day 6 part 3 Economics: Market Applications and Supply Shocks (copy)

The Economics of Campus and Universal Parking Shortages

• The issue of parking is a universal problem characterized by a perceived shortage of spots relative to those who wish to park.

• It is a common misconception to claim that "demand is always greater than supply" for parking. To be economically precise, the demand curve is not simply higher than the supply curve at all prices. Instead, the current price is set such that the actual quantity demanded exceeds the quantity supplied.

• Understanding the Market for Parking:     - Demand Curve: This follows a regular, downward-sloping trajectory.     - Supply Curve: In a short-run perspective, parking spots are fixed. Therefore, the supply curve is vertical, represented as $\bar{Q}$.     - Equilibrium: Equilibrium occurs at price $P^*$, where the quantity demanded equals the quantity supplied ($Q_d = Q_s$). At this equilibrium point, there is no shortage.

• Definition and Cause of Parking Shortages:     - A shortage occurs whenever the current price (let's call it $P_0$) is set below the equilibrium price ($P^*$).     - Shortage Calculation: The distance or difference between the quantity demanded and the quantity supplied at that lower price ($Q_d - Q_s$).     - The primary reason parking problems persist is that prices are not unrestricted. If prices were free to move, buyers would bid the price up until the market cleared at equilibrium.     - Price Ceilings: Parking involves a fixed price set below equilibrium that is not allowed to move, effectively acting as a price ceiling. This restriction prevents the market from clearing, resulting in an observed shortage.

• Case Study: Parking at Costco:     - Many wonder why parking is often "free" at locations like Costco. In this model, "free" simply means the price is fixed at zero ($P = 0$).     - When the price is zero, there is a maximum distance between the quantity demanded and the quantity supplied ($\bar{Q}$), creating a significant shortage.

• Economic Recommendation for Parking Problems:     - To eliminate a parking shortage, an economist would recommend increasing the price of parking to the market-clearing level.     - At this higher price, the quantity demanded would decrease to exactly match the fixed amount of spaces available ($\bar{Q}$).

Supply Shocks and Global Market Impacts: The 2011 Libyan Oil Crisis

• A supply shock is an actual event that physically disrupts the market supply. A prime example is the civil war in Libya that began in February 2011.

• Data on Libyan Oil Production:     - Libya was a major supplier, producing approximately $1.5 \times 10^6$ to $1.8 \times 10^6$ barrels of oil per day.     - Production Timeline: Before the civil war, production was stable at roughly $1.8 \times 10^6$ barrels per day. Between January 2010 and February 2011, the supply remained consistent.     - The Shock: Upon the start of the civil war in February 2011, Libyan supply plummeted ("tanked") effectively to zero.     - Post-Shock: Over time, supply gradually ramped up again, though it faced further volatility due to subsequent protests and regional issues.

• Modeling the Market Impact:     - Context: The global market for oil.     - Supply Shift: Because Libya was a significant producer, their shutdown caused a decrease in the aggregate world supply. This is represented by a leftward shift of the supply curve from $S$ to $S'$.     - Demand Stability: The demand for oil did not change as a result of the Libyan civil war; the demand curve remained stationary.     - Price Prediction: The model shifts the equilibrium from an initial price ($P_0$) to a new, higher equilibrium price ($P_2$). Therefore, the model predicts a spike in oil prices.

• Historical Price Evidence:     - Pre-Civil War: Oil prices were stable at approximately $\$90$ per barrel.     - Post-Insurrection Spike: Prices spiked immediately following the start of the war, confirming the demand-supply model's prediction.     - Brent Crude (Benchmark for global purchases): According to a Forbes magazine article from March 3, 2011, Brent crude on the ICE futures exchange closed at US $\$116.35$ a barrel on a Wednesday, the highest settlement since August 2008.     - West Texas Intermediate (WTI - American market price): This also hit a 2.5-year high, gaining $2.6\%$ in a single day to reach US $\$102.23$.

• Practical Applications for Students and Investors:     - The demand-supply model uses "imaginary lines" to make highly accurate predictions about real-world events.     - Market players, such as speculators in futures and stock market investors, use these global event analyses to invest in shares and generate profit.     - Comparison to the Global Pandemic: A pandemic acts as a separate type of shock that "tanked" oil prices, making them briefly negative. Understanding the demand-supply model allows individuals to anticipate these shifts and dump shares before prices decline significantly.

Questions & Discussion

• Question 1 (Top Hat QX): Investors and students were asked to predict the effect on world market supply when a large supplier like Libya shuts down.     - Answer: The market supply decreases, shifting the supply curve to the left.

• Question 2: Based on the predicted change in supply, what will be the resulting effect on global oil prices?     - Answer: Prices are expected to increase as the equilibrium point moves up along the stationary demand curve.