Wednesday, April 20, 2011

Revisiting the Reach of the BP Oil Spill

A year ago, cleanup efforts to recover from the Gulf oil spill were just beginning, but the effects of the spill were already finding their way into markets. While the debates and projections attempt to forecast how far the oil will spread, economists understand that the effects of the spill will reach further than the oil itself ever could. While many initial discussions focused on the local impact of the disaster, applications of the basic supply and demand model shed light on how a regional disaster can spread to national and global markets.

Soon after the disaster, the Associated Press reported that the price of shrimp started to climb in response to the spill. To begin to understand why, consider the direct effect of the spill on the supply of shrimp caught in the Gulf. The graph to the left reflects the market for Gulf-coast shrimp. As shown on the graph the oil spill reduces the supply of locally caught shrimp in the gulf as fishermen have been prevented from conducting much of their normal business. In response to the reduced supply, the equilibrium price rises, while the amount of shrimp sold falls.

Assume that shrimp caught in the Gulf and shrimp caught elsewhere are separate goods, though the markets for each are clearly related. Aside from the environmental problems associated with catching shrimp in the gulf, there may be variations in quality or style between shrimp caught in different locations. That said, shrimp are still shrimp, so even if consumers have a slight preference for one type or another, shrimp from other locations can be considered substitutes. When two goods are substitutes, an increase in the price of one of the goods causes an increase in demand for the other, all else held constant. When the market price for Gulf-caught shrimp rises (along with concerns that shrimp caught in the gulf may be contaminated) many buyers will look to purchase shrimp from other regions, like North Carolina, South Carolina, Georgia, and Texas. The second graph to the left illustrates how an increase in the price of a one good (Gulf shrimp) causes an increase in the demand for a substitute good (non-Gulf shrimp). The result here matches the reports by the AP: An increase in the equilibrium price and quantity of non-Gulf shrimp due to the effects of the oil spill.

Interestingly, the effects of the oil spill will also be felt by companies that have nothing to do with catching anything from the sea. For example, consider the market for tartar sauce. Many people like putting tartar sauce on their shrimp when they eat it, but have no desire to eat tartar sauce on its own. Economists would call tartar sauce a compliment to shrimp. When two goods are compliments, an increase in the price of one of the goods causes a decrease in demand for the other, all else held constant. On the final graph below, you can see the effect that higher equilibrium prices of shrimp have on the tartar sauce market. When the market price goes up, consumers will purchase less shrimp, and if less shrimp is consumed, consumers have less of a need for tartar sauce. This decreases the demand for tartar sauce, resulting in a decrease in the equilibrium price and quantity of tartar sauce.

There is still too much uncertainty about how much damage has been caused and the extent of the long-term effect on the environment for economists to reliably give exact figures on how these markets will change. However, the basic supply and demand confirms that the effects of this spill can be seen far beyond the Gulf region.

Discussion Questions:

1) How will the elasticity of supply and the elasticity of demand for non-Gulf shrimp affect the magnitude of the change in equilibrium price and quantity? How do economists describe the magnitude of a change in demand for one good in response to a change in the price of another?

2) What other markets do you expect to be affected by a change in the price of shrimp? What will happen to the equilibrium price and quantity in each of these markets? Are these goods compliments or substitutes?

3) Suppose that instead of an oil spill earlier this year, weather patterns had changed to make the shrimp season in the Gulf abnormally productive. If it were easier to catch shrimp in the gulf, what would you expect to happen to demand for shrimp caught in other regions? What about the demand for complementary goods like tartar sauce?

4) If you wanted to work on a shrimp fishing boat, all else held constant, which labor market do you think would be more favorable to join, one in the Gulf coast or one in South Carolina? Why?

5) Suppose the fishing industry is monopolistically competitive. Do you expect firms to enter or exit the market in the Gulf right now? In the long-run, assuming that fishing conditions return to their pre-spill levels, what can you say about the firms that will be in the market? Is it possible that any existing firms will be better off now than they were before the spill? If so, how?

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