Supply Shocks and Prices

Causes of Inflation: Supply Shocks, part 1

Did you hear the news?

·      Gasoline prices jump! Expect long lines at the pump!

·      Pipeline lashed by hurricane! Most of the south without gas next week!

·      Florida Dubbed Plywood State after Devastating Storms!

·      The price of eggs nearly triples!

·      Used farm tractor auctions for record price!

These made-up headlines are taken from real events in 1973, 2005, and 2023. In the last post, we studied how changes in demand increased prices and led to inflation during the pandemic. To recap, demand went up in part due to pandemic-era aid and low interest rates. Demand continues to rise as the baby boomers (born 1947-1963) retire. [1] But that’s only part of the story. In this post and the next, we’ll examine the supply shocks that led to inflation of 2021 through 2023. Fortunately, the last time we saw this kind of inflation was in the late 1970s / early 1980s.

Supply shocks also caused that inflation. At the time, oil was the culprit. For the southern states, Hurricane Katrina, in addition to a host of major storms and hurricanes, pummeled the gulf states during the 2004-2006 hurricane seasons. The result: a damaged oil pipeline wreaking havoc on oil supplies after Katrina, and major rebuilding throughout the lower regions of the south sending the costs of building materials skyrocketing.

Before we start, let’s review supply. Supply is not the same as inventories. Supply is what’s being made, inventories are supplies on hand. Supply goes down, or shifts in, as it did in the cases we’ll study, when the costs of production rises. Costs of production rises when:

·      Prices of inputs rise

·      Natural disasters occur

·      Interest rates rise

·      Business taxes rise or subsidies to producers fall

·      Number of producers falls

·      In rare cases, technology falls

During the oil embargo of 1973-1974, the price of a major input into all goods and services production, oil, quadrupled. Prices at the pump rose from $2.59 to $3.19 (in 2022 dollars) from 1973-1974.

Before the advent of electronic files, music downloads, and ebooks, all goods had to be shipped on a truck. For example, in the early 1970s, when I found music I liked I’d ask my dad to buy it. We were living in Cranbury, NJ, and got WABC out of New York. We would go to the mall to buy the 45, using gasoline to get there. Now if I want a song, I download it. No traveling, no physical product. As a result, the economy is lighter.

Alan Greenspan, in a speech in 1999, noted that a ten-story building weighed less than a ten-story building built decades before. Now, we download ebooks and audio books rather buying physical books. We even check our bank statements online, rather than getting them in the mail. We buy tax software online and download the program, rather than getting the forms, filling them out, and sending them to the IRS by mail. [2]

None of these were readily available before the twenty-first century. We had to meet in the office, rather than via Zoom or Teams. All of this required oil for refining into gasoline that, at the time, the US didn’t produce in high enough quantities.

One of my students reminded me that everything we buy at a store comes by truck. So, in the 1970s, when our fuel-hungry American economy was hit by a sharp reductions in the supply of oil from the Oil Producing and Exporting Countries (OPEC), gasoline had to be rationed.

Lines got longer and gasoline prices rose. And oil prices kept rising, affecting all the costs of all the goods we bought. My dad, who worked for an oil company, was happy to leave the lines in New Jersey behind when we moved back to Georgia. From 1973 to 1980 gasoline prices nearly quadrupled from $2.59 to $4.25.

Gasoline prices nearly doubled again in the south on August 30, 2005, as Hurricane Katrina damaged the main pipeline to the southern states. The pumps were out the next day as worried commuters panicked and lined up at the closest pump. [3] Most gas stations were empty the next week in Atlanta as then-Governor Sonny Purdue imposed price caps on gasoline.

Another supply problem can come because of the weather. One building project at my school, Clayton State University, was delayed by rain as Georgia moved out of drought and into a season of hurricanes and major storms. My son’s graduation from Georgia Tech was held at the Omni in Atlanta, right after tornadoes ripped through the building during the March 14-15, 2008, outbreak. Materials shortages happened as a result of rebuilding needed after those damaging storms, and costs rose.

Next time, we’ll return to the present and look at how supply shocks during the pandemic caused inflation to spike. [5]

Thank you for taking the time to read this. Comments and questions welcome.

Nikki

[1] Yes, that’s me, a late b(l)oomer.

[2] I still send my GA return by mail. One year I delayed a federal tax refund by mailing my 1040. See Welcome to 2024.

[3] I got lucky and filled my pump the day before the crisis. I was out shopping that day, in possibly my most inefficient shopping trip I ever made, and every time I passed the Q-T on Hwy 124 In Snellville the price went up by a dime. Prices at the pumps closer to Atlanta went over $6.00 (in 2005 dollars, in 2022 dollars, closer to $9.00).

[4] The Dean at the time had some strong words about contractors who didn’t plan for weather. In fairness, the state was in drought until 2000. Katrina and the strong hurricane season of 2004-2006 affected the cost of materials for the new College of Business. We could build the space, but there was no money for office furniture!

[5] In 2004, I also experienced one of the rare instances of technology reduction. The license for the whiteboard system I used as a help to teach graphs and math problems online lapsed. I’m still trying to find a way to recreate the process but have failed. I swore then never to teach online again, by the way.