Let me get the typical reactions to the BP mess out of the way first: RAWR! Oil everywhere! RAWR! Pelicans! RAWR! Should have been more careful! RAWR! Who would have thought that giant oil funnels were not a good idea? RAWR! Maybe Kevin Costner can save us! (Not even kidding.)
Now that we’re all caught up…I know people are upset about what is going on in the Gulf of Mexico, but it’s important to remember that in a brilliant (read, desperate) PR move, BP made it clear that it is going to pay all of the costs of oil spill cleanup. (Yes yes, I know we are going to have to wait and see whether that actually happens.) This seems fair, to a degree, but it’s certainly worth noting that simply paying to clean up the mess isn’t going to compensate everyone for their losses. BP seems to understand this, so it has clarified what is covered under the heading of “cleanup costs”:
In a fact sheet posted to the company’s website Monday, the British-based BP also said it will pay compensation for “legitimate and objectively verifiable” property damage, personal injury and commercial losses.
Okay, so BP does seem to realize the strain that it is putting on people in the fishing industry, for example, and it’s vowing to compensate the fishermen for the fact that it’s kind of hard to sell fish that has been pulled out of an oil slick. (I’ve heard of oily fish before, but this is ridiculous.) What BP doesn’t seem to understand is the way that the forces of supply and demand work. Consider the following, via Environmental Economics:
The supply of Gulf Coast food — and the cost of it — fluctuates on a daily basis, with the NOAA Fisheries Services map of safe and affected fishing waters constantly being redrawn. ABC reports that in light of the reduced amount of seafood on the market, “Fish that normally sold for $2.50 a pound were going for $3.25.”
Well duh. The oil spill has made it more difficult for fishermen to find and catch untainted fish, so they are now bringing in less fish than they were before, even though they are putting in the same level of resources as before. Economists categorize this as a form of reduction in technology, and a reduction in technology results in a reduction in supply, mainly because the decreased technology makes the fish more expensive and thus less attractive to produce. (See here for a video refresher.) This reduction in supply leads to a higher market price for fish and a lower quantity of fish sold. (Again, see here for a little video on the topic.)
The point that often gets lost is that both consumers and producers of fish lose out when the fish becomes more expensive to produce. Fishermen can’t push all of their cost increases onto consumers, and consumers can’t make the fishermen eat the entire amount of the cost increase. We can quantify (or at least graph) the change in value for both consumers and producers in the market for fish:
The solid lines are the original supply and demand for fish, and their intersection corresponds to the price of $2.50 and whatever quantity of fish was originally sold. The dotted supply line represents what happened to the supply of fish as a result of the oil spill (note that this is a shift of supply to the left, which represents a decrease), and where this line meets the demand curve shows the increased price of $3.25 and the new quantity of fish sold. As I said above, the reduction in the supply of fish leads to an increase in price and a decrease in the quantity sold of fish.
It’s not surprising the consumers lose out in this deal, since they get less fish and they pay a higher price for it. The solid blue triangle on the graph is how much value the fish market provides to consumers after the supply decrease, and the hatched area is the amount of value lost by consumers because of the supply decrease. (The value before the supply decrease is the solid and hatched areas put together.) Some consumers lose out because they are still buying fish but paying a higher price for it, and other consumers lose out because they used to benefit from buying fish but the higher price has pushed them out of the market entirely.
How does the value to producers change as a result of the supply decrease? This change is less intuitively obvious, since producers sell less (fewer? I apparently can’t decide whether fish are countable.) fish but they get a higher price for the fish that they do sell. I said before, however, that the fishermen can’t pass along all of the cost increase to their customers, and that means that their margins are going to go down because of the supply decrease. In this way, the fishermen are indeed also losing out, since they are getting lower margins on fewer fish:
In this case, the solid triangle is the value to producers after the supply decrease, and the hatched triangle is the value to producers before the supply decrease. (Note that the areas overlap a little- it was hard to clearly indicate that with a Sharpie.) It’s harder to see, but it is indeed the case that the new triangle is smaller than the old one.
Who loses out more- producers or consumers? It’s actually not clear, since it depends on the relative elasticities (read, price-sensitivities, or see here for a video) of supply and demand. If consumers are insensitive to price, for example, producers will be able to push most of the cost increase onto them and not have to suffer much in terms of a reduction in quantity sold. Therefore, if consumers are less price-sensitive than producers, they will lose out more from the oil spill, and vice versa.
I bring this up because none of BP’s PR grandstanding addresses the cost to the consumers of the goods that are affected by oil being all over the place, but it’s a cost that is very much present and relevant. Granted, it’s a harder cost to reimburse, since the buyers are more spread out than the sellers, and it’s not really obvious how to find those people who stopped buying fish altogether because of the price increase. Economically speaking, if BP reimbursed the fishermen in real time for their cost increases rather than just for their lost profits, the market should be able to adjust to distribute that reimbursement properly, but that doesn’t address how to retroactively compensate for the damage that has been done. Therefore, I am hereby requesting that BP reimburse me 75 cents a pound for all of the fish I have bought in the last 40 or so days. I’ll even be nice and let the accrued interest on that amount slide.