MarketIntellibitsTM                    
January  31,   2006
Volume II   Issue 2


Economics 102: What drives supply and demand?

From the feedback I got to Economics 101, it seems that most of us took that
course a long time ago. But it also seems that some industries never quite
got it.

So, it looks like Economics 102 is necessary.

I’m sure that many of us remember those supply and demand curves from
Macroeconomics. I admit, I never understood them, and they’re still
confusing. But it’s okay:  after spending some time in the real world, most of
us understand the principles. But, it you want more of the theory, and why it’
s more confusing than it has to be, visit
http://www.mktintell.
com/supplyanddemand

Still, when it comes to supply and demand, especially in the paper industry,
there are a few things that a worth covering, so let’s bring on  Economics
102.

First,  supply.

If producers can’t make money they shut down. If they think they’ll make
money in the future, they add capacity. If buyers think that prices will go up,
they build inventory and inventory is part of supply. Imports are also part of
supply.

Next, demand.

Demand changes with price. We call this elasticity. The price of personal
computers has come down, and now a lot of us own them. Computer
demand is very elastic. For other items, demand is not very elastic. We don’t
make more copies if the price of copy paper comes down by 10%, or fewer if
it goes up by 10%. Copy paper demand is not very elastic. Still, if copy paper
were to cost three times as much,   we would watch our usage and demand
would fall. Copy paper demand has some elasticity, but just not as much as
computers.

Demand is determined by consumption, of course. Exports are part of
demand, too, as are purchases for inventory.

In the paper business, supply seems to be pretty stable. It takes years to
add new capacity, and old capacity only goes away when it is not needed.
Imports can be a bit of a wildcard,  but on a global level, capacity, and hence
supply, only changes by a few percent from year to year. Indeed, supply
should be pretty stable.

Demand would seem to be pretty stable, too. Consumption rarely grows or
declines by more than a few percent, and exports are not big enough to
have a major impact. Demand, also, should be pretty stable.

You might wonder why markets are so volatile if supply and demand are
stable. The answer is inventory.

If the normal inventory level is one month’s supply, but the actual inventory
today is 2 month’s supply, then next month, while that excess inventory is
being worked off, there will twice as much supply as needed.  Alternatively,
if the normal inventory is one month’s supply, but price increases are
anticipated, and everyone decides at the same time that they need two
months supply, then next month demand will be twice as much as normal.

This is volatility.

It can get worse. Imagine that paper is tight, and so a print buyer calls five
printers to find one who can get paper and do the job. The five printers all
know paper is tight and so each of them calls five merchants, and each of
them, calls five mills…

Well you can imagine what happens.  

Some people have claimed that the gas shortage of the seventies was
caused because everyone was driving around with a full tank of gas – they
would top off the tank to be sure they had gas and because they wanted to
avoid the next price increase. Similarly, some people claim that the paper
shortage of 1995 was caused by buyers accumulating inventory – they
needed more paper because paper was harder to get, and the price was
going up.

I never did buy the theory about the gas shortages, but I know from
experience that the theory abut the paper shortage is pretty much right on
the mark. I was selling paper in 1995, and in May of 1995 I had a lot of
unhappy customers because they couldn’t get all the paper they wanted, but
in July, my orders dropped by 50% because they had too much inventory.

If you look at recent statistics on paper shipments, supply and demand, you
will find quite a bit of volatility – coated papers up nearly 10% in 2004, but
down in 2005, and uncoated papers also up in 2004 and down in 2005. But
most of the time, especially when there is excessive volatility,  if you break
it down, you will find that the biggest variance from one year to the next is
not consumption,  imports, exports or capacity – it is inventory.

And inventory actually hits three ways: while it is rising, it causes an
increase in demand, but later, when it falls, it generates a decrease  in
demand coupled with increased supply.

If you want to understand market supply and demand, make sure you
understand inventory.

Is there going to be a paper shortage this year? I don’t know. It’s up to you.


For more information about paper industry supply, demand, and prices, call
Jack Miller at 203 925 0326, or email Jack Miller at
jack.miller@market-intell.com





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