One can be very modern and say that supply and demand curves are not real, but they are.
I’m not arguing that supply curves aren’t real; I’m arguing that the super-long term supply curve is virtually flat (the price elasticity of supply is arbitrarily high). I find it compelling to imagine a chicken producer accepting contracts to produce chickens 10 years from now. At what prices and quantities would the producer accept the contracts? I would say it would accept all contracts at or above the Cost, at as high a quantity as possible. With lead time and certainty, the issues that create short term elasticity don’t apply. (And yes, short term market shocks and uncertainties are real, but they’re just built into the profitability model of Cost.)
the lower price will cause a switch towards chicken consumption among other people who were on the margin of demand.
Under the simplified assumptions we’ve been using, the starting price is the Cost of producing chicken. When the price drops in your scenario, that means chicken producers are operating at a loss. True they might not throw out any chickens if they appropriately adjust price, but they will not be satisfied with the new equilibrium (because the price is too low). Instead they will reduce production, let the price rise back to the starting point, and let the new chicken consumer (who values chicken at slightly less than Cost) drop back out of the market.
If you don’t believe that the producers will keep reducing consumption until the price rises back to the original level and the “new consumers” (who value chicken < Cost) stop buying again, then you have to explain why producers aren’t already producing more chickens than they are (in the absence of any dietary changes). In other words, if “new consumer” demand exists, and producers are still profitable with slightly lower prices, why haven’t they scaled up production to larger than what it actually is today to sell chickens to “new consumers”?
I’m arguing that the super-long term supply curve is virtually flat
Huh? A flat supply curve means that the producers will produce the same number of chicken regardless of the price at which they can sell them. I don’t see why this should be true in long term.
I find it compelling to imagine a chicken producer accepting contracts to produce chickens 10 years from now. At what prices and quantities would the producer accept the contracts? I would say it would accept all contracts at or above the Cost, at as high a quantity as possible.
Not quite. You are implicitly assuming that the Cost is fixed in stone and it isn’t. The chicken producer should accept all 10-year forwards on chicken if and only if he can buy matching forwards on his production inputs, otherwise he is exposed to the risk of, say, the price of feed going up.
Huh? A flat supply curve means that the producers will produce the same number of chicken regardless of the price at which they can sell them. I don’t see why this should be true in long term.
I mean “horizontal” rather than “vertical”. In that sense, a flat supply curve means a constant price, not a constant quantity.
Not quite. You are implicitly assuming that the Cost is fixed in stone and it isn’t. The chicken producer should accept all 10-year forwards on chicken if and only if he can buy matching forwards on his production inputs, otherwise he is exposed to the risk of, say, the price of feed going up.
I agree, but this is the type of pressure on Cost that I have no expectation of being in any particular direction. As a result, on expectation these perturbations average to zero, and the argument holds. It would be interesting if we had a reason to expect that Cost would go up or down depending on the amount of production. These are the issues my last section in the original article was intended to address.
I agree, but this is the type of pressure on Cost that I have no expectation of being in any particular direction.
The received wisdom is that if the demand for chicken feed goes up, the cost and price will go up, if the demand goes down, the cost and price will go down.
If the received wisdom is that a larger chicken industry will increase the price of chicken feed, then my prior is that it’s true in the short term, but not the long term. Chicken feed might be in finite supply, in which case Cost might grow with chicken industry size, but there are other reasons I can imagine Cost might shrink with increasing chicken industry size (listed in original article) and I don’t have enough confidence about any of these factors to break my prior that Cost at industry size 2X is ~Cost at industry size X.
So what you are basically saying is that in the long run the price will be driven close to the lowest average price—right?
As a result, on expectation these perturbations average to zero, and the argument holds.
Still not quite, as once you recognize that “perturbations” will happen, you need to engage in some risk management (zero mean does not imply zero volatility). In your scenario the chicken producer seems to be fine with the 50% chance of going bankrupt at the delivery time which isn’t a good assumption to make.
So what you are basically saying is that in the long run the price will be driven close to the lowest average price—right?
Yes; in the long term the producers that have higher-than-average Costs will be driven out of the market.
Still not quite, as once you recognize that “perturbations” will happen, you need to engage in some risk management (zero mean does not imply zero volatility). In your scenario the chicken producer seems to be fine with the 50% chance of going bankrupt at the delivery time which isn’t a good assumption to make.
I’m modeling risk management as part of the typical Cost of doing business, along with things like interest rates, opportunity costs of capital, chicken feed, other inputs, etc. Separating out risk management as a stand-alone variable doesn’t seem to change anything.
I’m arguing that the super-long term supply curve is virtually flat (the price elasticity of supply is arbitrarily high).
Yes you are. And I think this is wrong. And here is why (stated differently from my original reply which also thought it was wrong).
Consider a world in which the entire demand for chickens is one guy who lives on the island of Kauai. In Kauai, chickens run wild through the streets and yards and fields. Since there is this one guy who buys a chicken every week, the shopkeeper scoops up a chicken in his yard on his way to work whenever he knows his chicken customer is coming. Cost of production, close to zero.
Consider an alternative world in which everybody is eating a chicken every day. The chicken producers certainly buy up lots of land in low cost places where it is cheap to build chicken production. This doesn’t fill the need, i.e. price is way above the marginal cost to produce the last chicken. So they build chicken production closer to centers of demand, where real estate and labor are more expensive. This doesn’t meet demand, i.e. price is still higher than the marginal cost to produce the most expensive chicken. Finally, someone builds 10 level chicken coops with HVAC systems, water desalinators to provide drinking water to the chickens, and pays a fortune to process the chicken poop into a benign fertilizer product which they essentially have to give away in order to keep it from stacking up around their chicken coops. Finally demand is met.
The point is, demand is filled by suppliers that pay different costs to create the chickens they sell. The cheapest producer makes the most profit, he is lucky. The most expensive producer makes just enough profit to keep producing, the slightest drop in price will put him out of business.
Even within a given production facility, the marginal cost to produce an extra chicken rises as the “capacity” of the production facility is filled. So for the christmas rush, 10% more chickens are grown, but it raises the costs of the facility 15% because they are paying night-workers instead of day workers, they are having to build dormitories to house their extra workers, they need a higher quality of automation in order to get 10 chickens per cubic foot instead of 8 chickens per cubic foot which their cheaper robots manage, etc.
So in a world where everybody wants chickens a lot, people will spend more to consume chickens because they will spend more to produce chickens, because the cheapest production sites and methods will be saturated before the market is.
I think your scenario is a good illustration of “finite inputs”, which I listed as one of five example ways in which the long term supply curve may not actually be flat (at the end of the original article).
While I think that finite supply is a very real force (that, if strong enough, would create significant long term price elasticity of supply as you claim), the other four examples I mentioned also seem very real to me, and it’s not obvious which ones win out for any particular industry.
If Cost always grew with industry size, products in big industries would always cost more than the same product from equivalent but smaller industries (where both supply and demand is reduced). Intuitively/anecdotally this doesn’t seem to be true; I think the most common reasons it’s not true are “gains to scale”.
Looking at the extremes doesn’t tell you that chicken production is an increasing-cost industry at the margin. Sure input costs are important (the OP agrees—see last section), but there are also economies of scale, R&D investment, and so on pushing the other way, so it’s ultimately an empirical matter whether chicken production is increasing- or decreasing-cost at current levels of production (again I’m just repeating what the OP says).
IMO this issue is actually less relevant than the OP seems to think, because we’re only talking about very small marginal changes to chicken demand, and there’s no way the long-run supply curve is steep enough for that to matter. But one could try to estimate the long-run supply curve at least “locally”, which might settle this issue.
I’m not arguing that supply curves aren’t real; I’m arguing that the super-long term supply curve is virtually flat (the price elasticity of supply is arbitrarily high). I find it compelling to imagine a chicken producer accepting contracts to produce chickens 10 years from now. At what prices and quantities would the producer accept the contracts? I would say it would accept all contracts at or above the Cost, at as high a quantity as possible. With lead time and certainty, the issues that create short term elasticity don’t apply. (And yes, short term market shocks and uncertainties are real, but they’re just built into the profitability model of Cost.)
Under the simplified assumptions we’ve been using, the starting price is the Cost of producing chicken. When the price drops in your scenario, that means chicken producers are operating at a loss. True they might not throw out any chickens if they appropriately adjust price, but they will not be satisfied with the new equilibrium (because the price is too low). Instead they will reduce production, let the price rise back to the starting point, and let the new chicken consumer (who values chicken at slightly less than Cost) drop back out of the market.
If you don’t believe that the producers will keep reducing consumption until the price rises back to the original level and the “new consumers” (who value chicken < Cost) stop buying again, then you have to explain why producers aren’t already producing more chickens than they are (in the absence of any dietary changes). In other words, if “new consumer” demand exists, and producers are still profitable with slightly lower prices, why haven’t they scaled up production to larger than what it actually is today to sell chickens to “new consumers”?
Huh? A flat supply curve means that the producers will produce the same number of chicken regardless of the price at which they can sell them. I don’t see why this should be true in long term.
Not quite. You are implicitly assuming that the Cost is fixed in stone and it isn’t. The chicken producer should accept all 10-year forwards on chicken if and only if he can buy matching forwards on his production inputs, otherwise he is exposed to the risk of, say, the price of feed going up.
I mean “horizontal” rather than “vertical”. In that sense, a flat supply curve means a constant price, not a constant quantity.
I agree, but this is the type of pressure on Cost that I have no expectation of being in any particular direction. As a result, on expectation these perturbations average to zero, and the argument holds. It would be interesting if we had a reason to expect that Cost would go up or down depending on the amount of production. These are the issues my last section in the original article was intended to address.
The received wisdom is that if the demand for chicken feed goes up, the cost and price will go up, if the demand goes down, the cost and price will go down.
If the received wisdom is that a larger chicken industry will increase the price of chicken feed, then my prior is that it’s true in the short term, but not the long term. Chicken feed might be in finite supply, in which case Cost might grow with chicken industry size, but there are other reasons I can imagine Cost might shrink with increasing chicken industry size (listed in original article) and I don’t have enough confidence about any of these factors to break my prior that Cost at industry size 2X is ~Cost at industry size X.
So what you are basically saying is that in the long run the price will be driven close to the lowest average price—right?
Still not quite, as once you recognize that “perturbations” will happen, you need to engage in some risk management (zero mean does not imply zero volatility). In your scenario the chicken producer seems to be fine with the 50% chance of going bankrupt at the delivery time which isn’t a good assumption to make.
Yes; in the long term the producers that have higher-than-average Costs will be driven out of the market.
I’m modeling risk management as part of the typical Cost of doing business, along with things like interest rates, opportunity costs of capital, chicken feed, other inputs, etc. Separating out risk management as a stand-alone variable doesn’t seem to change anything.
Yes you are. And I think this is wrong. And here is why (stated differently from my original reply which also thought it was wrong).
Consider a world in which the entire demand for chickens is one guy who lives on the island of Kauai. In Kauai, chickens run wild through the streets and yards and fields. Since there is this one guy who buys a chicken every week, the shopkeeper scoops up a chicken in his yard on his way to work whenever he knows his chicken customer is coming. Cost of production, close to zero.
Consider an alternative world in which everybody is eating a chicken every day. The chicken producers certainly buy up lots of land in low cost places where it is cheap to build chicken production. This doesn’t fill the need, i.e. price is way above the marginal cost to produce the last chicken. So they build chicken production closer to centers of demand, where real estate and labor are more expensive. This doesn’t meet demand, i.e. price is still higher than the marginal cost to produce the most expensive chicken. Finally, someone builds 10 level chicken coops with HVAC systems, water desalinators to provide drinking water to the chickens, and pays a fortune to process the chicken poop into a benign fertilizer product which they essentially have to give away in order to keep it from stacking up around their chicken coops. Finally demand is met.
The point is, demand is filled by suppliers that pay different costs to create the chickens they sell. The cheapest producer makes the most profit, he is lucky. The most expensive producer makes just enough profit to keep producing, the slightest drop in price will put him out of business.
Even within a given production facility, the marginal cost to produce an extra chicken rises as the “capacity” of the production facility is filled. So for the christmas rush, 10% more chickens are grown, but it raises the costs of the facility 15% because they are paying night-workers instead of day workers, they are having to build dormitories to house their extra workers, they need a higher quality of automation in order to get 10 chickens per cubic foot instead of 8 chickens per cubic foot which their cheaper robots manage, etc.
So in a world where everybody wants chickens a lot, people will spend more to consume chickens because they will spend more to produce chickens, because the cheapest production sites and methods will be saturated before the market is.
I think your scenario is a good illustration of “finite inputs”, which I listed as one of five example ways in which the long term supply curve may not actually be flat (at the end of the original article).
While I think that finite supply is a very real force (that, if strong enough, would create significant long term price elasticity of supply as you claim), the other four examples I mentioned also seem very real to me, and it’s not obvious which ones win out for any particular industry.
If Cost always grew with industry size, products in big industries would always cost more than the same product from equivalent but smaller industries (where both supply and demand is reduced). Intuitively/anecdotally this doesn’t seem to be true; I think the most common reasons it’s not true are “gains to scale”.
Looking at the extremes doesn’t tell you that chicken production is an increasing-cost industry at the margin. Sure input costs are important (the OP agrees—see last section), but there are also economies of scale, R&D investment, and so on pushing the other way, so it’s ultimately an empirical matter whether chicken production is increasing- or decreasing-cost at current levels of production (again I’m just repeating what the OP says).
IMO this issue is actually less relevant than the OP seems to think, because we’re only talking about very small marginal changes to chicken demand, and there’s no way the long-run supply curve is steep enough for that to matter. But one could try to estimate the long-run supply curve at least “locally”, which might settle this issue.