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Heidi Hall
Tell students that understanding the concepts of supply and demand is will help them explain what happens to prices: why they increase and why the decrease. Explain that this lesson will also help remind them of the differences between changes in quantity supplied/quantity demanded and changes in supply/demand. Draw a market graph on the board. Explain that equilibrium is found when quantity supplied and quantity demanded are equal. At this point, there is no surplus (excess supply) or shortage (excess demand); all produced units are consumed. Ask students the following questions:
Put students into pairs or small groups. Distribute copies of the Supply and Demand Practice handout to each student. Have each student graph the scenarios described in the worksheet individually, write the rationale for their answers, and then compare answers with their group or partner. Tell them they will receive one point for each correct graph and rationale if they had a match. If their graphs and rationale do not match or are incorrect, they receive no points. Review the answers to each question before proceeding to the next one to ensure students receive immediate feedback on their answers and address student questions about the graph or rationale. (Note: You may want to set a time limit on each question to keep the activity moving. In addition, you may choose to use handheld white boards or other similar devices if available.) After completing the assignment, award a prize to the group/pair with the highest number of points.
Have students continue the story of the newly married couple by creating two new scenarios, with one scenario focused on the shifters of demand and the other focused on the shifters of supply. Tell students their stories should be centered around the new couple furnishing their new home. Require them to draw a correctly labeled graph showing the shift change and using arrows to show the change in price and quantity. Also have them write a brief explanation to support their answers. (Answers will vary.)
Have students write a wedding toast to the newly married couple. Tell them to include at least one shifter of supply and one shifter of demand as well as a statement clarifying the difference between a change of demand/supply versus a change in quantity demanded/quantity supplied. Ask for volunteers to read their toasts to the class. (Answers will vary.)
Have students work in small groups to create a wedding-styled infographic on demand, supply, and equilibrium explaining the shifters of demand and supply. In addition, have them clarify the difference between a change in demand/supply and a change in quantity demanded/supplied. Ask groups to share their infographics with the rest of the class. (Answers will vary.)
These are times of rapid transition for the U.S. economy. With the winding down of the worst of the pandemic, businesses have added jobs at a rate of 540,000 per month since January. Many consumers are making large purchases with savings accumulated during the pandemic, sending new home sales to their highest level in 14 years and auto sales to their highest level in 15 years.
While a fast pivot to growth is good news for businesses and workers, it also creates challenges. Entire industries that shrank dramatically during the pandemic, such as the hotel and restaurant sectors, are now trying to reopen. Some businesses report that they have been unable to hire quickly enough to keep pace with their rising need for workers, leading to an all-time record 8.3 million job openings in April. Others do not have enough of their products in inventory to avoid running out of stock. The situation has been especially difficult for businesses with complex supply chains, as their production is vulnerable to disruption due to shortages of inputs from other businesses.
Figure 1 shows that both the economy-wide and retail-sector inventory-to-sales ratios hit record lows in March. These ratios measure how many days of current sales that businesses and retailers could support out of existing inventories. When the pandemic hit, businesses were stuck with billions of dollars in unsold goods, causing inventory-to-sales ratios to surge briefly before businesses liquidated these inventories. But, as the economy recovered and demand increased, businesses have not yet been able to bring inventories fully back to pre-pandemic levels, causing inventory-to-sales ratios to fall.
The figure shows that while retailers had 43 days of inventory in February 2020, today they have just 33 days. Inventories of cars and homes are also at or near record lows, sufficient for just one month of car sales and 4.4 months of home sales, as compared to pre-pandemic levels of about two months for cars and 5.5 months for homes. These low inventories have caused cascading issues in industrial supply chains. In the latest U.S. Census Small Business Pulse survey, held from May 31 to June 6, 36 percent of small businesses reported delays with domestic suppliers, with delays concentrated in manufacturing, construction, and trade sectors, as shown in Figure 2. While no comparable survey data exist from before the pandemic, industry-specific surveys on input shortages suggest these levels are much higher than usual.
Data also suggest these shortages are holding back business activity in some sectors. A record share of homebuilders, surveyed by the National Association of Homebuilders in May, reported shortages of key materials such as framing lumber, wallboard, and roofing. Homebuilders appear to be responding to these shortages in part by delaying new construction, as housing starts have been volatile for several months.
Another impact of the shortages has been abrupt price increases. Between May 2020 and May 2021, prices of commodities tracked within the Producer Price Index rose by 19 percent, the largest year-over-year increase since 1974, in part reflecting base effects. Some increases have been especially dramatic. Facing a shortage of lumber, homebuilders briefly sent prices to $1,711 per thousand board-feet last month, an amount that implies a typical 2,000-square-foot house would require more than $27,000 in framing lumber alone, relative to a lumber bill of about $7,000 before the pandemic.[1] Lumber prices have now rapidly come back down, falling 38 percent from their record high, in an early sign that some shortages may be short-lived.
Supply-chain disruptions are also having a material impact on consumer prices, especially in the motor vehicle sector. Over half of the May increase in core inflation as measured by the Consumer Price Index comes from this sector, if we include prices of new, used, leased, and rental automobiles. This sector also accounted for one-third of the economy-wide increase in prices compared to a year ago.[2]
While the economy-wide nature of these shortages is unusual, the history of supply disruptions in specific industries may offer insights as to how the shortages will be resolved over time. In the past, many industries have been surprised by strong demand and caught with too little inventory of specific goods. Others have been hit with a supply shock due to a crop failure or a natural disaster which took key factories temporarily offline, such as after the 2011 earthquake in Japan. In many such cases, markets made their way back to equilibrium relatively quickly.
The toilet-paper shortage in the early days of the pandemic offers another useful case study. Stay-at-home orders led to a sudden 40-percent increase in demand for retail toilet paper, the fluffier kind used by households. Yet supply cannot rise overnight to satisfy demand. Toilet paper is bulky to store, and demand is ordinarily very stable, which led retailers to keep only two to three weeks of sales in inventory and manufacturers to operate their plants at 92-percent capacity. Worried they would be left without toilet paper, Americans cleaned out store shelves.
How did U.S. toilet-paper manufacturers respond to the shortages? None appear to have added production lines or built new plants to expand capacity. That is because the modern toilet-paper manufacturing process is highly mechanized and capital-intensive, requiring four-story-tall machines that cost billions of dollars and months to assemble before a single roll comes off the line. And few appear to have converted factories from scratchier commercial toilet paper to retail varieties, unlike the rapid retoolings that allowed U.S. manufacturers to ramp up production of cleaning wipes and hand sanitizer. Nor did many sell commercial toilet paper to households.
Instead, manufacturers wrung a bit more out of their existing processes. They ran plants at nearly 100-percent capacity and restarted idled machinery. Some streamlined their product offerings, reducing machine downtime and, in particular, shifting to large-roll products that could get more paper to households without costly changes to machinery. Others invested in their distribution systems, so that they could anticipate and respond more quickly to local shortages.
There is evidence indicating that the current disruptions are likely to be mostly transitory. Indices of current delivery times are at record highs in surveys of manufacturers by three regional Federal Reserve Banks, but Fed indices for future delivery times are in their typical ranges. While current indices report conditions at the time of the survey, the future indices report expectations about conditions in six months. Taken together, the data suggest that manufacturers anticipate current supply-chain issues will have abated within six months or so.
While markets will eventually adjust, they can be slow and the impact on producers and consumers can be costly. The public sector can play a valuable role in reducing these costs by facilitating short-term adjustments and by addressing vulnerabilities in U.S. supply chains. The U.S. government has, at critical moments, provided such support: helping Japan respond after the 2011 earthquake, for instance, or producing COVID-19 vaccines through Operation Warp Speed. Last week, the Biden-Harris Administration released the conclusions of its 100-day review of supply chains for four critical products: semiconductor manufacturing and advanced packaging; large capacity batteries, like those for electric vehicles; critical minerals and materials; and pharmaceuticals and active pharmaceutical ingredients. Guided by these reviews, the Administration will act to address both short-term strains and long-term vulnerabilities, such as those due to excessive concentration of production of key inputs in a few firms and locations.
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