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Regional MattersFebruary 25, 2022Supply and Demand: When Will We See Balance?By Jason Kosakow and Sonya Ravindranath Waddell

1.Explain how your chosen article connects to the economic textbook topic; include a direct quote of the topic from the textbook (required, with in-text citation).

2. What is the industry discussed?

3. How many firms participate in the industry (many, a few, one)?

4. Specify the market & company(ies) and explain your answer.

5. Is(Are) there (one, few, several, many) firm(s) in the industry, what is the market structure of this industry?

Article:Regional MattersFebruary 25, 2022Supply and Demand: When Will We See Balance?By Jason Kosakow and Sonya Ravindranath Waddell

Fifth District firms continue to struggle to fully meet customer demand for their goods and services. Anecdotally, firms have reported a shortage of raw materials and commodities, increased lead time from suppliers, difficulty finding the transportation for inputs or merchandise, and an absence of available workers. A new measure of global supply chain pressure from the New York Fed shows stress across global supply chains, and nationally, job postings remain at record highs, corroborating anecdotal evidence. These pressures have pushed up prices and contributed to some of the highest inflation measures the United States has seen in decades. Surveys of firms in the Fifth District indicate, once again, that firms do not expect these pressures to go away immediately. For many firms, the uncertainty of the situation makes it impossible to predict when they will be able to fully meet demand for their goods and services.

Firms Struggle to Meet Customer Demand

In our February survey of business conditions that was fielded from January 27 through February 16, firms reported that prior to the pandemic, they were largely able to fill demand for their products and services. Almost all firms reported filling more than 75 percent of demand prior to the pandemic and nearly two-thirds of firms were able to fully meet demand. Currently, however, only 32 percent of firms report fully meeting demand, and that percentage only increases to about 40 percent well below pre-pandemic when firms are asked about their outlook for the next six months.

What percentage of demand for your goods or services could you, can you, or will you be able to meet?Bar chart with 5 data series.Percent of FirmsNote: Based on results from 215 -216 firms. Rebased to exclude "Not sure"View as data table, What percentage of demand for your goods or services could you, can you, or will you be able to meet?The chart has 1 X axis displaying categories.The chart has 1 Y axis displaying values. Data ranges from 0 to 99.Less than 25%25% to 49%50% to 74%75% to 99%100%Before COVID-19CurrentlyIn the Next 6 Months0%25%50%75%100%Source: Federal Reserve Bank of Richmond

What percentage of demand for your goods or services could you, can you, or will you be able to meet?Percent of FirmsNote: Based on results from 215 -216 firms. Rebased to exclude "Not sure"End of interactive chart.

In addition, the share of firms able to meet 100 percent of customer demand declined from September 2021 when we asked a similar set of questions. In September, 38 percent of firms reported meeting 100 percent of demand (compared to 32 percent in February 2022). Meanwhile, a larger share of firms in February (63 percent versus 54 percent in September) were meeting somewhere between 50 percent and 99 percent of demand. In other words, the obstacles Fifth District firms were facing with production and service provision were not removed between September 2021 and February 2022; in fact, the ability to meet demand deteriorated slightly.

Labor, Labor, Labor ... but Also Inputs

In both September 2021 and February 2022, firms reported that difficulty finding workers was the number one reason for not being able to meet demand. This is corroborated by conversations with regional businesses most of whom identify finding qualified workers as a predominant challenge and the Fifth District index for the availability of qualified workers, which has remained at historic lows for months. But perhaps the reason for firms struggling more to meet demand since September is the growing challenge of finding and paying for inputs and the availability of timely freight services. Compared to September, in February, three times more Fifth District firms reported the rising costs of inputs as a challenge to meeting demand.

Why do you expect to not be able to meet demand?Bar chart with 2 data series.Percent of FirmsNote: Based on results from 136 firms in September 2020 and 129 firms in February 2021 that don't expect to fully meet demand in the next six months. ^asked to manufacturing firms onlyView as data table, Why do you expect to not be able to meet demand?The chart has 1 X axis displaying categories.The chart has 1 Y axis displaying values. Data ranges from 0 to 71.September 2021February 2022Availability oflaborAvailability ofinputs neededfor productionAvailability ordelays infreight/shippingDemandincreasing atunmanageablerateNot enoughproductioncapacity^Rising costs forinputs neededfor productionOther020406080Source: Federal Reserve Bank of Richmond

Why do you expect to not be able to meet demand?Percent of FirmsNote: Based on results from 136 firms in September 2020 and 129 firms in February 2021 that don't expect to fully meet demand in the next six months. ^asked to manufacturing firms onlyEnd of interactive chart.

There is still a lot of uncertainty around when these challenges will abate. Although 40 percent of respondents expect to fully meet demand in the next six months, 37 percent of firms do not expect to fully meet demand until at least the end of 2023, and another 18 percent are facing too much uncertainty in their environment and operations to predict when they will be able to ramp up production to meet demand. There are very few differences in these expectations between manufacturers and service providers. Nearly 50 percent of firms don't expect to be able to meet demand by the end of 2022, an indication that labor and supply chain obstacles could last well into 2023 or beyond.

When do you expect to be able to fully meet customer demand for your goods or services?Bar chart with 6 bars.Percent of Firms Note: Based on results from 216 firmsView as data table, When do you expect to be able to fully meet customer demand for your goods or services?The chart has 1 X axis displaying categories.The chart has 1 Y axis displaying values. Data ranges from 4 to 40.Fully MeetDemand in Next 6MonthsBy end of 2022First half of 2023Second half of20232024 or laterToo uncertain toknow for sure01020304050Source: Federal Reserve Bank of RichmondWhen do you expect to be able to fully meet customer demand for your goods or services?Percent of Firms Note: Based on results from 216 firmsEnd of interactive chart.

What Are the Ways to Find Labor and Mitigate Supply Chain Disruptions?

Considering that firms most commonly cite labor availability as a challenge, it is not surprising that many firms are trying to attract workers. Two-thirds of respondent firms reported raising wages, and more than 50 percent are exploring new methods of recruitment. Many firms are also asking more of existing employees and automating to reduce the need for labor. On the supply chain side, firms most often report diversifying supply chains and moving away from "just in time" production by increasing inventory, to the extent feasible.

Have you taken any of the following actions to increase production or service provisionBar chart with 13 bars.Percentage of Firms Note: based on results from 214 firms.View as data table, Have you taken any of the following actions to increase production or service provisionThe chart has 1 X axis displaying categories.The chart has 1 Y axis displaying values. Data ranges from 7 to 64.Raised wages for hard-to-fill positionsEngaged in new methods to recruit new ...Diversified supply chainsRequired existing employees to work lon...Increased inventory (moved away from "j...Increased use of automation/technology ...Negotiated to pay more and get service f...Changed shipping logisticsSwitched to suppliers located within or cl...Relaxed hiring criteria (stopped drug scr...Reconfigured supply chains outside of N...OtherWe have not taken actions to increase pr...010203040506070Source: Federal Reserve Bank of Richmond Have you taken any of the following actions to increase production or service provisionPercentage of Firms Note: based on results from 214 firms.End of interactive chart.

What Does This Mean for Supply and Demand as We Move Through the Year?

Labor shortages and supply chain disruptions (both for firms and their vendors/freight providers) are impacting the ability of businesses to meet customer demand. Nearly every firm in our February 2022 survey has taken some action to mitigate these challenges from asking existing workers to do more to raising wages to changing structure or location within their production process. Anecdotes range from hotel managers cleaning rooms to grocers installing self-checkouts to manufacturers attempting to increase inventories over the longer term. Once supply and demand even out, will businesses revert to pre-pandemic operations? We do not know the answer, but for now, firms are trying to do more with fewer people, extending lead times, and using innovative solutions to continue operations when inputs are scarce.

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Consumer Surplus, Producer Surplus, Social Surplus

Consider a market for tablet computers, as shown inFigure 3.23. The equilibrium price is $80 and the equilibrium quantity is 28 million. To see the benefits to consumers, look at the segment of the demand curve above theequilibriumpoint and to the left. This portion of the demand curve shows that at least some demanders would have been willing to pay more than $80 for a tablet.

For example, point J shows that if the price was $90, 20 million tablets would be sold. Those consumers who would have been willing to pay $90 for a tablet based on the utility they expect to receive from it, but who were able to pay the equilibrium price of $80, clearly received a benefit beyond what they had to pay for. Remember, the demand curve traces consumers' willingness to pay for different quantities. The amount that individuals would have been willing to pay, minus the amount that they actually paid, is calledconsumer surplus. Consumer surplus is the area labeled Fthat is, the area above the market price and below the demand curve.

Figure3.23Consumer and Producer SurplusThe somewhat triangular area labeled by F shows the area of consumer surplus, which shows that the equilibrium price in the market was less than what many of the consumers were willing to pay. Point J on the demand curve shows that, even at the price of $90, consumers would have been willing to purchase a quantity of 20 million. The somewhat triangular area labeled by G shows the area of producer surplus, which shows that the equilibrium price received in the market was more than what many of the producers were willing to accept for their products. For example, point K on the supply curve shows that at a price of $45, firms would have been willing to supply a quantity of 14 million.

The supply curve shows the quantity that firms are willing to supply at each price. For example, point K inFigure 3.23illustrates that, at $45, firms would still have been willing to supply a quantity of 14 million. Those producers who would have been willing to supply the tablets at $45, but who were instead able to charge the equilibrium price of $80, clearly received an extra benefit beyond what they required to supply the product. The amount that a seller is paid for a good minus the seller's actual cost is calledproducer surplus. InFigure 3.23, producer surplus is the area labeled Gthat is, the area between the market price and the segment of the supply curve below the equilibrium.

The sum of consumer surplus and producer surplus issocial surplus, also referred to aseconomic surplusortotal surplus. InFigure 3.23, social surplus would be shown as the area F + G. Social surplus is larger at equilibrium quantity and price than it would be at any other quantity. This demonstrates the economic efficiency of the market equilibrium. In addition, at the efficient level of output, it is impossible to produce greater consumer surplus without reducing producer surplus, and it is impossible to produce greater producer surplus without reducing consumer surplus.

Inefficiency of Price Floors and Price Ceilings

The imposition of a price floor or a price ceiling will prevent a market from adjusting to its equilibrium price and quantity, and thus will creat an inefficient outcome. But there is an additional twist here. Along with creating inefficiency, price floors and ceilings will also transfer some consumer surplus to producers, or some producer surplus to consumers.

Imagine that several firms develop a promising but expensive new drug for treating back pain. If this therapy is left to the market, the equilibrium price will be $600 per month and 20,000 people will use the drug, as shown inFigure 3.24(a). The original level of consumer surplus is T + U and producer surplus is V + W + X. However, the government decides to impose a price ceiling of $400 to make the drug more affordable. At this price ceiling, firms in the market now produce only 15,000.

As a result, two changes occur. First, an inefficient outcome occurs and the total surplus of society is reduced. The loss in social surplus that occurs when the economy produces at an inefficient quantity is calleddeadweight loss. In a very real sense, it is like money thrown away that benefits no one. InFigure 3.24(a), the deadweight loss is the area U + W. When deadweight loss exists, it is possible for both consumer and producer surplus to be higher, in this case because theprice controlis blocking some suppliers and demanders from transactions they would both be willing to make.

A second change from theprice ceilingis that some of the producer surplus is transferred to consumers. After the price ceiling is imposed, the new consumer surplus is T + V, while the new producer surplus is X. In other words, the price ceiling transfers the area of surplus (V) from producers to consumers. Note that the gain to consumers is less than the loss to producers, which is just another way of seeing the deadweight loss.

Figure3.24Efficiency and Price Floors and Ceilings(a) The original equilibrium price is $600 with a quantity of 20,000. Consumer surplus is T + U, and producer surplus is V + W + X. A price ceiling is imposed at $400, so firms in the market now produce only a quantity of 15,000. As a result, the new consumer surplus is T + V, while the new producer surplus is X. (b) The original equilibrium is $8 at a quantity of 1,800. Consumer surplus is G + H + J, and producer surplus is I + K. A price floor is imposed at $12, which means that quantity demanded falls to 1,400. As a result, the new consumer surplus is G, and the new producer surplus is H + I.

Figure 3.24(b) shows a price floor example using a string of struggling movie theaters, all in the same city. The current equilibrium is $8 per movie ticket, with 1,800 people attending movies. The original consumer surplus is G + H + J, and producer surplus is I + K. The city government is worried that movie theaters will go out of business, reducing the entertainment options available to citizens, so it decides to impose a price floor of $12 per ticket. As a result, the quantity demanded of movie tickets falls to 1,400. The new consumer surplus is G, and the new producer surplus is H + I. In effect, theprice floorcauses the area H to be transferred from consumer to producer surplus, but also causes a deadweight loss of J + K.

This analysis shows that a price ceiling, like a law establishing rent controls, will transfer some producer surplus to consumerswhich helps to explain why consumers often favor them. Conversely, a price floor like a guarantee that farmers will receive a certain price for their crops will transfer some consumer surplus to producers, which explains why producers often favor them. However, both price floors and price ceilings block some transactions that buyers and sellers would have been willing to make, and creates deadweight loss. Removing such barriers, so that prices and quantities can adjust to their equilibrium level, will increase the economy's social surplus.

Demand and Supply as a Social Adjustment Mechanism

The demand and supply model emphasizes that prices are not set only by demand or only by supply, but by the interaction between the two. In 1890, the famous economistAlfred Marshallwrote that asking whether supply or demand determined a price was like arguing "whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper." The answer is that both blades of the demand and supply scissors are always involved.

The adjustments of equilibrium price and quantity in a market-oriented economy often occur without much government direction or oversight. If the coffee crop in Brazil suffers a terrible frost, then the supply curve of coffee shifts to the left and the price of coffee rises. Some peoplecall them the coffee addictscontinue to drink coffee and pay the higher price. Others switch to tea or soft drinks. No government commission is needed to figure out how to adjust coffee prices, which companies will be allowed to process the remaining supply, which supermarkets in which cities will get how much coffee to sell, or which consumers will ultimately be allowed to drink the brew. Such adjustments in response to price changes happen all the time in a market economy, often so smoothly and rapidly that we barely notice them.

Think for a moment of all the seasonal foods that are available and inexpensive at certain times of the year, like fresh corn in midsummer, but more expensive at other times of the year. People alter their diets and restaurants alter their menus in response to these fluctuations in prices without fuss or fanfare. For both the U.S. economy and the world economy as a whole, marketsthat is, demand and supplyare the primary social mechanism for answering the basic questions about what is produced, how it is produced, and for whom it is produced.