Market Power

Musings by an academic economist on the power of markets and the power over markets.

Wednesday, January 26, 2005

Natural Disasters and Price Fluctuations

This very interesting article appeared in this morning's Wall Street Journal (paid subscription required) on the effect the tsunami had on the Banda Aceh economy. First of all, regardless of what you've heard, the tsunami is not going to be good to the overall economy of Banda Aceh or any other economy devastated by the tsunami. More to the point, here is the first quote:

The economy of Banda Aceh has been turned upside down by calamity, generosity and opportunity. The earthquake, the tsunami and the arrival of thousands of foreign aid workers bearing food, goods and money have combined to warp prices, wages and rents in this devastated city at the northern tip of the island of Sumatra. The price of salt is up because the coastal salt makers have been wiped out. Beef is down because of fear of disease. Fresh fish is up, but few want to buy any. Rumor has it that fish are contaminated because they have been feeding off corpses swept out to sea.

Nowhere has the uproar been more pronounced than in the housing market. Perhaps half the homes in Banda Aceh were destroyed by last month's earthquake and the tsunami that followed, leaving more than 125,000 people around the city living in tent camps, according to the United Nations. Now not only do the survivors need housing, but so do the aid workers here to help them.

Last summer's hurricanes that hit coastal areas of the US did a lot of damage and there were many instances of price spikes, so-called "price gouging", that occured in markets for things such as bottled water and construction services. We are seeing some similar things going on in Banda Aceh, but a primary diffence between Banda Aceh and the areas hit by the hurricanes is the huge loss of life as a result of the tsunami. This has put a damper on the upward price shocks.

Here is a graphic from the article detailing price changes and primary reasons:

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Another quote:

...Said Firdaus, the 35-year-old owner of Rajawali Furniture, has no customers for the polished dining-room sets and entertainment centers his carpenters make. Moreover, Mr. Said has seen a surge in the price of nails, finishes and wood. His only client at the moment is a Swedish aid organization that is paying him $390 apiece to build 20 two-stall, white outhouses with zinc roofs and turquoise squat toilets for the refugee camps. His monthly profit has plunged about 75%, to roughly $400. He expects his business to boom when rebuilding begins.

At Lambaro market, Marhaban, a 48-year-old poultry dealer smeared with chicken juices, wouldn't budge when two women in head scarves offered him the pre-tsunami price of 20,000 rupiah -- about $2.25 -- for a scrawny chicken. Mr. Marhaban, who like many other Indonesians uses only one name, wouldn't part with it for less than $2.60. The tsunami decimated his own flock, so now he has to bring in chickens from the city of Medan, a 12-hour truck ride across the mountains. Before the disaster, he sold 500 chickens a day; now he's lucky to sell 150. "The situation is very unstable right now," he said.

Price gouging is normally reserved for criticizing producers. They, supposedely unfairly, take advantage of a natural disaster to make a profit. Can the same be said of consumers who know businesses are having trouble selling their wares because of the death of so many former customers?

Another quote:

Fishmongers are in worse shape than poultry peddlers are. Many fishermen were killed or left boatless when their coastal villages were crushed. Many fish sellers died, too. One who survived is Ismail Husein, who lost his wife and their five children to the tsunami. His stock at Sibreh market, less than 10 miles outside Banda Aceh, consists of just a few small blue tuna and other fish shipped from across Sumatra.

Counterbalancing the short supply is diminished demand. Worried about contamination, many people here are afraid to eat fish these days. So while Mr. Ismail is charging more per fish now, he is selling fewer of them. His pre-tsunami daily profit, about $11.25, has been cut by 80%.

For my principles students: that's an example where both demand and supply shift. If Mr Ismail's prices are indicative of the market, then he believes that supply shifted more than demand did. What leads us to this conclusion?

Another quote:

The Indonesian government's food logistics agency, Bulog, keeps an eye on the prices of staples, especially rice. The agency maintains a 30,000 metric ton rice stockpile in warehouses around Aceh province and has released 5,000 tons into the market to keep the price near its target of roughly 15 cents a pound. The government is considering intervening to reduce the prices of sugar, flour and palm oil, said Tito Pranolo, Bulog's director of business development. "The market is not working right now."

A good deal of the problem, he said, is the fierce competition for truck freight from Medan. Aid groups use the undamaged city as a distribution center and have hired fleets of trucks to carry relief supplies to Banda Aceh, pressing up costs for private traders.

Aid agencies are also bidding up the price of cars, thousands of which were destroyed by the tsunami. Irfan Juliansyah, 34, used to have a one-man-band act playing "My Way" and other standards at the Kuala Tripa Hotel restaurant. The tsunami flattened the hotel, so he now rents his flashy Daihatsu jeep to Catholic Relief Services and hires himself out as its driver. As a musician, he earned about $540 a month. His jeep pulls in $1,800 a month, a huge sum in a country where per capita income was $710 in 2002, according to the World Bank.

The market is working like it should be working. Just because prices of some goods increase does not mean that a market is working poorly or unfairly. Indeed, the price increases are needed to bring in resources to produce stuff now in higher demand. The graphic above says that a whole chicken cost $2.25 before the tsunami and now costs $2.60... why doesn't it cost much more? One reason given in the graphic is that chickens are now trucked in from Medan. The resources used to make chickens have alternative uses, and the price increase signals producers that chickens are now relatively more valuable than before. Had prices not been allowed to increase, would there have been enough food to feed those in Banda Aceh?

I also find it interesting (not surprising) that the influx of aid (and thus aid workers) have increased demand for various products, increasing their prices.