Tramp Shipping and Perfect Competition: Elasticity of Demand and Supply

Shipping Markets

•       The shipping industry is made up from a number of different markets

•       Each has its own characteristics

–      type of product

–      number of suppliers

–      number of customers

–      barriers to entry and exit

Basic Shipping Market Structure

 Bulk Trades and the Assumptions of the Perfectly Competitive Model

•       Many buyers and sellers

–      Neither shipowners nor shippers control the market but what about shipping pools and oil majors?

•       Buyers and sellers are price takers

–      They have to accept the freight rate as set by the market

•       The service provided is homogenous

–      There is no difference between one bulker and another, no point in advertising but does quality count?

•       Freedom of entry and exit for firms

–      Ships can be readily bought and sold

•       Both buyers and sellers have perfect knowledge of the market

–      freight rate information widely published but some secret deals

•       No government interference ?

–       subsidised ships or crews, protectionism,  tax breaks

What is Elasticity?

•       The price elasticity of demand measures the percentage response in demand to a given percentage change in price

–      how much the quantity demanded will change if there is a change in the price of the good

•       Elasticity of supply measures the responsiveness of a change in the quantity supplied of a good to a change in its price

Pε_d = % change in Q/ % change in P

A price cut resulting in an increase in revenue

A price cut resulting in a decrease in revenue

Price Elasticity of Demand

•       Whether total revenue increases or decreases depends on how responsive the quantity demanded is to a change in price

•       The price elasticity of demand is the percentage change in the quantity demanded of a good divided by the percentage change in its price

•       Elasticity does not depend on units of measurement

Factors that influence the  elasticity of demand in shipping

•       The value of the own price elasticity of demand for the final good

•       The existence of close substitutes

•       The proportion of the total final price which transport constitutes

Elasticity of supply

Factors which affect elasticity of supply are:

•       The ease with which production can be increased

•       The length of time allowed to adjust supply

Elasticity of supply

•       MS is zero elastic

•       SS is inelastic

•       LS is elastic

Demand for Oil Transport

•       Demand is price inelastic

•       The freight rate has little effect on quantity  demanded

The Demand Curve

Supply of Oil Transport

•       The world tanker fleet is fixed in the short run

•       Up to a point, supply can be changed through speed changes, waiting for cargo, lay-up, transfer of oil/bulk ships between cargo types, transfer of ships between size segments. Supply is elastic

•       Beyond that point, it becomes hard to increase supply - all the slack has been taken up. Supply becomes inelastic

Short run supply curve

 Changes in Freight Rate

Changes in Freight Rate

•       At D₀  price is  low, P₀

•       Demand then increases a lot (perhaps due to a rise in world economic activity) and the demand curve moves to D₁. Price increases slightly to P₁.

•       A further, relatively small increase in demand to D₂ sends prices very high at P₂.

•       All slack has gone from the system. Only high cost small or old ships are available.