Egg prices will rise in New Zealand, even without a major avian flu outbreak

Last year, I posted about avian flu in the US and the impact on egg prices, noting that prices will rise. Thankfully there hasn't been a major outbreak of avian flu in New Zealand as yet, although it seems likely there will be soon. Domestic birds, such as chickens, are at risk, and as I noted in that earlier post, that affects the supply of eggs. And New Zealand egg suppliers are acting now, as the New Zealand Herald reported earlier this week:

It comes as New Zealand’s largest egg supplier Mainland Poultry, accounting for nearly 40% of the country’s eggs, is putting hundreds of thousands of free-range chickens into lockdown after the deadly bird flu virus was detected in the country last week.

Putting free-range chickens into lockdown will raise the costs of production for free-range eggs. The effect on the market for free-range eggs is shown in the diagram below. Before the chickens were locked down, the free-range egg market was in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of free-range eggs traded of Q0. The lockdown increases the costs of producing free-range eggs, which decreases supply to S1. This increases the equilibrium price of free-range eggs to P1, and reduces the quantity of free-range eggs traded to Q1.

Free-range eggs and colony eggs are substitutes. Once free-range eggs become relatively more expensive, some consumers will switch to colony eggs. The effect on the colony eggs market is shown in the diagram below. Before the change in the price of free-range eggs, the market for colony eggs was in equilibrium, where demand DA meets supply SA. The equilibrium price was PA, and the quantity of colony eggs traded was QA. Since some consumers switch to the relatively cheaper colony eggs, that increases the demand for colony eggs from DA to DB, increasing the equilibrium price of colony eggs from PA to PB, and increasing the quantity of colony eggs traded from QA to QB.

Overall, eggs are going to cost more, regardless of whether they are free-range eggs or colony eggs. And even without a major outbreak of avian flu. If avian flu does take hold in New Zealand, the price of eggs of both varieties will go up even further.

Farmers can't avoid high synthetic nitrogen fertiliser prices by switching to organic fertiliser

The New Zealand Herald reported yesterday:

New Zealand farmers face hefty increases in the price of fertiliser this spring as a result of the escalating US-Iran conflict and the war in Ukraine.

The Middle East plays a big role in the global fertiliser market because of its supply of natural gas and mineral resources.

Russia is also a major supplier of fertiliser.

Renewed hostilities in the Persian Gulf – and the virtual closure of the Strait of Hormuz – have driven oil prices up to about US$90 ($154) a barrel for Brent crude, the international benchmark.

Synthetic nitrogen fertiliser is generally manufactured from ammonia created using the Haber-Bosch process. This requires hydrogen, which is often derived from natural gas (mainly methane). Since the Middle East is a major supplier of natural gas, a lot of nitrogen fertiliser is manufactured in the Middle East. The current conflict in the Middle East is constraining the transport of nitrogen fertiliser from the Persian Gulf, reducing the supply of nitrogen fertiliser.

The effect of this on the market for nitrogen fertiliser is 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 nitrogen fertiliser traded of Q0. The Middle East conflict reduces shipping of nitrogen fertiliser, which decreases supply to S1. This increases the equilibrium price of nitrogen fertiliser to P1, and reduces the quantity of nitrogen fertiliser traded to Q1.

Can farmers avoid the higher price of nitrogen fertiliser by switching to an alternative product, such as organic fertiliser (compost, or manure)? Not really. Consider what happens in the market for organic fertiliser, shown in the diagram below. Before the change in the price of nitrogen fertiliser, the market for organic fertiliser was in equilibrium, where demand DA meets supply SA. The equilibrium price was PA, and the quantity of organic fertiliser traded was QA. Since nitrogen fertiliser and organic fertiliser are substitutes, and nitrogen fertiliser is now relatively more expensive (as shown above), farmers switch to the relatively cheaper organic fertiliser. That increases the demand for organic fertiliser from DA to DB, increasing the equilibrium price of organic fertiliser from PA to PB, and increasing the quantity of organic fertiliser traded from QA to QB.

So, the effect overall is that the price of both nitrogen fertiliser and organic fertiliser increase. Farmers cannot easily avoid high fertiliser prices. We can expect that to flow through into higher prices for farm produce, as well as lower profits for farmers.

The supply-side story behind falling meth prices in New Zealand

Chris Wilkins, Marta Rychert, and Robin van der Sanden (all Massey University) wrote an article in The Conversation last month about the price of methamphetamine:

Methamphetamine has become dramatically cheaper over the past seven years, even as authorities report record seizures, according to the latest New Zealand Drug Trends Survey.

The annual online survey of over 8,800 people who use drugs shows wholesale prices of the illegal and harmful substance (per gram sold to dealers) have fallen by 41%, while street-level “point” prices (0.1 gram retail deals) have dropped by 27%.

The decreasing price of meth is not a new phenomenon. In fact, I wrote about it last year. Wilkins et al. try to tease out the reason underlying the decreasing price. Based on a simple supply and demand model of the market for meth, there are two main possibilities: an increase in supply, or a decrease in demand. Wilkins et al. go through a number of plausible factors on both sides of the market, dismissing each in turn, including:

• sellers feeling that there is less risk of arrest (which would increase supply), but Police report record seizures, which Wilkins et al. argue seems to rule that out;
• less strict enforcement by Police against people found with small quantities of drugs (which would increase supply, but probably demand as well), but that wouldn't affect large sellers;
• decreasing production costs (which would increase supply), but production costs only make up a fraction of the street price; and
• a decrease in buyers (which would decrease demand), but wastewater data suggests that meth consumption has increased.

The last point, that meth consumption has increased alongside the decrease in price, points strongly to an increase in supply as the main change. That doesn't rule out a change in demand, but the increasing consumption tells us that the increase in supply must be greater than any possible decrease in demand. But if it isn't lower risks of arrest, weaker enforcement, or decreasing production costs, that is causing supply to increase in the New Zealand meth market, then what is? Wilkins et al. point to:

...new global sources of methamphetamine supply.

New Zealand and Australia have traditionally sourced methamphetamine from lawless regions of Asia known as the Golden Triangle. More recently, however, growing seizures have been linked to Mexican drug cartels, often transiting through Canada.

Australian authorities say these cartels can supply methamphetamine at less than one-third the price of Asian producers and that about 70% of seized meth now originates from North America.

It may also explain the rising supply of cocaine in New Zealand, with Mexican cartels deeply involved in global cocaine trafficking.

So, new sources of meth have increased the supply, decreasing the equilibrium price, and increasing the quantity of meth traded in the New Zealand market. Wilkins et al. also point to competition:

On top of this, digital drug markets – including darknets and social media sales – may be lowering the cost of finding alternative sellers and better deals, increasing competition and pushing prices down.

Economists often think of competition as a good thing. However, in the market for illegal drugs, that might not necessarily be the case. How can government best respond? Fighting the supply side of the market alone is unlikely to be successful, as I have noted before. The increased supply from new sources make this even more challenging. A renewed focus on reducing demand is necessary as well, and would likely be much more effective in the long run.

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

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.

Anticipating higher future petrol prices, consumers actually push up petrol prices now

In his 1984 book The Evolution of Cooperation, Robert Axelrod suggested that people cooperate in repeated games because of 'the shadow of the future'. They alter their behaviour by cooperating now, because they anticipate that will lead to greater gains for them in the future. I really like this analogy of the shadow of the future affecting our decisions now, and not just in the context of game theory and repeated games. In fact, we've seen it play out in a different context this past week, as reported by the New Zealand Herald:

Kiwis are rushing to fill up their cars across the country amid fears of price increases at the pump because of escalating conflict in the Middle East.

Video sent to the Herald of Waitomo Tinakori petrol station in Wellington today showed a queue of cars waiting for fuel, with vehicles spilling out on to the road.

Waitomo Group CEO Simon Parham said there has been a similar increase in demand at stations across the country, with sales increasing by 10-15% this week.

“People are filling up and filling their cars ahead of the price increase that will flow through the market over the coming weeks because of the Iran conflict,” he said.

To see what is going on here, let's consider the retail market for petrol, as shown in the diagram below. Before the current conflict in the Middle East, the equilibrium price of petrol was P0, and Q0 petrol was traded per week. Then the conflict begins. Consumers anticipate that the price of petrol will increase in the future, so they decide to fill up their vehicles now. That increases the demand for petrol from D0 to D1. The equilibrium price of petrol increases to P1, and there is Q1 petrol traded in the week. 

Notice that by trying to avoid the high petrol price in the future, the consumers cause the price to rise today, which is exactly the outcome they were trying to avoid! In effect, when consumers rush to fill up early, they bring some of the future price pressure forward into the present. Expectations about future prices can cause self-fulfilling prophecies like this, which is a point I will make in my ECONS101 class in several weeks, when we talk about financial markets (where self-fulfilling prophecies are a clear and present danger at all times). The shadow of the future matters - consumers' actions based on trying to avoid future price rises make those price rises happen now instead.

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.

International trade and the domestic price of butter in New Zealand

If you're in New Zealand, you probably couldn't avoid the news over the last six months about the price of butter. In case you missed it though, this New Zealand Herald article from January explains:

The price of butter has topped $9 for a 500g block in some shops and one analyst is warning prices could stay high for months due to global butter supply shortages...

A spokesperson for New World and Pak’nSave operator Foodstuffs said any change in supplier pricing had a direct impact on the price for customers.

“The price of butter on our shelves is primarily influenced by the broader dairy market and the wholesale costs set by our suppliers,” the spokesperson said.

“Over the past 18 months, global butter commodity costs have risen by around 43%...

ANZ agricultural economist Susan Kilsby said butter prices had lifted by 24% over the past year in the global markets.

“Demand for cream [which is used to make butter] does tend to peak over the Christmas holiday period which tightens supply available for butter,” Kilsby said.

“Butter has been in short supply in some parts of the world, as dairy production is relatively stagnant in many markets, whilst demand continues to lift.”

Unfortunately for Kiwi consumers, Kilsby expected butter prices to stay relatively high for the next three to six months.

Let's unpack what's going on with the price of butter. First, let's consider the impact of international trade. This is shown in the diagram below. New Zealand is an exporting country, which means that New Zealand has a comparative advantage producing butter (and other dairy products). That means that New Zealand can produce butter at a lower opportunity cost than other countries. On a supply-and-demand diagram like the one below, it means that the domestic market equilibrium price of butter (PD) would be below the price of butter on the world market (PW0). Because the domestic price is lower than the world price, if New Zealand is open to trade there are opportunities for traders to buy butter in the domestic market (at the price PD), and sell it on the world market (at the price PW0) and make a profit (or maybe the suppliers themselves sell directly to the world market for the price PW0). In other words, there are incentives to export butter. The rest of the world is willing to buy as much butter as we are willing to supply. [*] So, the demand curve in the domestic market for butter becomes D+exports (the red line in the diagram). The price in the domestic market is determined by the intersection of that demand curve and the supply curve, which is the price PW0. The domestic consumers end up having to pay the price PW0 for butter, since they are competing with the world price (and who would sell at the lower price PD when they could sell on the world market for PW0 instead?). At this higher price, the domestic consumers choose to purchase Qd0 butter, while the domestic dairy farmers sell Qs0 butter (assuming that the world market could absorb any quantity of butter that was produced). The difference (Qs0 - Qd0) is the quantity of butter that is exported.

In terms of economic welfare, if there was no international trade in butter, the market would operate at the domestic equilibrium, with price PD and quantity Q0. Consumer surplus (the gains to domestic timber consumers) would be the area AEPD, the producer surplus (the gains to domestic dairy farmers) would be the area PDEF, and total welfare (the sum of consumer surplus and producer surplus, or the gains to society overall) would be the area AEF. With trade, the consumer surplus decreases to ABPW, the producer surplus increases to PWCF, and total welfare increases to ABCF. Since total welfare is larger (by the area BCE), this represents the gains from trade. So to summarise, exporting butter makes domestic butter consumers worse off (lower consumer surplus), domestic dairy farmers better off (higher producer surplus), and society overall better off (higher total welfare).

Now consider how the increase in worldwide demand for butter (as noted in the article) affects the world market for butter, as shown in the diagram below. World demand has increased from DW0 to DW1, and that increases the equilibrium world price from PW to PW1.

Now, let's go back to the New Zealand domestic market for butter. The world price has increased from PW to PW1, as shown in the diagram below, and demand including trade has moved up from D+exports to D+exports1. Now, the domestic consumers have to pay the higher price PW1 for butter, since they are still competing with the world price (and the world price is now higher). At this higher world price, the domestic consumers now choose to purchase Qd1 butter, while the domestic dairy farmers now sell Qs1 butter (still assuming that the world market could absorb any quantity of butter that was produced). The quantity of exports is now (Qs1 - Qd1). That means that more butter is now being exported.

What does that mean for economic welfare? With the higher world price, the consumer surplus decreases further to AGPW1, the producer surplus increases further to PW1HF, and total welfare increases further to AGHF. In other words, the increase in the world price of butter makes domestic consumers worse off, but it makes domestic dairy farmers better off, and society overall better off.

While we might like dairy farmers to sell us butter at a lower price than they can receive from the world market, there is little incentive for them to do so. New Zealand butter consumers must pay the world price of butter. The world price has increased, so the domestic price of butter must increase as well. That higher butter price makes dairy farmers (and society overall) much better off. However, that will come as cold comfort to households that must pay a small fortune to butter their toast.

*****

[*] This assumes that the domestic market for butter in New Zealand is a small proportion of the total world market, such that domestic supply and demand do not affect the world price. For butter, that is unlikely to be true, as New Zealand exports a substantial proportion of global butter supply. However, for the purposes of this analysis, it doesn't have a big impact since we are not considering changes in domestic market conditions.

Why the accommodation supplement does little to help low-income tenants

In an article in The Conversation earlier this year, Edward Yiu and William Cheung (both University of Auckland) discuss New Zealand's accommodation supplement for low-income renters:

New Zealand’s unaffordable housing market has left many low and middle-income families reliant on the accommodation supplement to cover rent and mortgage payments.

But our new research has found the scheme, which costs the government almost NZ$2 billion a year, might not be an effective tool in addressing the country’s housing affordability crisis.

Introduced in 1993, the accommodation supplement is a weekly, means-tested payment designed to subsidise part of a household’s rent or mortgage. The supplement is calculated using the actual rent or mortgage payments a client is paying.

But our study looking at data from Auckland between 2019 and 2023 found accommodation supplement rental subsidies were not delivering meaningful improvements in affordability for renters.

That the accommodation supplement doesn't deliver improvements in affordability for renters is consistent with a simple model of the market for rental housing, as shown in the diagram below. This is the stylised version of this market that I use in my ECONS102 class, and is based on the rental market for land. In this market, the supply curve is very inelastic (very steep), and starts at a positive quantity (meaning that if rent falls to zero, there is still a positive quantity of land that is made available to rent). That's because of two reasons. First, this market includes owner-occupiers. They would rent land to themselves, even if the rent falls to zero (that explains the positive quantity when the rent is zero). Second, the quantity of land supplied doesn't respond very much to the rent - landlords can't suddenly make more land available - as Mark Twain once noted: "The thing about land is, they aren't making it anymore". Twain isn't quite correct, as land can be reclaimed from the ocean. However, landlords are unlikely to be very responsive to changes in rent, making the supply curve very inelastic.

Now, consider this market operating at equilibrium (with no accommodation supplement). The market operates at the point where supply meets demand, at a rent of R0, with Q0 housing (technically, land) rented. The accommodation supplement acts as a subsidy, paid to the tenants. We show this on the diagram with a new curve, D+subsidy, which lies above the demand curve D. It acts like an increase in the demand for rental accommodation. The price that landlords receive for housing increases to RL. That is the rent that tenants pay to the landlords. However, once the accommodation supplement is subtracted, the effective rent paid by the tenants decreases to RT (the difference between RL and RT is the amount of the accommodation supplement).

But notice the difference in the rents with the accommodation supplement to the equilibrium rent. The rent that landlords receive increases by a lot (from R0 to RL). The effective rent paid by tenants is barely affected (decreasing from R0 to RT). Landlords benefit the most from the accommodation supplement, with tenants barely benefiting at all. That is because the side of the market (supply or demand) that is more inelastic will always capture most of the gains from a subsidy. In this case, the supply is very inelastic (and certainly more inelastic than demand), so landlords stand to gain most from the subsidy.

It gets worse though. The increase in rents that landlords receive also affects rents paid by tenants who don't receive the accommodation supplement at all. These higher-income tenants pay higher rents as well, because they have to compete with the subsidised tenants for housing. However, the government doesn't provide them with any subsidy, making them clearly worse off as a result.

So, it should be no surprise that the accommodation supplement does not deliver meaningful improvements in affordability for renters. It barely has any effect on the effective rent paid by tenants who receive the accommodation supplement, and raises the rents paid by tenants who don't receive the accommodation supplement.

Are there better options? Yiu and Cheung suggest that:

...mortgage support seems to level the playing field more effectively than rental assistance.

Possibly. If a mortgage subsidy allows some low-income tenants to become owner-occupiers instead, then they will benefit greatly (from capital gains, as well as many other benefits associated with home ownership). If the mortgage subsidy is given to landlords as well, it might help to lower rents. Overall, it could well be more effective than the current accommodation supplement paid to tenants. It is certainly something worth further exploration.

When drug prices fell, Mexican drug cartels pivoted to avocados

One of the determinants of the market supply of a good is the price of other goods that the seller could sell instead (what we refer to as 'substitutes in supply'). For example, consider a seller that could use their resources to produce two goods, A and B. Say that the price of A decreases, while the price of B stays the same. The seller will respond by using less of their resources to produce A, and therefore using more resources to produce B. The quantity of A supplied will decrease, while the supply of B will increase. [*]

The Waikato Economics Discussion Group looked at an example like this at our meeting today, based on this recent article by Itzel De Haro (University of Navarra), published in the journal World Development (open access). De Haro looks at whether, when the price of heroin in the US fell because of the introduction of fentanyl, the Mexican drug cartels pivoted to the avocado industry instead. In short, De Haro finds evidence consistent with that story, and consistent with the theory of the supply curve outlined above. Let's break down how De Haro showed this.

De Haro first notes that:

Mexico is also the main exporter of heroin to the U.S., responsible for 90% of the heroin consumed in the country... Consequently, fluctuations in heroin demand in the U.S. can significantly impact opium production, cartel competition and violence within Mexico...

However, beginning in 2013, the demand for opioids shifted due to the introduction of Fentanyl in the U.S...

The decrease in the U.S. demand for heroin directly affected the demand for raw opium paste used to produce heroin. As a result, prices of opium paid by drug cartels to opium farmers in Mexico decreased significantly, falling 50% to 80% between 2017 and 2019...

In other words, the price of heroin decreased, and heroin became less profitable for drug cartels. Poppy farming also became less profitable for farmers So, it is natural for the cartels (and poppy farmers) to look for alternative (and more profitable) uses of their resources. De Haro built a crop suitability index for poppy and avocado growing for the eight states in Mexico that are the main focus of the study. The index is based on the FAO’s Ecological Crop Requirements (Ecocrop) database, and historical precipitation and temperature data obtained from AgMerra, along with land elevation data from INEGI. The two suitability indexes look very similar geographically. From Figure 5 (panels (c) and (d)) in the paper:

Notice that the areas that are most suitable for growing avocados (the darker green areas on the map on the left) are to a large extent the areas that are most suitable for growing poppies (the darker blue areas on the map on the right). So, farmers have a choice of using the land for growing poppies or avocados. And cartels have a choice of targeting poppy farmers or avocado farmers in a particular area.

De Haro then looks at violence and cartel activity data across those eight states over the period from 2011 to 2019. Specifically, De Haro looks at the overall homicide rate, the homicide rate for agricultural workers, the homicide rate for males aged 15-40 killed by a firearm (as a proxy for inter-cartel violence), and drug cartel presence (based on various measures derived from data from the Mapping Criminal Organizations (MCO) project). The main regression specification looks at whether US fentanyl deaths in the previous year affects violence (or cartel activity) in the current year, differently in areas that are more suitable for growing avocados and areas that are more suitable for growing poppies, controlling for a variety of other variables.

First, looking at violence, De Haro finds that:

...the introduction of Fentanyl in the U.S. led to increases in the homicide rates of avocado-suitable municipalities, while having the contrary effect on poppy-suitable municipalities.

Because the suitability index is just an index, the actual coefficients on the variables in the regression don't have a natural interpretation (and the interaction effects make things tricky). However, it looks like a one-standard-deviation higher avocado suitability is associated with a 7.1 percent increase in the homicide rate, while a one-standard-deviation higher poppy suitability is associated with a 6.9 percent decrease in the homicide rate. De Haro also finds an:

...increase in homicides of agricultural workers for avocado-suitable municipalities, suggesting that cartels may be using force to extract revenue from farmers, possibly to enforce extortion payments, or through violent robberies.

The effects are slightly larger here, with a one-standard-deviation higher avocado suitability associated with an 8.3 percent increase in the agricultural worker homicide rate, and a one-standard-deviation higher poppy suitability associated with a 7.4 percent decrease in the homicide rate. Finally, for inter-cartel violence, De Haro finds:

...no effect in avocado-suitable municipalities and a decrease in poppy-suitable municipalities...

This latter null effect might seem surprising. However, whether cartels are fighting over poppies or fighting over avocados, the amount of fighting may well be similar. And what De Haro finds is consistent with that. Turning to cartel presence generally, De Haro finds:

...small and no statistically significant effects on cartel presence and market concentration in municipalities suited for avocados. This suggests that, despite substantial revenue growth in the avocado industry over the past two decades, the potential profits that cartels can extract are not significant enough for them to move into these municipalities.

Another way of interpreting this last result is that the cartels don't need to move into the avocado-suitable municipalities because those municipalities are also generally those that are poppy-suitable, and therefore the cartels are already there!

So, overall, De Haro finds evidence that cartels redirected their attention from poppies to avocados, when the price of heroin (derived from poppies) fell, decreasing the profitability of poppy cultivation. The practical effect was more homicide of agricultural workers in areas more suitable for avocado growing, and less homicides of agricultural workers in areas more suitable for poppy growing.

When the price of a good falls (poppies), sellers want to sell less of it, and instead use their resources for something else (avocados) instead. It turns out that drug cartels act like rational and profit maximising sellers.

*****

[*] The difference in terminology here is important. A given supply curve holds constant all of the determinants of supply other than the price. When there is a change in price, the market moves along the supply curve (a change in quantity supplied). When there is a change in one of the other determinants of supply (other than price), the entire supply curve shifts (a change in supply). In this example, because the price of A has decreased, the market moves along the supply curve for A. The seller wants to sell less of A because the price is now lower, so there is a decrease in the quantity of A supplied. The price of B has not changed, but one of the other determinants (the price of the substitute in supply, A) has decreased. That leads the seller to want to sell more of B, so there is an increase in the supply of B. This change happens regardless of the price of B. In other words, the seller would want to sell more of B at each and every price. The entire supply curve for B will shift to the right.

Your matcha fix is going to cost you more

The New Zealand Herald reported last month:

At a minimalist Los Angeles matcha bar, powdered Japanese tea is prepared with precision, despite a global shortage driven by the bright green drink’s social media stardom.

Of the 25 types of matcha on the menu at Kettl Tea, which opened on Hollywood Boulevard this year, all but four were out of stock, the shop’s founder Zach Mangan told AFP.

“One of the things we struggle with is telling customers that, unfortunately, we don’t have” what they want, he said.

With its deep grassy aroma, intense colour and pick-me-up effects, the popularity of matcha “has grown just exponentially over the last decade, but much more so in the last two to three years”, the 40-year-old explained.

It is now “a cultural touchpoint in the Western world” - found everywhere from ice cream flavour boards to Starbucks.

This has caused matcha’s market to nearly double over a year, Mangan said.

“No matter what we try, there’s just not more to buy.”

Thousands of kilometres away in Sayama, northwest of Tokyo, Masahiro Okutomi - the 15th generation to run his family’s tea business - is overwhelmed by demand.

“I had to put on our website that we are not accepting any more matcha orders,” he said.

Producing the powder is an intensive process: the leaves, called “tencha”, are shaded for several weeks before harvest, to concentrate the taste and nutrients.

They are then carefully deveined by hand, dried and finely ground in a machine...

“It takes years of training” to make matcha properly, Okutomi said. “It’s a long-term endeavour requiring equipment, labour, and investment.”

What has happened in the market for matcha is explained in the diagram below. The market started at equilibrium, where the supply curve S0 met the demand curve D0. The equilibrium price of matcha was P0, and the quantity of matcha traded was Q0. Demand increases to D1. If prices don't adjust and remain at the original price of P0, then the quantity of matcha supplied remains at Q0, but the quantity of matcha demanded increases to QD. There will be a shortage of matcha.

However, when there is a shortage the market will eventually adjust, and the price will increase to the new equilibrium price of P1 (where the supply curve S0 meets the new demand curve D1), while the quantity of matcha traded increases to Q1. But notice that, even if the market adjusts to a new equilibrium, the quantity of matcha increases only slightly. That's because the supply curve is very inelastic (very steep). That's because the matcha producers cannot adjust quickly to the change in price by producing more - it takes a lot of time to add productive capacity in matcha.

Finally, the price of matcha drinks is also going to increase. To see why, consider the market for matcha drinks, shown below. The market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and a quantity of matcha drinks traded of Q0. The cost of matcha increases, so tea sellers face higher costs of production. This decreases the supply of matcha drinks to S1. This increases the equilibrium price of matcha drinks to P1, and reduces the quantity of matcha drinks traded to Q1.

Be prepared to pay more for your favourite matcha drinks.

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

Mexico's lake of tequila

What happens when prices fail to adjust to a new equilibrium? Mexico found out the hard way at the end of last year, as the Financial Times reported in December (paywalled):

Mexico is sitting on more than half a billion litres of tequila in inventory, almost as much as its annual production, as the fast-growing industry reckons with slowing demand and the prospect of tariffs on exports to the US under Donald Trump.

By the end of 2023, the industry had 525mn litres of tequila in inventory, either ageing in barrels or waiting to be bottled, according to data shared with the Financial Times by the Tequila Regulatory Council. Of the 599mn litres of tequila produced last year, about one-sixth remained in inventory, according to the figures.

“Much more new spirit is being distilled than is being sold, and inventories are starting to accumulate,” said Bernstein analyst Trevor Stirling, attributing the build-up to falling demand and new distillery capacity that has recently begun operating in Mexico. “The tequila industry is set for a very turbulent 2025.”

Consider the market for tequila, as shown in the diagram below. The market was originally in equilibrium, where the supply curve S0 meets the demand curve D0, with an equilibrium price of P0 and Q0 units of tequila being traded. Then demand decreased to D1, and supply decreased to S1. The market should move to the new equilibrium, where the supply curve S1 meets the demand curve D1. However, say that the price remained at the original price P0 for a little while. What would happen?

If the price remained P0, the quantity of tequila supplied would increase to QS (because with the supply curve S1, the quantity supplied at the price P0 is equal to QS). The quantity of tequila demanded would decrease to QD (because with the supply curve D1, the quantity demanded at the price P0 is equal to QD). The difference between QS and QD is the quantity of tequila that remains unsold - a surplus, or excess supply. Or, as the FT article refers to it, a 'tequila lake'.

What happens next? In a market with excess supply, we would expect the price to adjust. Since tequila distilleries can't sell all of their tequila inventory, and it is costly to store it, they would start to lower the price. This 'bidding down of the price' by sellers would continue until the excess supply is eliminated. On the diagram above, that happens when the market gets to the new equilibrium, at the lower price P1, where Q1 tequila is traded.

And the FT article even notes some evidence that this adjustment is happening:

Two of the largest tequila brands, Bacardi-owned Patrón and Casamigos, which is now owned by London-listed Diageo, have been cutting prices for more than a year in response to weaker consumer demand, according to research by Bernstein.

Eventually, there would be no more tequila lake. Which is sad, because it calls to mind some interesting imagery. Here's what ChatGPT thinks a tequila lake looks like:

That's one way to get rid of the tequila lake, I guess!