When consumers of toilet paper first became aware of the coronavirus and the possibly lengthy stay-at-home orders that seemed sure to follow, the reaction generally fell one of two ways. It might seem like the process doesn’t involve many human beings at all, because it’s so automated. On the other hand, people who used to work outside now use more toilet paper at home (40% more by one estimate), as they use none at work (or in restaurants, hotels, or schools). How many of those do you think are maximizing profit? Few everyday experiences have defined the coronavirus pandemic like the toilet paper shortage we all saw. When we’re describing real life, and not just an economic model, we need to always remember that part. The demand in the U.S. is estimated at 10,000 doses a year, but it costs the same to build a plant that can make 1,000,000 doses as it does to make 10,000. So, either you’re not assuming firms are profit-maximizers, in which case you need to offer a different explanation for their behavior, or you’re inconsistent in your explanation, in which case you need to correct the inconsistency. (for a price of 4, the firm could produce either 10 units or they could produce 60 units. Why don’t producers just produce more to fill unmet demand? All production planning is based on probabilistic considerations. Their fears are not without justification, because the government is likely to worsen the problem. Right, but no profit-maximizing firm operates on the left-hand portion of the MC curve, so it’s irrelevant. If you have constantly idle capacity that can produce at the same marginal cost, you would probably look at export markets or to underserved markets in the US. Let’s trace the great run on toilet paper and walk through the various scenarios that played out in the manufacturing, distribution and retail sectors. To elaborate on my point, adding more and more costs (eg transaction costs, externalities, etc) into the model can complicate the analysis and affect the marginal cost curves, but the overall point, that a profit-maximizing firm operates on the upward-sloping portion of the marginal cost curve and thus to increase production price must rise, remains. In a perfectly competitive model, the firm faces constant marginal revenue at P. Oh, and let me apologize to Dylan: I was not reading him right. Therefore, real consumption (C) of toilet paper has not changed. Jewelry is on one sense a very competitive market. I do think that in real life, for most markets, we’re much closer to a monopolistic competition model, than the perfectly competitive one. states are shut down. Write how Covid has impacted the demand for two separate items and write a paragraph for each. It’s easy to see all this with graphical analysis (or mathematical analysis for the brave); more difficult with verbal analysis. As students learn in ECON 101, marginal cost is increasing in the short-run (and often in the long-run too). To assume that firms would not try to increase quantity supplied (short of government price restrictions) because demand might fall at some point is to effectively assume they are not profit-maximizing. It would be a matter of operating at a level where your marginal cost (and average cost) was below that price. The companies that are here today, about 50% won’t exist in 5 years (probably a much higher percentage than that right now, unfortunately). The answer is found in the basic economic principles of supply and demand. She is simply investing in her business to produce, and make consumers aware of, her widgets. That would imply an upward sloping marginal cost curve at that point (remember the definition of cost above). I guess a vast army of idle workers does serve the use of suppressing wages. Be that as it may, Dylan is correct because marginal cost curves tend to be U-shaped, just like average cost curves. Toilet paper: Toilet paper was very rare to find in stores at the beginning of this pandemic. That’s a rule for companies operating at peak efficiency and using all of their fixed resources, a situation that I can tell you applies to approximately no one. I’ve worked with plenty of startups that have sold each item they produce at an absolute loss, trying to goose demand enough to be able to make their products cheaper so they can make a profit. In sum: due to whatever restrictions you want to throw, no firm will operate at the downward-sloping portion of the marginal cost curve because they will be operating inefficiently, making losses, and shut down. But doesn’t undermine the point in the least; indeed, proves my point (I leave it as an exercise to the reader to prove it). You Can Do This By Hand And Take A Picture Of Your Work And Attach It As A File If You Do Not Want To Draw A Graph On The Computer So, since the outbreak GP is making more than double what they normally makes. Working with less equipment, the marginal (supplementary) worker has a lower productivity. You can have increasing returns and economies of scale with increasing marginal costs. If the firm is a profit-maximizer, they will necessarily produce on the upward-sloping portion, since that maximizes profit (as opposed to maximizing loss). If the downward slope of the demand curve is steeper than the downward slope of the supply curve, then they can intersect on the left-hand arm of the supply(/marginal cost) curve. They could even decrease the price by a large amount, and still increase margins, because the marginal cost of producing an extra dose is just so small. Will running all the time introduce a bottle-neck into the supply line that isn’t there when you are running at lower capacity? I have two right beside me. Noted your responses and have replied. As for toilet paper, it is not the case that the virus is causing a mass wave of dysentery. What explains the current shortage of so many goods is the combination of higher demand, price caps decreed by governments, and increasing marginal. P = MC only in a specific situation: a perfectly competitive market. Terms And this would just end the shortage. Look, a profit-maximizing firm will operate wherever he can maximize profit. (In the longer, the industry might have to bid up wages or the prices of other factors of production to divert them from other industries.) So why don’t the toilet paper manufacturers just get in contact with Walmart, and suggest shipping the toilet paper that would go to schools to sell at Walmart? I think one of the points in contention here is the assumption on profit maximizing. I mean, if you want proof that firms are profit-maximizing, I suggest you explore the field of Industrial Organization, which has won several Nobel Prizes. I also think that companies not busy being born, are busy dying. Yes, that seems true. Estimates from the Statista Consumer Market Outlook show that the United States leads the way when it comes to the use of toilet paper. https://www.glassdoor.com/job-listing/manufacturing-laborer-temporary-georgia-pacific-JV_IC1155905_KO0,31_KE32,47.htm?jl=3527462796&ctt=1586819664764&srs=EI_JOBS, The Effect of the Minimum Wage on Employment and Unemployment. That a given price control does create as shortage is a necessary (but not sufficient) condition for the hypothesis that the industry is competitive. But let the shortage worsens, and they will probably revert to solutions like that. That’s because I had muddle brain and made an embarrassing mistake. This would ease residential TP sales for those who want to stockpile and avoid all the issues with price, quality expectations, ect. ), price controls do not include precise and individualized figures but things like “no more than 10% over prices during the past three months” (look at the California penal code, which I quote from memory), or “prices in excess of prevailing market prices” (from Trump’s executive order, literally). In my career, having done consulting for dozens if not hundreds of companies, the ones that were profitable numbered in the single digits. He was not mistaking marginal and average costs. Their profit is maximized where p=mc at 60 units. I have two right beside me. Producing more would leave some product unsold (a higher marginal cost because those resources could have gone to other uses) and producing fewer would leave some rent that could have been captured (again, a higher marginal cost). Luckily, even the strongest price control and subsequent rationing attempts by authorities probably won’t lead to the toilet paper dystopia Pierre paints at the end of the post. Another thing to understand is that quantity demanded is higher than quantity supplied because government price controls don’t allow the price to fully adjust upwards. See if all this fuss is for naught. The graph below demonstrates these changes. Let me try to address Dylan’s point in a different way: Take a look at Figure 7.8 here. Since quantity demanded is now higher than quantity supplied at the ex ante price, producers would fill the gap only if they could increase production at the same marginal cost, that is, only if they could produce additional units at the same cost. The Truth About TP Supply and Demand. There are numerous ways to teach your children about economics. But still, the basic point is they’re jacking up their production to the point where they really can’t make much more at their existing facilities. The demand line shifts up from D1 to D2—increasing prices, but only temporarily. Yes, that is what I did mean. Don’t forget either that, in the absence of a Central Planning Board (which we still don’t have, thank God! Image courtesy of Nic Stage on Flickr. But smaller no-brand producers, including entrepreneurs in foreign countries, will work to meet the unsatisfied demand that the shortage implies. See Chapter 4 here. I can sell 1 at $10,000. Of course, there is uncertainty in production (as in everything). Be that as it may, Dylan is correct because marginal cost curves tend to be U-shaped, just like average cost curves. If you are on the left-hand side of the MC curve, MC decreases with increased production. Actually, in your example, at a price of $4, they would lose money no matter how much or how little they produced because their very minimum average total cost is $6.67 per unit. Every single unit it would produce would have a marginal cost higher than the price at which it sells it. The mistake y’all are making is assuming that the marginal cost curve is independent of the demand curve. If the downward slope of the demand curve is steeper than the downward slope of the supply curve, then they can intersect on the left-hand arm of the supply(/marginal cost) curve. It should thus be obvious that the short-run marginal cost of producing toilet paper increases with production, which means that the supply curve of toilet paper has a positive slope. If the firm was big enough to affect the market, increasing production could cause the market clearing price to decline enough to eliminate profit. And its also a Nielsen stat, industrywide, I did read that a bit too quickly. as it seemingly contradicts the commonplace, stylized fact that there are often increasing returns and economies of scale. This doesn’t make sense. The problem of our friends is what you pointed out before: they assume that there is only one firm in each market. Thus there is little incentive for firms to increase capacity because once the tp-mania wears off, there will be a significant decline in the demand for toilet paper as people use up their inventory. Likewise, even if firms are willing to eat temporarily lower profits so as not to expensively restructure production in response to lower prices (say, from a binding price ceiling), huge cuts in price are infeasible without substantially reduced supply. Here’s another example. If he cannot sell a higher quantity, then the marginal cost is higher because he is foregoing other profit opportunities. Have my marginal costs just gone up? However, that can only happen when the firm is a monopolist. Stores replenish supply on generally stable demand signals and patterns. The toilet paper bubble must eventually burst. Aside from the current Coronavirus pandemic and the associated crisis level response the supply of toilet paper is virtually never an issue. Really appreciate and am enjoying the discussion and education. Part of these sales could have been imported, or taken from stocks (if they still dare to keep some), or produced in production lines with, of course, higher marginal cost (that’s why they had been idled). During a crisis, one must not totally discount the desire to make special efforts, even if only for the corporate image, but also possibly for charitable or neighborly motives. Just going to put in a few comments here as reply to some of the things I’ve seen: Yes, I’m used to dealing with companies that are closer to the monopoly side of the market than the perfectly competitive side of things. They’re not going to build another factory just because of the current demand because they know its going to snap back to normal and then they’ll two facilities operating at 40% capacity. As I said, I don’t disagree with the basic thrust of the article that we want producers free to be able to raise prices if they need to to respond to changes in demand. That’s really neither here nor there, the articles convey the sense that the preexisting facilities are making all they can make. The firm can reduce costs by producing more. Thank you for the economic point. Walmart could sell them with some sort of sign saying, “We apologize for the low quality of this toilet paper, but we figure some toilet paper is better than none. Since firms are profit-maximizers, no firm will willingly remain in a market where they are making losses; those resources will be re-allocated to other uses. Yet, they still typically cast pieces individually, or in batches of 5 for designs that are particularly popular. A common objection to the simple supply-and-demand model that predicts a shortage when the price is capped below its equilibrium level goes as follows. Eh, not really. Can you negotiate better supply agreements by buying in larger quantities? In that case, whatever part of the market you went for (match them on price or try to be “premium” and sell for $7 or **shudder** trying to undersell them), you wouldn’t worry about the price being different for #1 and #10. (In fact, if borders are open, there is a monopoly of a tradeable good only when hell freezes over.). On the other hand, people who used to work outside now use more toilet paper at home (40% more by one estimate), as they use none at work (or in restaurants, hotels, or schools). I have trouble understanding both John’s point about demand being a cost. Translate the economic model into actionable business advice, please. That might be the case right now (although even there, I’m doubtful, since I don’t think either of us are all that great at optimizing for efficiency), but it certainly isn’t the moment she gets an order for 10 rings. How well does MC=P explain drug prices, or online movie purchases, or Kindle books? The cost of producing that ring is roughly $25 in material and labor. They created something new, but couldn’t create enough demand for their new product or service to be financially viable. Pierre is discussing a perfectly-competitive market. by Daniel James Devine. Not yet, anyway. Also, some of the work of polishing and the like needs to be redone when an order actually goes out, because metals tarnish. The willingness of consumers to pay for products is known as demand. Why toilet-paper demand spiked 845%, and how companies kept up with it. I’m going to try one more example, and then try to go and get some real work done today. Maybe I’m messing up marginal cost and average cost, although I think I’ve got those pretty straight. I think it is important to note that I’m not interested in a model of the overall market, but a model of a firm, and the firm should not be assumed to be at some kind of equilibrium. Yes, those are all marginal costs of producing more than you can sell, and so the firm is optimizing at the steady state. And the fact that price controls have created shortages on this market is an indication that it is. But, because she can’t have that guarantee, she only makes them as she gets the orders for them. Looking at this article, we see that shipping is somewhat of a constraint. It took a while, but the problem with what Jon and Pierre are arguing finally emerged deep in Dylan’s post: Jon: “no profit-maximizing firm operates on the left-hand portion of the MC curve”. ), 2) If you were right that firms and plants produce below marginal cost=price, they would leave money on the table. All that has changed is that people have decided to invest in toilet paper inventory (I). Demand for Marcal toilet paper from retail customers is up over 25%, he said. So it does not have a supply curve or, in other terms, its quantity supplied is not given by its marginal cost (which is, of course, increasing, at least in the short-run). Price-control and “anti-gouging” laws often allow some limited price increases, and there may be much arbitrariness in their enforcement. You’re not going to want to do that, unless you think you can sell more than just one additional widget. None of these things can be determined just from theory, they depend on the specifics of the business. 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