Understanding Wellington and toilet paper

Toilet paper has been running out all around the world, with Australian’s genuinely fighting over it in supermarkets – and there has been a big show about it in the news.

This leads to some interesting thought experiments such as:

And yet, here I am in a big Wellington supermarket. It has:

  1. lots of toilet paper,
  2. specials on all the toilet paper!

This doesn’t seem to make sense. If concerns about COVID-19 are driving people to panic buy toilet paper we know that the demand curve has shifted right, and prices should have risen! So what is going on. Lets put our economics hats on and find out 🙂

Wellingtonian’s are different

Hey it could just be that Wellingtonian’s are different, and they realise that during a pandemic toilet paper isn’t a particularly high priority. Or maybe the constant earthquake awareness in the region means that everyone already stocks up on toilet paper.

In that case, if the supermarket has stocked up expecting a surge in demand they would be highly disappointed, and will have built up extra stock (as shown by the stacks of toilet paper all over the supermarket). In this case, the discounts are to clear out this extra stock.

Here there was an anticipated increase in demand, but it was smaller than expected – as a result toilet paper providers oversupplied and ended up discounting. A similar argument has been used for looking at Nurofen prices in winter here.

This seems like a reasonable reason – it involves people in Wellington being different and their local supermarkets not realising.

But I feel nervous acting like supermarkets are that dumb, and that people in Wellington are particularly special, so what else could explain this observation?

Competition, collusion, and an opportunity to sell toilet paper

New Zealand has only two supermarket chains. These supermarkets are the primary suppliers of toilet paper.

Given this duopoly we can think about supermarket competition as a Cournot game. In this instance, imagine the supermarkets were exactly the same. If a supermarket cuts prices to sell an extra unit of toilet paper this will reduce the revenue of the other supermarket – due to this spillover the supermarkets overproduce (relative to the monopoly level) and end up with less than half of the monopoly profits each.

This is a prisoners dilemma – if they could coordinate they could make half the monopoly profits each, but they each have an incentive to deviate from this, and so compete themselves into a position with lower profits.

Now supermarket competition is repeated through time, and so there is some degree of tacit collusion between the retailers. They will generally both hold their prices up, in order to generate greater profits, even though they each have an incentive at a given point in time to undercut their rival.

In the current situation we have an observed increase in demand for toilet paper. In this high demand state we have greater profit opportunities if you can be the retailer serving the market!

Because of this, there is a large reward for undercutting your rivals. This greater reward during the high demand state may be so tempting that tacit collusion collapses, and the supermarkets start competing with each other!

As a result, even though demand for toilet paper has increased the fact that both supermarket chains are trying to benefit from this ends up driving down prices as collusion over toilet paper prices collapses!

This was another explanation given for Nurofen prices dropping during winter here.

An issue with this explanation is the observed oversupply of toilet paper in the supermarket – they have cut prices to sell more, and yet the shelves are stocked to the brim!

It could be that supermarkets are trying to keep a large stock of toilet paper in case their competitor does not respond – and as both supermarkets are cutting prices they end up oversupplying toilet paper.

However, I think that – in this instance – there is a better explanation.

Complements and halos: Loss leading loo paper

Toilet paper is in the news. Get to the supermarket, wrestle your neighbors for toilet paper, and you will be safe from COVID-19. It’s a bit ridiculous – but the availability and price of toilet paper is an important heuristic right now for what location to shop in.

Supermarkets do not sell just one good. As a result, if a special on toilet paper – along with stacks and stacks of toilet paper from wall to wall in the store – will get people in the door, then that also ensures that people will buy OTHER goods and services from the supermarket.

In other words, toilet paper and other supermarket goods are complements, and the discounts and advertising of toilet paper is a way supermarkets can get you in the door to purchase these other goods.

This broad concept has a common name called the “Halo effect“. However, as that post notes this effect is quite unclear as it is the mix of two things, the complementarity of products due to their co-location, and brand spillovers.

In this instance it is just the former we are meaning. In fact there is a better term in this context, where the supermarket may be willing to sell toilet paper at a loss to get people in the door – a loss leader.

Because of the fear of COVID-19, people are trying to find something they can control to give themselves a sense of protection – in this case toilet paper purchases.

Seeing this, supermarkets recognise that people are especially responsive to toilet paper availability and prices and so use these sales to increase demand for their other – higher margin – products.

Just look at these places overseas:

Mate, those places are loaded up with toilet paper!

So maybe Wellingtonians aren’t that special, and supermarkets just realise that showing us toilet paper gets us in the door during a crisis. Well played 😉