Toilet Paper: Increasing Marginal Cost
A common objection to the simple supply-and-demand model that predicts a shortage when the price is capped below its equilibrium level goes as follows. Why don’t producers just produce more to fill unmet demand? They should be happy to do so. And this would just end the shortage. Correct?
No. This objection is not valid. Producers will only do so if it they make profits, which will not be the case at the capped price. Since quantity demanded is now higher than quantity supplied at the ex ante price, producers would fill the gap only if they could increase production at the same marginal cost, that is, only if they could produce additional units at the same cost. As students learn in ECON 101, marginal cost is increasing in the short-run (and often in the long-run too). This means that producers will be incited to increase production only if the price they get increases.
Technically, the reason is that, with fixed capital (plants, machines, and equipment) in the short-run, any variable factor of production used to increase production (say, labor) will have diminishing marginal productivity. The 10th worker around the machine will have a lower productivity than the first one. An interesting Medium story helps understand; see Will Oremus, “What Everyone’s Getting Wrong About the Toilet Paper Shortage” (April 2).
On the current market for toilet paper, there are two reasons why consumer demand has increased. On the one hand, consumers fear that the shortage will persist or worsen (like in Cuba or Venezuela), so they want to stock toilet paper. Their fears are not without justification, because the government is likely to worsen the problem. On the other hand, people who used to work outside now use more toilet paper at home (40% more by one estimate), as they use none at work (or in restaurants, hotels, or schools).
Another thing to understand is that quantity demanded is higher than quantity supplied because government price controls don’t allow the price to fully adjust upwards. The Medium story is very weak on the role of prices and the impact of price controls, but economic theory can fit this gap and help better understand the economic consequences that we observe.
As usual for all goods and services, the marginal cost of producing toilet paper increases with quantity supplied (produced). The Medium story illustrates that. Take Georgia-Pacific, a leading American producer of toilet paper. Producing more toilet paper for consumers on its current production lines would require more workers, whose marginal productivity would decrease. Working with less equipment, the marginal (supplementary) worker has a lower productivity. Consequently, marginal cost is increasing.
Can’t Georgia-Pacific evade the law of increasing marginal cost by having its commercial production lines produce toilet paper for consumers? No, marginal cost will also increase on these lines. Commercial toilet paper is made of recycled fibre and is less soft and thinner. Even if production lines of commercial toilet paper can be retooled, at a cost, to make a product better adapted to consumer demand, the packaging will also have to be modified. The commercial product is shipped on crates in individually wrapped rolls, rather than in brightly branded packs of 6 or 12. The commercial production lines would need to be retooled at the packaging end too, again at additional cost.
Add to this the cost of distribution proper (which economists include in “production”). The logistics has to change, which probably implies higher costs in the short-run. Walmart distribution centers give a narrow half-an-hour window for supplier deliveries. Moreover, the paper company knows that when people go back to their normal workplaces and the government’s price controls are (hopefully) lifted, the production-line switching will have to be done in reverse.
It should thus be obvious that the short-run marginal cost of producing toilet paper increases with production, which means that the supply curve of toilet paper has a positive slope. (In the longer, the industry might have to bid up wages or the prices of other factors of production to divert them from other industries.) The more toilet paper to be supplied, the higher the price must be. (Charities can offer toilet paper below the market price, but they would have to pay a higher price to the producer.)
A Wall Street Journal story of yesterday (“P&G Toilet Paper Factory Keeps Delivering as Coronavirus Strikes its Town,” April 12, 2020) tells us that the Procter & Gamble plant in Albany, Georgia, increased by 20% its production of toilet paper and paper towels. This may be possible, up to a certain point, for a number of reasons. Some equipment might have been idle, as we are told was the case in the P&G plant. The allocation of production across the company’s plants might have changed. Price-control and “anti-gouging” laws often allow some limited price increases, and there may be much arbitrariness in their enforcement. During a crisis, one must not totally discount the desire to make special efforts, even if only for the corporate image, but also possibly for charitable or neighborly motives. But the limits of this flexibility will rapidly be reached when hard financial realities hit.
Toilet paper is not special: all goods, including those in more demand during the current crisis, have increasing marginal costs of production. What explains the current shortage of so many goods is the combination of higher demand, price caps decreed by governments, and increasing marginal.
This simple economic model makes other predictions. Despite price caps, the price of a roll of toilet paper will increase stealthily if the quality decreases: lower quality for the same price. There will be a temptation to produce coarser, commercial-type toilet paper and to sell it at the price of the previous softer variety. But large companies like Georgia-Pacific or Procter and Gamble, which are incited to maintain the value of their brands (which are worth billions or even tens of billions of dollars), will not yield to this temptation except if the shortage situation gets closer to Cuba or Venezuela. But smaller no-brand producers, including entrepreneurs in foreign countries, will work to meet the unsatisfied demand that the shortage implies. Black markets will develop. Many national bottoms prefer coarser toilet paper than none at all.
It may not end there. When the two toilet paper rolls allowed per customer at the grocery store are not available anymore (the price is low but the thing is unfindable), and when jails fill up with smugglers and black marketers (“hoarders” and “profiteers,” as governments have called them across all modern history), some voices will be raised for toilet paper to allocated, and perhaps even manufactured, by the government. Give the production or distribution to the army! (Perhaps after they first tried to have the job done by the FDA, the CDC, or Amtrack?)
Perhaps, one day, when people meet on the street a very old Elizabeth Warren or Donald Trump, they will excitedly beg for an autograph. “He (or she) is the one to whom we owe our federal ration of recycled toilet paper, thank God!”