When supply and demand drive prices: When hotcakes are selling like hotcakes!

Supply chain disruptions and temporary demand increases have led to price spikes which seem to have become the norm lately. For the most part, they are not here to stay, so if you are considering a purchase, delaying may be wise. Patience may indeed pay off during this time of price tribulation.

Supply and demand models form the cornerstone of modern economics, because at the end of the day supply and demand drive prices. Here’s why…

1. Higher demand leads to higher pricing.

Imagine you have 10 straw hats to sell every day that cost you (after all costs such as labour, rent and material are factored in) $5.00 per hat. In the winter, demand is low, so you may be willing to sell them just barely above cost. But in the summer demand increases and since you only have 10 hats to sell, you will sell them to the higher bidders, which has the effect of increasing the price. Perhaps knowing that purchasers are willing to pay more, you may skip the bidding process and just price them on the shelf at a higher price.

• Greater supply leads to lower pricing.

Suppose now that your supplier increases your allotment to 100 hats per day. Two things happen. First your fixed costs such as rent are divided among 100 hats rather than 10, so your cost per hat goes down. Second, wanting to maximize your profits you will want to sell as many hats as possible, and in order to do so, you will likely accept a lower price as long as it’s still profitable.

This is truly the essence of Economics 101 and it explains much (but not all) of how pricing works.

How does this relate to today? A tsunami of unrelated circumstances has caused both supply chain disruptions leading to higher prices and increased demand leading to even higher prices. Sometimes rare events cause significant price increases that make sense, and in those times, we just need to be willing to pay the higher prices recognizing that it is so for good reason. But in many other cases (especially right now) it’s a reason to just wait a month or a quarter or even a year for prices to fall. 

When there is a disaster, and everyone needs batteries we often see prices go up. Why? Is the retailer “gouging” us? Maybe, but maybe not. In order to meet the demand for batteries, the retailer needs to increase their own supply. This may mean having the batteries flown in on a rush basis (instead of their usual trucking shipment) in order to get them into the store at the time of need. Obviously, this is more expensive, and that additional cost needs to be reflected in the price of the batteries. Rather than decrying the retailer, we should be thankful in these circumstances that they are taking the risk of paying more to bring batteries in so that they are available to us in our time of need. Obviously, they need to charge more.

Today isn’t so much a time of crisis as it is a wave of colliding events. On the supply side we have the Suez Canal blockage, container shortages, semiconductor shortages, along with disruptions in bringing goods to market due to COVID related restrictions. On the demand side we have pent up demand due to delays in spending during COVID lockdowns and related to that an excess amount of cash in consumers’ pockets burning holes. 

There is also a cascading effect. For example, a crib manufacturer was having difficulty obtaining foam for his mattresses. Prices had gone up already, but now expected shipments were delayed. His reasonable response: pay the higher price, get in the stock he needs now and in addition order even more so that he can maintain a higher inventory to prevent further in-house shortages. That means more foam in his warehouse making less available to other retailers and manufacturers, which leads again to more shortages and higher prices.

Combine all of the above (less supply, greater demand and the cascading effect) and it’s no wonder we’ve seen prices increase. The good news is that in those cases where the price increases are the greatest it’s likely a temporary increase and once the supply evens out with demand, once manufacturers and retailers believe they have the right amount of inventory, then prices will normalize. Retailers and manufacturers are likely to try (and succeed to some degree) to increase their profits by keeping some of those prices up, but normal competition will force them to bring them down significantly. 

In the meantime, if you are considering a large purchase, check out how much it’s gone up lately. If it’s significant, then try to discern whether that’s due to temporary circumstances or if it’s likely to be permanent. For example, a friend recently told me he planned to build a shed. Since the price of 2x4s had gone up 8-fold he decided to hold off. Already prices have declined as some of the demand has been filled. He is certain that 2×4 prices will come down even more (and I’m inclined to agree with him), so he is continuing to wait.

If you are able, consider holding off on those big purchases. You may be rewarded with much lower prices very soon.

Arnold Machel, CFP® lives, works and worships in the White Rock/South Surrey area where he attends Gracepoint Community Church.  He is a Certified Financial Planner with IPC Investment Corporation and Visionvest Financial Planning & Services.  Questions and comments can be directed to him at dr.rrsp@visionvest.ca or through his website at www.visionvest.ca.  Please note that all comments are of a general nature and should not be relied upon as individual advice.  The views and opinions expressed in this commentary are those of Arnold Machel and may not necessarily reflect those of IPC Investment Corporation.   While every attempt is made to ensure accuracy, facts and figures are not guaranteed. 

Arnold is now accepting a limited number of invitations to speak for the 2021/22 calendar years.  If you are interested in having him speak to your congregation or other group (when gatherings are allowed to resume) regarding money matters, please contact us at admin@visionvest.ca or (604) 542-2818 with your preferred date and time.