gas (LNG) paid US$4 million ($6.7m) to skip the line and avoid a wait that can take up to five days, according to an official report.

A surge in such payments has been recorded since the US-Israeli attacks on Iran began February 28, which led to the blockade of the Strait of Hormuz, a critical waterway for one-fifth of the world’s oil and natural gas exports from Gulf countries.

The impact on the price of transits through the Panama Canal is shown in the diagram below. Before the Strait of Hormuz was blockaded, the market for Panama Canal transits was in equilibrium, where demand DA meets supply SA. The equilibrium price was PA, and the quantity of transits was QA. The blockade increased the demand for Panama Canal transits from DA to DB, increasing the equilibrium price of transits from PA to PB, and increasing the quantity of transits from QA to QB.

This increase in the price of Panama Canal transits doesn't just affect the cost of transporting oil or natural gas. Other ships must also pay the higher price. That increases the cost of shipping, which will flow through to the prices of imported goods, as shown in the diagram below. The market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of imported goods traded of Q0. The higher cost of Panama Canal transits increases the 'costs of production' of imported goods, which decreases supply to S1. This increases the equilibrium price of imported goods to P1, and reduces the quantity of imported goods traded to Q1.

So, it's not just oil and natural gas prices that will be pushed up by the blockade of the Strait of Hormuz. The resulting higher shipping costs will flow through to all sorts of other goods that are traded internationally and require shipping, including and especially those passing through the Panama Canal.

Declining migrant rights in Europe shows Milanovic's model of migration flows and migrants' rights in action

The Financial Times reported earlier this week (paywalled):

Immigration has become more controversial since shifting from predominantly white European to predominantly non-white, non-European — mostly Asian in the UK, mostly African in France. These trends will continue: Africa’s population is forecast to jump from 1.5 billion today to 2.5 billion by 2050, while Europe’s working-age population craters...

How can politicians square the circle of needing immigrants but not wanting them? By posturing against the most visible forms of immigration (small boats on the Channel or the Med, and asylum-seekers) while quietly letting in more workers. Britain’s vote for Brexit was largely driven by anti-immigration feeling, but immigration to the UK has soared since then. Italy’s rightwing leader Giorgia Meloni makes a show of trying to process asylum-seekers in Albania — reflecting a widespread European desire to offshore asylum — while also issuing nearly a million non-EU work visas. The French parliament voted through a strict immigration law in 2023, yet in 2024 immigration jumped.

Branko Milanovic's model of migration flows and migrants' rights, which was explained in his book Capitalism, Alone (which I reviewed here) and which I expanded on in this earlier post can be used to explain these changes. Over time, Europeans have become willing to accept lower migration flows for a given amount of migration rights. In the model, this equates to a decrease in the demand for migrants (the demand in this model represents the public tolerance for migrants). This situation is shown in the diagram below. Initially, the equilibrium level of migrant rights R0 was associated with migration flows to Europe of M0. Then, as Europeans' demand for migrants decreases, the 'demand curve' shifts to the left, from D0 to D1. The equilibrium now occurs where the new curve D1 intersects with the supply curve S0, with lower migration flows (M1) and lower migrant rights (R1).

As the Financial Times article notes, migrant rights are eroding:

The new trend, as seen for instance in the UK, is to give immigrants time-limited visas for specific job sectors, reduce their right to bring family members, and make them wait longer — decades, in some cases — before they can get permanent settlement. In France, the far-right Rassemblement National party, the likely next government, wants to scrap birthright citizenship, meaning that people could spend their lives in the country while forever remaining second-class outsiders.

Milanovic's model helps us to explain how changes in Europeans' preferences for migrants translate into both lower migration flows and lower migrant rights. To improve migrants' rights, the process would likely have to happen in reverse, with Europeans returning to a more welcoming state.

Read more:

• Milanovic's model of migration flows and migrants' rights, expanded

Milanovic's model of migration flows and migrants' rights, expanded

In my review of Branko Milanovic's book Capitalism, Alone yesterday, I noted that there were a couple of missed opportunities for the book to go deeper on certain topics. One of those was a simple model of migration flows and migrants' rights, presented in Chapter 4 of the book. Milanovic motivates this model with a discussion of the native-born population's view on migrants, based on the following proposition (emphasis is from the book):

...The native population is more likely to accept migrants the less likely the migrants are to permanently remain in the country and use all the benefits of citizenship.
This proposition introduces a negative relationship between (i) willingness to accept migrants and (ii) extension of migrants' rights...

Milanovic then goes on to illustrate this relationship with a simple diagram, noting that:

...it seems reasonable to believe that there is a kind of demand curve for migrants, where the demand is less when the cost of migrants, in terms of the rights and sharing of the citizenship premium they can claim, is greater.

This 'demand curve' relationship that Milanovic describes is shown in the diagram below (by the line D). Milanovic distinguishes between two cases, represented by two points on the demand curve in the diagram: (1) high on the curve (at point A), where migrants have extensive rights, but the native-born population would desire very few migrants; and (2) low on the curve (at point B), where migrants have few rights, and the native-born population are willing to accept more migrants.

However, here is where Milanovic misses an opportunity. Yes, there may be such a demand curve for migrant flows. However, there is also a corresponding supply curve, constructed from the decisions of the potential migrants themselves. Ceteris paribus (holding all else constant), migrants would desire to go to destinations where they would have greater citizenship rights. In other words, the supply of migrants in this model is upward sloping, as shown in the diagram below (by the line S).

Now consider Milanovic's two cases. The first case, where migrants are offered extensive rights, is illustrated in the diagram below. Consider migrant rights of R1. The native-born population desires very few migrants (MD1), but the number of migrants who want to migrate to such an attractive destination is high (MS1). There will be conflict. There is an excess supply of migrants (the difference between MD1 and MS1). The native-born population feels like they are being overwhelmed by migrants who are taking advantage of the rights of citizenship that they have not 'earned'. The native-born population agitates, and the government relents, eventually by offering fewer citizenship rights to migrants. This continues until rights reach R0. This is the equilibrium amount of citizenship rights. The equilibrium migration flow is M0.

Now consider Milanovic's second case, where migrants are offered few rights, which is illustrated in the diagram below. Consider migrant rights of R2. The native-born population is willing to accept many migrants (MD2), but the number of migrants who want to migrate to such an unattractive destination is low (MS2). There will be few migrants, and the economy may suffer as a result. There is an excess demand for migrants (the difference between MS2 and MD2). The government wants to attract more migrants, so they begin to offer migrants more rights. This continues until rights reach R0. This is the equilibrium amount of citizenship rights. The equilibrium migration flow is again M0.

Having established equilibrium migrant rights and migration flows, we can now use the model in much the same way as the standard model of demand and supply. Consider some exercises in comparative statics (the movement from one equilibrium to another). If there is an exogenous increase in the supply of migrants, such that more migrants are willing to migrate at each and every level of rights, then the supply curve shifts to the right. The equilibrium level of migrant rights will fall. If populist rhetoric reduces the willingness of the native-born population to accept migrants, then the demand curve shifts to the left. The equilibrium level of migrant rights will fall. And so on.

Obviously, the model is not a perfect description of the relationship between migrant rights and migration flows. However, Milanovic could easily have built up this model (as I have done above) and used it more extensively to explore the relationship here. By ignoring the role that migrants' choices play (the supply curve in the model above), Milanovic suggests that only the demand curve matters. That is, that only the choices of the native-born population will affect migration. Clearly, that is an incomplete description. The level of citizenship rights that migrants receive will depend on government actions, and the forces (upward or downward) that impact those actions depend on both the native-born population and the migrants.

Even this post has, I think, barely scratched the surface of the utility of a model like this, to understand the politics of migration flows and migrants' rights. I'm sure that there is much more that can be done with this.

Sellers of natural diamonds are in trouble

The Financial Times reported earlier this year (paywalled):

Over 70 per cent of the world’s lab-grown diamonds for jewellery — many destined for the ring fingers of newly engaged couples — originate in a Chinese factory, with Henan at the centre of the synthetic trade...

For the natural diamond industry, Feng’s factories and others like them have been devastating. The explosion of lab-grown diamonds on the international jewellery market has coincided with a slump in demand, sending the price of smaller natural diamonds to their lowest levels in a decade.

Marty Hurwitz, head of the Grown Diamond Trade Organisation, says lab-grown diamonds have “been a massive disruption. People in the industry at first didn’t believe it and, second, couldn’t accept it.

“This has been the first competitive product that mined diamonds have ever faced.”

To see the impact of the growth of the lab-grown diamond market on natural diamonds, let's first consider the market for lab-grown diamonds, shown in the diagram below. The 'explosion of lab-grown diamonds' is demonstrated by the increase in the supply, from SA to SB. The equilibrium price of lab-grown diamonds has decreased from PA to PB, and the equilibrium quantity of lab-grown diamonds traded has increased from QA to QB.

Next, consider the effect on the market for natural diamonds, shown below. Lab-grown diamonds and natural diamonds are close substitutes (so close that no regular consumer can tell them apart!), and lab-grown diamonds are now cheaper. So, as the quote from the Financial Times article notes, the demand for natural diamonds has decreased, from D0 to D1. The equilibrium price of natural diamonds has decreased from P0 to P1, and the equilibrium quantity of lab-grown diamonds traded has decreased from Q0 to Q1.

This is a real problem for the producers of natural diamonds. The product that they are selling is decreasing in price, and they are selling a smaller quantity. That must make those sellers worse off. And, to make matters worse, they should have seen this coming. I wrote this post back in 2019, wondering why De Beers wasn't investing in its own production facilities for lab-grown diamonds. It turns out that they were, as the Financial Times article notes:

In 2018, De Beers established its own lab-grown diamond company, Lightbox, which started churning out cheap synthetic stones. Part of the thinking was to create a bifurcated market that would ensure the luxury appeal of expensive natural stones was maintained while undercutting synthetic rivals. 

Instead, it sparked a price war that also dragged down the price of natural diamonds, which were simultaneously hit by a slump in demand due to lower marriage rates during the pandemic. By the end of 2024, De Beers had amassed an inventory of unsold diamonds worth $2bn, the largest stockpile since the 2008 financial crisis.

Again, that outcome could and should have been anticipated. De Beers (and other natural diamond producers) need to find some way of differentiating natural diamonds from lab-grown diamonds (I will return to this point in a future post). Otherwise, the natural diamond sellers are in real trouble.

Read more:

• Market power and disruption in the diamond industry

Is free employment mediation really free if you have to wait for it?

The New Zealand Herald reported last month:

An employment lawyer is advising businesses to bypass the government’s free employment mediation service.

There was currently a seven-week waiting list to access the Ministry of Innovation, Business and Employment’s mediation service, which was supposed to be a way to avoid drawn-out disputes between employers and their employees.

“Don’t wait,” Rotorua employment lawyer Michelle Urquhart said, adding the cost of accessing private services was well worth it given the risks associated with leaving a dispute to fester.

MBIE advised availability was limited due to high demand and apologised for the inconvenience, though wait time was an improvement from the peak 11-week wait in February.

When the price of a good or service is zero (free), there is often a shortage (excess demand) for the good or service - there are more people wanting to access the good or service than there is available. This is illustrated in the diagram below. If the market for public mediation services operated at equilibrium, the market price would be P0, and the quantity of mediation services would be Q0. That quantity (Q0) is both the quantity of mediation demanded, and the quantity of mediation supplied (the number of mediation appointments available for businesses). We can say that the market clears, because quantity demanded is equal to quantity supplied (the market is in equilibrium).

However, the price is below equilibrium, at zero (free) [*]. At that zero price, the quantity of mediation demanded is QD, while the quantity of mediation supplied is QS. Since QD is greater than QS, there is excess demand (a shortage). That is what we are seeing, with long waits for mediation services.

That excess demand needs to be managed. Ordinarily, we would expect the price to rise when there is excess demand, but since the government has set the price at zero, that cannot happen. So, the alternative is that the excess demand is managed with a waiting list. When a business wants to access the free employment mediation service, it is added to the waiting list, and then needs to wait until the service is available.

Ironically, the operation of the waiting list means that the 'free' mediation service is no longer 'free'. It just has no monetary cost. There is a cost associated with waiting for the mediation, because in the meantime whatever employment dispute necessitated mediation is not being resolved (and festering, as the employment lawyer in the quote above notes). The costs of that unresolved situation might be much less than the cost of paying for private mediation services. The free public services are not really free at all. It should be little wonder that some businesses are opting for private mediation services instead.

Mexico's agave farmers learn the lessons of dynamic supply and demand

The Financial Times reported earlier this year (paywalled):

But in 2018, the tequila boom in the US presented Antonio, who requested we not use his real name, with an opportunity to get back into the fields and connect with his father. With the price of agave, the key ingredient in tequila, reaching record heights, everyone with a patch of land was rushing to plant the crop, or to sell their land to others keen to do so. As it peaked at some 30 pesos ($1.45) per kilogramme, doctors, dentists, and many others piled into the business. The number of registered agave growers rocketed from 3,180 in 2014 to 41,000 in 2023. For several years, the region was abuzz with a sense of possibility, even among those without land to grow on. Opportunistic investment companies set up crypto-esque trading websites encouraging Tapatíos, people local to the area, to place bets that the price of agave would keep rising...

A couple of years after he planted his crops, Antonio secured a contract with a tequila producer promising to buy his plants. The deal gave him the confidence to plant more, but did not include any kind of price protection. In 2022, when his first crops were still a couple of years from maturity, he started to hear about falling prices. Within two years the spot price had plummeted to between 1 and 3 pesos per kg. “We started to plant all excited, making the investment when things were good without really knowing that it’s all cyclical,” he says.

Stories like Antonio’s are now crystallised into tequila industry lore: the hapless middle-class professionals who helped fuel the agave oversupply crisis that is now rocking Jalisco.

In my ECONS101 class, we teach a model of dynamic supply and demand that explains fluctuations in market prices such as those that the Mexican agave farmers have been experiencing. It isn't all bad news. As you will see, the farmers who can ride out the low prices and profits will likely find themselves in a period of higher prices and profits before too long.

Consider the market for agave, and assume that it is perfectly competitive - most importantly, there are no barriers to entry into the market or barriers to exit from the market. The market for agave is shown in the diagram on the left below. The diagram on the right will track changes in agave farmers' profits over time. Initially (at Time 0) the market is at equilibrium (where demand D0 meets supply S0) with price P0, and agave farmers are making profits π0. Now say there is a permanent increase in demand at Time 1, to D1. This increase in demand may be because of an increase in the production of tequila (as I noted in this post earlier this month). Prices increase to P1, and agave farmer profits also increase (to π1). There are no barriers to entry (this is a perfectly competitive market), so the higher profits encourage new farmers to enter this market (like Antonio). Supply increases to S2 (more producers) at Time 2. Price falls to P2, and agave farmer profits also fall (to π2). This is the situation that the Financial Times article describes.

What happens next? At Time 2 profits are low and some agave farmers will choose to exit the market (no barriers to exit because this is a perfectly competitive market). Supply will decrease to S3 (fewer producers) at Time 3. Price will increase to P3, and farmer profits will increase to π3. So, as I noted above, provided the agave farmers can ride out the low prices and profits, the market will recover as other farmers drop out of the market.

The problem for agave farmers like Antonio is that this was foreseeable. When prices and profits are high, and lots of farmers are moving into the market, that is not a good time to invest in an agave farm. The increase in supply is going to lead to lower prices and profits in the future. This is made even worse in this case because, as the FT article notes:

Although tequila remains the world’s fastest-growing spirit, the peak growth is over, and drinkers have been cutting back on boozing. That was already particularly true in the US, tequila’s largest export market, before President Donald Trump proposed launching a trade war. While large producers with long-held relationships with the tequila houses are able to ride out the cycle, farmers without solid contracts are now desperately trying to offload their agave in a saturated market. 

Mexico's tequila lake is doubling down on the cycle of low prices and profits for Mexican agave farmers. As I noted in the tequila lake post, the price of tequila will fall, and less tequila will be produced. That means that the prospects for agave farmers are even worse than portrayed in the market diagram above, because the demand for agave isn't going to stay high at D1, but will be decreasing back towards D0. That means even lower prices and profits for agave farmers.

The Financial Times wants us to feel sorry for the agave farmers like Antonio. But honestly, they should have done some due diligence. The clever business strategy when faced with a market that is heading into a cycle like that in the agave market is the 'hit and run' strategy. It is counterintuitive, but it says that when prices and profits are high, that is a good time to get out of the market. Forget selling agave, agave farms can be sold for a high price at that point in the cycle. The time to get into the market is when prices and profits are low, because the price to buy an agave farm will be much lower. Recognising that this market is perfectly competitive is important here, as is recognising what is happening in the market around you. If Antonio looked around, and realised that lots of other farmers were getting into agave farms, that should have made him curb his excitement. Hopefully, the farmers (and others) have now learned this lesson of dynamic supply and demand.

Read more:

• The rise and fall of craft beer?
• Just bought the farm (or rather not, if you understand dynamic supply and demand)

The increase in methamphetamine use in New Zealand has been driven more by supply than demand

The New Zealand Herald reported last month:

Prime Minister Christopher Luxon has asked his justice and police ministers to look at what more can be done to tackle methamphetamine use in New Zealand, which has nearly doubled in two years.

Police data shows an “unprecedented 96% increase in meth consumption when compared to 2023, with consumption increasing across all sites”...

The police report said the spike in methamphetamine use likely resulted from an increase in both supply and demand, along with a decrease in street-level pricing.

The changes in the market for methamphetamine described in the Police report are illustrated in the diagram below. In 2023, the market operated in equilibrium where the demand curve D0 intersects the supply curve S0. The equilibrium price (the street price of methamphetamine) was P0 and the equilibrium quantity of methamphetamine traded (and consumed) was Q0. Between 2023 and 2025, there was an increase in supply of methamphetamine (from S0 to S1) and an increase in demand for methamphetamine (from D0 to D1). The equilibrium quantity of methamphetamine consumed increased from Q0 to Q1 (an "unprecedented 96% increase" according to the article). The equilibrium price of methamphetamine decreased from P0 to P1 (a "decrease in street-level pricing: according to the article).

Ordinarily, when we see an increase in both supply and demand in a market, the increase in the equilibrium quantity is certain, but the change in equilibrium price is ambiguous. That's because an increase in demand causes an increase in the equilibrium price (ceteris paribus), while an increase in supply causes a decrease in the equilibrium price (ceteris paribus). In this case, the decrease in the street-level (equilibrium) price of methamphetamine tells us that the increase in supply of methamphetamine must have been larger than the increase in the demand for methamphetamine. So, the increase in methamphetamine use has been caused by both increases, but the supply side of the market is having a larger effect than the demand side.

Now, that doesn't mean that police should be targeting the supply side of the market. As I noted in this 2016 post, in the long run it is likely to be more effective to focus on the demand side, rather than the supply side, to reduce drug use. And that's what we should see now.

Read more:

• Police are not winning the P war - they need to focus on demand
• Evidence that the supply of methamphetamine is increasing
• The coronavirus lockdown and the New Zealand market for illegal drugs

Japan releases some of its emergency rice stockpile

The New Zealand Herald reported last week:

The Japanese Government said on Friday it will release a fifth of its emergency rice stockpile after hot weather, poor harvests and panic-buying over a “megaquake” warning nearly doubled prices over a year...

Rice prices had already began to change consumption patterns for some like Tokyo resident Eriko Kato.

“I still do buy rice occasionally, but since it’s so expensive I sometimes give up on buying it once I see the price,” Kato, 41, told AFP...

Tokyo resident Kato says she “sometimes just switches to noodles like udon or soba instead” because rice is more expensive.

The changes in the market for rice in Japan are illustrated in the diagram below. Before the poor rice harvest and panic-buying, the market was in equilibrium with a price of P0, and Q0 rice being traded. The poor rice harvest decreases the supply of rice from S0 to S1, while panic-buying increases the demand for rice from D0 to D1. The combined effect of these two changes is an increase in the price of rice (from P0 to P1). The change in the equilibrium quantity of rice traded is ambiguous - it depends on the relative size of the shifts in supply and demand. On the diagram below, the equilibrium quantity remains at Q0. However, if the increase in demand had been larger than the decrease in supply, then the equilibrium quantity traded would have increased. And if the increase in demand had been smaller than the decrease in supply, then the equilibrium quantity traded would have decreased. So, the model only tells us that we can be sure that the price of rice will go up.

If the Japanese government releases some of its emergency rice stockpile, then that will increase the supply of rice in the market. Let's assume that the increase in supply shifts the supply curve back from S1 to S0. The result is a decrease in the equilibrium price of rice (to P2), and an increase the equilibrium quantity of rice traded (to Q2). Notice though that the price of rice hasn't fallen all the way back to the initial equilibrium price. The Japanese government would have to release a lot of its emergency rice supply for that to happen. Or, the panic-buying of rice would have to subside (which is probably what the government is hoping will happen when it releases the emergency rice).

In the meantime though, the changes in the rice market will affect other markets. Consider the market for noodles, shown below. Rice and noodles are substitutes. When the price of rice increases, some consumers will switch to buying noodles (as described in the quote from the Herald article at the start of this post). The noodle market was previously in equilibrium with an equilibrium price of P0, and an equilibrium quantity of Q0 noodles traded. Consumers switching from rice to noodles increases the demand for noodles (from D0 to D1). This increases the equilibrium price of noodles (from P0 to P1), and increases the equilibrium quantity of noodles traded (from Q0 to Q1).

So, higher rice prices affect Japanese consumers, regardless of whether they are buying rice or noodles! Fortunately, the release of the emergency rice, lowering the equilibrium price of rice, will likely also lessen the demand for noodles and lower the price of noodles as well.

Avian flu and US egg prices

The New Zealand Herald reported earlier this month:

A resurgence of avian flu, which first struck the United States in 2022, is hitting chicken farms hard, sending egg prices soaring and rattling consumers accustomed to buying this dietary staple for only a few dollars.

In Washington and its suburbs, supermarket egg shelves are now often empty, or sparsely stocked. Some stores limit the number of cartons each client may buy. And everywhere, consumers are shocked by the high prices.

“They’re getting expensive,” 26-year-old student Samantha Lopez told AFP as she shopped in a supermarket in the US capital. “It’s kind of difficult ... My budget for food is already very tight.”...

More than 21 million egg-laying hens have been euthanised this year because of the disease, according to data published Friday by the US Agriculture Department. Most of them were in the states of Ohio, North Carolina and Missouri... 

The department reported the “depopulation” of a further 13.2 million in December.

Higher prices were the inevitable result, experts say.

“If there’s no birds to lay eggs ... then we have a supply shortage, and that leads to higher prices because of supply and demand dynamics,” said Jada Thompson, a poultry specialist at the University of Arkansas.

Let's consider the market for eggs, and how the shortage arose and why that means higher egg prices. This is all illustrated in the diagram below. Before avian flu, the market for eggs was in equilibrium, with a price of P0 and a quantity of eggs traded of Q0. The culling of chickens due to avian flu means that fewer eggs are produced. This is a decrease in the supply of eggs, shown by the supply curve shifting up and to the left, from S0 to S1. If egg prices were to remain at the original equilibrium price (P0), then the quantity of eggs demanded (Q0) would exceed the quantity of eggs supplied (QS) at that price, because egg producers are only willing to produce QS eggs at the price of P0, after the supply curve shifts. There would be a shortage of eggs, which is one of the things that we observe in the US egg market.

However, when there is a shortage, the market will tend to adjust. In this case, the market will adjust through the price of eggs increasing. How does that happen? Some buyers, who are willing to pay the market price (P0), are missing out on eggs. Some of them will find a willing seller, and offer the seller a little bit more, in order to avoid missing out. In other words, buyers bid up the price. The result is that the price increases, until the price is restored to equilibrium, at the new (higher) equilibrium price of P1. At the new equilibrium price of P1, the quantity of eggs demanded is exactly equal to the quantity of eggs supplied (both are equal to Q1). We can say that the market clears. There is no longer a shortage.

So, this model of supply and demand tells us that, because of avian flu, we should expect to see shortages of eggs (at least initially), and overall higher egg prices. Which is what we are observing.

Sweet treats are going to cost a bit more

The New Zealand Herald reported earlier this week:

Chocolate prices could be set to rise further as the cost of cocoa keeps pressure on...

Chocolate manufacturer Whittaker’s said in a statement that there had been “significant ongoing cost escalation of cocoa” driven by supply constraints.

It said there would be an impact on the future price of all chocolate.

The supply constraints for chocolate are being caused by "aging cocoa trees, diseases, and fluctuating weather patterns", which have reduced cocoa yields. The effects of reduced cocoa yields on the markets for cocoa and chocolate can be easily analysed using the supply and demand model that my ECONS101 class covered a few weeks ago. This is shown in the diagram below. Think about the market for cocoa first. The market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of cocoa traded of Q0. Poor yields reduce the cocoa harvest, decreasing supply to S1. This increases the equilibrium price of cocoa to P1, and reduces the quantity of cocoa traded to Q1.

Now consider the market for chocolate. The costs of producing chocolate have increased. That leads to a decrease in the supply of chocolate. The diagram for the market for chocolate is the same as that for cocoa, with the equilibrium price increasing, and the quantity of chocolate traded decreasing.

From the consumer's perspective, this means that chocolate is now more expensive. Some consumers will start to look for alternative sweet treats. What will happen in the market for those other sweet treats. That is shown in the diagram below. Since the price of chocolate has increased, other sweet treats are now relatively cheaper than chocolate, so some consumers will switch to other sweet treats. The effect on the market for other sweet treats is shown in the diagram below, where the market is initially in equilibrium with a price of PA, and a quantity of other sweet treats traded of QA. This increases the demand for other sweet treats from DA to DB, increasing the equilibrium price of other sweet treats from PA to PB, and increasing the quantity of other sweet treats traded from QA to QB.

So, it seems that consumers can't avoid higher prices by switching to other sweet treats, because higher price chocolate is likely to lead to higher prices for other sweet treats as well.

Finally, let me address this quote from Brad Olsen from the New Zealand Herald article:

“It might be more difficult for chocolate to increase in price, being a “nice to have” rather than a necessity as households are more careful with their money but chocolate for households is the necessary luxury so willingness to buy chocolate might remain pretty high despite higher prices.”

I guess this is the sort of quote you get from an economist who is caught on the hop by a journalist's question that they were not well prepared for. If chocolate is a luxury good, then ceteris paribus (holding everything else equal), it will tend to have more elastic demand. That means that consumers are more responsive to a change in price than for other goods that are necessities rather than luxuries. Of course, being a luxury is only one of many factors that determine how responsive consumers are to a change in price, and the other factors (like the number of substitute goods for chocolate, and the proportion of income that consumers spend on chocolate) will matter more. Nevertheless, a "necessary luxury" is not something that exists.

Higher council rates lead to higher property rents

The New Zealand Herald reported earlier this month:

Big increases in council rates may be contributing to a rent crunch in some parts of the country.

Data from CoreLogic shows the regions with the largest increase in rent since the end of the Covid freeze in 2020.

Ōakura, New Plymouth, is top of the list with an increase of 68% compared to September 2020. It is followed by Marfell, in the same area, at 67%. Westmorland, Christchurch, is third at 66% and Lower Shotover, Queenstown, at 64%.

Kiwibank economist Sabrina Delgado said there was a “very strong theme” of council rates rises being passed through to higher rents.

“Ōakura was one of the suburbs which saw an over 20% increase in council rates last year while Marfell saw a 17% increase in rates.”

In my ECONS102 class this week, in addition to covering economic welfare (as noted in yesterday's post), we covered the (rental) market for land. A couple of things make this market different from the regular markets we draw diagrams for. First, in theory, the supply of land is fixed. As Mark Twain once joked, when it comes to land, "they aren't making it anymore". However, in practice, we do make more land. Land is reclaimed from the sea, or swamps are drained, or conservation land is released. So, the supply of land isn't fixed, but it doesn't respond much to a change in rent. In other words, land supply is very inelastic. Second, we need to consider landowners who are owner-occupiers. In effect, those landowners are renting land to themselves. They aren't actually paying rent to themselves, but they still face a cost of using their land - there is an opportunity cost, because they could have rented the land to someone else, and they are giving up the rent that they could have received. Owner-occupiers would still rent land to themselves even if the rent was zero, so the supply of land is positive, even if the rent is zero.

Now, let's turn to the situation in the article, and show why increases in council rates lead to higher rents. This is shown in the diagram below. Before councils raised rates, the market is operating at equilibrium, where the supply of land SN0 meets the demand for land DN0. The equilibrium land rent is R0, and the equilibrium quantity of land rented is QN0. The increase in council rates raises the costs of landlords, shifting the supply curve up and to the left, to SN1. The new equilibrium rent is R1, and the equilibrium quantity of land rented is QN1. [*] So, the increase in council rates is passed onto tenants in the form of higher rents.

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[*] Now, you might wonder about the decrease in the quantity of land rented. Where does it go? Notice though that the shift upwards in the supply curve, which represents the increase in costs to landlords, is quite large (shown by the red arrow), while the decrease in quantity of land rented is small by comparison. So, there isn't much change in the quantity of land. Where does it go? Some landlords may leave land fallow, and no longer use it or rent it out. Some may be converted to conservation uses. Either way, that (small amount of) land is no longer available to rent (even to an owner-occupier themselves).

Fast food operators under threat from weightloss drugs

This week my ECONS102 class has been covering (among other things) economic welfare, and last week we covered the model of demand and supply. Interestingly, this NBR article from yesterday (paywalled) gives us an opportunity to apply both of these things:

But it hasn’t stopped Shoeshine’s ears pricking up hopefully at the tidal wave of stories about the ‘miracle’ drug Ozempic, made by Denmark’s Novo Nordisk, the drug initially developed to treat diabetes and now used ‘off label’ across the world to lose weight. The success of Ozempic, and sister drug Wegovy, a USFDA-approved treatment aimed exclusively at weight loss, has been astronomical...

It’s a wave of obesity solutions that’s not yet hit New Zealand, says Dr Luke Bradford, medical director for the Royal New Zealand College of General Practitioners. But, he adds, “it will” – particularly after the patent on pack-leader Ozempic comes off around 2031.

While Ozempic is not available in New Zealand at present, and GPs are prescribing slightly older versions for Type 2 diabetes (Saxenda and Victoza), Bradford said it was a matter of time as supply chains and production lines get up to speed; and as production starts to include oral versions that are easier again to ship.

“These drugs are incredibly effective at what they do,” he says...

For the majority of people, however, the main side effect of taking the likes of Ozempic and Wegovy is that their appetite is substantially reduced, as is their desire for and ability to handle alcohol. Reddit boards that canvas the effect of taking Ozempic are full of people suffering extreme illness after gorging on fast or fatty food (which reacts badly with the drug); enduring ‘hangovers from hell’ (alcohol irritates the stomach lining and exacerbates the drug’s digestive effects); and toilet adventures that don’t bear repeating...

Most companies involved in the fast-food area, as well as the likes of global players including Nestlé and PepsiCo, are looking at how they might need to pivot in this new era of drug-induced weight loss. McDonald’s, which lost 16% in value last year (the result of a number of factors including a cost-of-living crisis, higher input costs affecting profits, a global boycott, changing diets) is among companies investigating healthier, smaller options for weight shedding clientele.

One might think New Zealand’s Restaurant Brands, owners of KFC, Taco Bell, Pizza Hut, and Carl’s Jr across New Zealand, Australia, California, and Hawaii might also be looking at this trend and wondering what it might do to its bottom line.

I don't think that we need to spend too much time wondering, and a consideration of the demand and supply model, and economic welfare, can give us an answer (albeit not a perfect answer). Consider the market for fast food, as shown in the diagram below. The market starts in equilibrium, where the demand curve D0 intersects the supply curve S0, with Q0 fast food traded, at an equilibrium price of P0. Decreased calorie demand from consumers, alongside some pretty awful side effects from consuming fatty foods when using Ozempic or Wegovy, decreases the demand for fast food from D0 to D1. This reduces the equilibrium price of fast food to P1, and decreases the quantity of fast food traded to Q1.

Now, think about what this means for the producers of fast food. Producer surplus is the benefit that sellers get from operating in the market. It is the difference between the price that the sellers receive, and their (marginal) costs. On the diagram above, producer surplus is initially the area P0AC. However, after demand decreases, the producer surplus decreases to the area P1BC. Clearly, the sellers of fast food are made worse off by this change.

It's little wonder that fast food brands' share prices have been tumbling of late. For example, here's Restaurant Brands' share price over the last five years (source here):

For reference, the drug Wegovy was released in 2021, while Ozempic was released in 2017, but was approved for use in weight loss in 2021. Notice that is about the time that the Restaurant Brands share price starts to fall. Share prices reflect markets' expectations about future profits and cashflows (at least, in theory). The falling share prices reveal that the market believes that future profits and cash flows will be lower, possibly because effective weight-loss drugs (especially those that have awful side effects for people eating fatty foods) are going to harm those firms' profits.

Climate change is coming for your morning caffeine fix

The Financial Times reported last week (paywalled):

The price of coffee is set to rise from its current record high as climate change, shipping disruptions and new EU regulations drive up costs for roasters, Italian coffee giant Lavazza has warned...

However, Giuseppe Lavazza, chair of Lavazza Group, which owns Lavazza coffee, said the price of coffee on UK supermarket shelves, which is already up by about 15 per cent this year, could rise close to another 10 per cent by next year...

Coffee roasters such as Lavazza have been forced to put up prices and reduce profit margins as the cost of the raw material has surged, said Lavazza, who is the fourth generation to head the Turin-based coffee group...

“Climate change has affected the production in the most important robusta countries around the world, mainly Vietnam and Indonesia, reducing quite a lot the quantity available of these kinds of varieties.”

Weather forecasts suggest the next Vietnamese harvest will fail to replenish waning supplies of robusta coffee beans, which are used in espresso and for instant coffee.

To see what is going on in the coffee market, we can use the simple model of supply and demand (which I'm covering in my ECONS102 class this week). Consider the coffee market, shown in the diagram below. Last year, the market was operating at equilibrium, where the demand curve D0 intersects the supply curve S0. The equilibrium price of coffee was P0, and Q0 coffee was traded. The poor coffee production due to climate impacts decreases the supply of coffee from S0 to S1. As a result, the equilibrium price of coffee increases to P1, and less coffee (Q1) is traded.

Some consumers may be tempted to switch from coffee to tea (coffee and tea are substitutes). However, there is little respite from the higher prices to be found in tea. Even putting aside the fact that there might be negative climate impacts on tea production, the higher price of coffee, and the switching of consumers from coffee to tea, will likely drive up the price of tea as well.

To see why, consider the market for tea, shown in the diagram below. Last year, the tea market was operating at equilibrium, where the demand curve DA intersects the supply curve SA. The equilibrium price of tea was PA, and QA tea was traded. Consumers switching from coffee to tea increases the demand for tea from DA to DB. This leads to an increase in the price of tea to PB, and an increase in the quantity of tea traded, to QB.

Climate change has a lot to answer for, and now it's coming for your morning caffeine fix. 

Good news for broccoli lovers

The New Zealand Herald reported yesterday:

New Zealand broccoli lovers are in for a treat, as a “phenomenal” season has resulted in great prices for consumers.

According to the latest Stats NZ Food Price Index, the price of broccoli dropped 32.3 per cent in April compared to the same month last year.

Foodstuffs North Island’s head of butchery and produce Brigit Corson said this time a year ago, fresh produce was at the mercy of extreme weather events which wreaked havoc for many growers, but good weather had since turned this around.

“Right now, we’re seeing great supply for produce like broccoli because we’ve had months of fantastic weather, making for near-perfect growing and planting conditions.”

Corson said the price of fresh produce depended on a few different factors, including if it was in season, the growing conditions and whether it was in abundance.

“If there’s been a bumper crop and great supply, that’s when the prices go down.”

It is easy to see why the price of broccoli has decreased, using the model of supply and demand, as shown in the diagram below. Last year, when the conditions for growing broccoli were not good, the supply was S0, and demand was D0. The equilibrium price of broccoli was P0, and the equilibrium quantity of broccoli traded was Q0. This year, with better growing conditions, the supply of broccoli has increased to S1. Another way of thinking about this is that, at each and every price, more broccoli would be supplied, shifting the supply curve out to the right (to S1). The result is that the equilibrium price of broccoli decreases to P1, and the equilibrium quantity of broccoli traded increases to Q1.

Overall, good news for broccoli lovers, and easily anticipated using the model of supply and demand.

The consequences of free drivers licence test resits

The New Zealand Herald reported this morning:

On October 1, at the Labour Government’s directive, NZ Transport Agency Waka Kotahi (NZTA) changed driver licence fees to an all-in-one fee for each stage of testing and the fees to resit a driver test, or to cancel or reschedule, were removed.

The intention was to help ease costs for people going through the driver licensing system. The Transport Minister at the time, Michael Wood, said the changes would save drivers on average $86 each and cumulatively save $5.5 million every year altogether.

But delays to practical test bookings have followed since the change. Average wait times for the week ending April 14 were 44 days for a full licence test throughout the country and 55 days for a restricted test.

The longest delays for a full test were 52 days in the Bay of Plenty, and 68 days in Wellington for a restricted test.

The issue is affecting all regions in New Zealand. As an example, at 10am on April 3 there were only 15 available spots nationwide for a full licence test and only 10 for a restricted licence test.

It should be no surprise that when you lower the price of something, without that price change being driven by a decrease in costs or a decrease in demand, you end up with a shortage. This can be seen in the diagram below. At the original market price for a driver licence test of P0, the quantity of driver licence tests is Q0. That quantity (Q0) is both the quantity of tests demanded, and the quantity of tests supplied (the number of tests available for drivers to take). We can say that the market clears, because quantity demanded is equal to quantity supplied (the market is in equilibrium).

With the market price below equilibrium, at P1, [*] the quantity of driver licence tests demanded is QD, while the quantity of driver licence tests supplied is QS. Since QD is greater than QS, there is excess demand (a shortage). That is what we are seeing, with long waits for driver licence tests.

There are other problems as well. From the same New Zealand Herald article:

[VTNZ’s national technical manager for vehicle testing, Craig] Basher said a large factor of the delays has been the amount of people not showing up to tests, with 2000 no-shows for booked practical tests in the last month.

He has also received feedback that more drivers are turning up unprepared and with unfit cars, making simple mistakes and trying to rebook straight away without further practice.

When a learner driver has to pay for another driving test when they miss an appointment, that creates an incentive to show up, and to show up prepared and with a good quality vehicle. When the learner driver doesn't have to pay, the incentive to show up is much less. In other words, the opportunity cost of missing a driving test is lower when learner drivers don't have to pay for the next appointment. When the opportunity cost of something decreases, people tend to do more of it. In this case, that means more missed driving test appointments.

None of this is surprising to an economist. And the solution is obvious:

[Minister of Transport, Simeon] Brown said he is talking with NZTA and the Ministry of Transport to deal with the issue, which he said could include reintroducing resitting fees.

Some may argue that increasing the number of test slots, and increasing the number of driving instructors, would decrease the shortage. However, that ignores that part of the problem is the number of missed appointments. Both the shortage and the excessive number of missed appointments could be alleviated if the price of repeat driving tests was allowed to increase. Learner drivers would have to pay a little more to get their licence, but they wouldn't have to wait as long, and would have a stronger incentive to show up for their driving test well-prepared.

*****

[*] Notice that the price doesn't fall all the way to zero, because the first drivers test is not free, only the resits. So, the average price of a drivers licence test is not zero.

The global price of nickel collapses, and Australian miners are hurting

This article in The Conversation yesterday by Mohan Yellishetty (Monash University) discussed the state of the global market for nickel:

Nickel is a metal crucial for the production of stainless steel, alloys, electroplating and the batteries used in electric vehicles.

The global price has dived from a high of US$50,000 in 2022 to just US$16,400 per tonne on Monday in response to a huge increase in supply from Indonesia, much of it from Chinese-owned and operated mines.

To see how this works, consider the diagram below, which represents the market for nickel. Before the increase in supply from Indonesian nickel mines, the supply was S0, and demand was D0. The equilibrium price of nickel was P0 (US$50,000), and the equilibrium quantity of nickel traded was Q0. The increase in the global supply of nickel to S1 decreased the equilibrium price to P1 (US$16,400), and increased the equilibrium quantity of nickel traded to Q1.

Should we be worried about this situation? Yellishetty clearly is:

Australia is a leading producer of critical minerals, supplying all ten of the elements needed for lithium-ion batteries, and has the advantage of better environmental, social, and governance (ESG) standards that make it an attractive destination for investment.

But it lacks the capacity to refine all of its own production, meaning it has to dispose of many of the critical minerals it extracts as byproducts...

Until Australia can find a way to break free of the market stranglehold of our biggest customer, those investments will remain at risk.

Australian nickel producers are now receiving a much lower price for their nickel. Clearly, that makes them worse off. Nickel is less profitable, and: 

On Thursday BHP wrote down the value of its West Australian nickel division Nickel West to zero and said it was considering placing the entire division into a “period of care and maintenance”.

Some Australian producers (like BHP) may shut down operations, albeit temporarily (in mining terminology, "care and maintenance" refers to a temporary closure).

However, the negative impact on Australian miners isn't the end of the story. Nickel consumers are clearly better off, because they are now buying more nickel (the equilibrium quantity has increased), and they are paying a lower price per tonne. Since nickel is an input into the production of a number of products, such as electric vehicle batteries, lower nickel prices lower the production costs of those products. That flows through into lower prices of the final products that include nickel as an input, meaning lower prices for electric vehicles and replacement batteries. [*] So, it's not all bad.

Some people may be concerned that the nickel profits are going to Chinese-owned mining firms. However, that concern would need to be weighed up against the fact that consumers (including Western consumers) will benefit from lower nickel prices. The Australian mines aren't going away completely, unless for some reason they lose the capability necessary to re-start production. If that were to happen, then maybe governments might decide to act, but not right now.

*****

[*] The relevant market diagram for the electric vehicle battery market is exactly the same as the one shown above. Lower costs of production lead to an increase in supply (because the supply curve shows the marginal costs of production, and lower costs shift that curve down and to the right), which decreases the equilibrium price and increases the equilibrium quantity of electric vehicle batteries.

Drought in Central America, and prices in Australia

In an article in The Conversation last month, Stephen Bartos (University of Canberra) wrote that:

What does a drought in Central America have to do with Australia’s cost of living? Quite a lot, if the drought affects the Panama Canal.

The 425 square kilometre Gatun Lake was built in the early 1900s to store water for the Panama Canal. Water is needed to float ships so they can navigate the canal. Now drought has severely affected the lake’s water levels.

Because of this the Panama Canal Authority has had to cut the number of ships using it. Hundreds of ships have queued up to wait their turn...

Delays mean higher costs. These in turn flow on to prices charged by wholesalers and retailers. We see it in the prices we now pay for the goods we buy.

Supply chain disruptions are only one of the many reasons why the cost of living is going up.

To see how the shipping delays caused by the low water levels in the Panama Canal affect prices of goods in Australia, consider the market for some good that is produced in Europe (or the East Coast of the US) and then transported to Australia, as shown in the diagram below. Initially, the market operates at equilibrium, where the demand curve D0 intersects the supply curve S0. The equilibrium price of the good is P0, and Q0 of the good is traded. The delays increase the costs of supplying the good to consumers in Australia. This is represented by a decrease in the supply of the good from S0 to S1. As a result, the equilibrium price of the good increases to P1, and less of the good (Q1) is traded.

So, while the Panama Canal is far from Australia, the low water levels there flow through into higher prices in Australia. This won't affect all goods directly, as many goods (and basically all services) don't require transport through the Panama Canal. However, as Bartos notes:

Yes Panama, at 1,000 kilometres north of the equator, is in the northern hemisphere. For trading, it is more important to America and northern Asia.

But Australia will still be affected by the disruption. Our supply chains are connected. Ripple spread through supply chains through prices. Even if products we buy or sell are not physically in the affected part of a supply chain, when their prices increase ours do too.

Bartos offers a solution to these higher prices:

Strategies for dealing with the unavoidable impacts on supply chains include diversifying.

This would mean having more suppliers, all using different chains, so that if one fails, we have other options.

Shortening chains by using more local suppliers where possible, would also help, as would embracing the joy of substitution – if one product becomes more expensive or unavailable, often there is another just as good.

Of course, none of those solutions really solve the problem of higher prices, because they must be higher-cost options than the existing transportation of goods through the Panama Canal. If they weren't higher cost, then someone would be using them already! As for substituting for other goods (such as those produced locally), that will increase the demand for those substitute goods. This is shown in the diagram below. Initially, this market operates at equilibrium, where the demand curve DA intersects the supply curve SA. The equilibrium price of the good is PA, and QA of the good is traded. The increase in the demand from DA to DB leads to an increase in the price of the substitute goods to PB, and an increase in the quantity of the substitute good traded, to QB.

So, the prices of goods transported via the Panama Canal increase, and the prices of substitute goods also increase. Overall, higher prices seem almost inevitable - all that Bartos is really suggesting is that Australians have a choice over how they end up with those higher prices.

The price of beer in Abu Dhabi and Sharjah

In my ECONS102 class, we discuss the difference between a market where the sale and purchase of a good is illegal, and a market where the sale and purchase of the same good is legal. One surprising result is that it is not certain that the good will be more expensive in the market where it is illegal.

Consider the example of the market for beer in Abu Dhabi and Sharjah (two of the United Arab Emirates). Alcohol sale and consumption is legal in Abu Dhabi (although public intoxication is not), whereas alcohol sale and consumption are illegal in Sharjah (see here or here). Now consider the difference in the price of beer between the two markets. We can demonstrate this with a supply and demand diagram, as shown below. Demand for beer will be lower in Sharjah (DS) than in Abu Dhabi (DA), because consumers must consider the risk of punishment for consuming alcohol in Sharjah, whereas there is less risk in Abu Dhabi (unless the consumer is drunk in public). Similarly, the supply of beer will be lower in Sharjah (SS) than in Abu Dhabi (SA), because sellers face higher costs in Sharjah, due to the costs associated with the punishment of being caught.

Now compare the equilibrium price and quantity in each emirate. The quantity of beer traded (adjusted for population differences) is higher in Abu Dhabi (QA) than in Sharjah (QS). However, the equilibrium price of beer is lower in Sharjah (PS) than in Abu Dhabi (PA). How can this be? Notice that the difference in demand between the two countries is larger than the difference in supply. A lower supply increases the equilibrium price, while a lower demand decreases the equilibrium price. The two effects offset each other, so when the demand difference is larger, the net effect is a lower price. If, instead, the difference in supply was larger than the difference in demand, then the price would have been higher in Sharjah than in Abu Dhabi. And if the differences in supply and demand were exactly the same, then the price would have been the same in both emirates. In other words, while the difference in quantity is clear, the difference in equilibrium price is ambiguous - the price could be higher, lower, or the same in Sharjah as in Abu Dhabi, depending on the relative difference in supply and demand.

That the price may be lower where a good is illegal is quite counter-intuitive. The reason why this result is counter-intuitive is because most people jump immediately to what they think the price difference should be, and try to work backwards from that. However, economists know that you should never reason backwards from a price change. Instead, economists use a model (in this case, supply and demand) and work out the difference in price as the last step in the process (not the first step).

The result is counter-intuitive, but is it realistic? According to the website Expatistan, the price of a beer at a neighbourhood pub in Abu Dhabi is 40 Dirham, while the price of the same beer in Sharjah is 31 Dirham. [*] So, it may be realistic. Surprising as it may be, a good sold in a place where it is illegal may not be more expensive than the same good sold in a place where it is legal.

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[*] I have no idea how they gathered the price data for Sharjah. It is apparently based on seven observations as of June 2022, so I'm taking it at face value.