The Tactical Economist

Introduction

Mass destruction of infrastructure occurs every year at the expense of natural disasters. Acapulco, Mexico, is no different, as they suffered such as a result of Otis, a category five hurricane that wiped out the area, destroying 377 hotels. The Mexican government has intervened in the market, and is providing $3.4 billion in aid, subsidizing resorts in Acapulco in order to pay off loans. A subsidy is a type of intervention, where a paymentis made to the firm for the purpose of increasing the production of a good. In this case, payments must be made to Acapulco's resorts, to be able to redeem the original supply of rooms.

The consumption of the hotel rooms generated revenue for Acapulco's economy through tourism. These hotels are the “backbone of the local economy,” meaning that when they are producing at an allocative efficient rate, the supply of hotel rooms is able to meet the demand.

Analysis

The free market equilibrium quantity is able to exist from the lack of a shortage/surplus, and operates under the assumption of the lack of intervention. This occurs at a point where the supply of rooms available meets the demand of said rooms. This translates to the equilibrium price of rooms equals the quantity of rooms available. This also ensures allocative efficiency, a socially optimal situation that occurs due to resource distribution ensuring maximum possible consumer surplus (benefit of buyers who can purchase a room at a price lower than willing/able to pay) and producer surplus (benefit resorts receive through prices higher than willing/able to supply). When the market is at this state, the government doesn't need to intervene. This free market equilibrium would've persisted if not for the negative supply shock, which is an unanticipated change that causes a shift in the supply of a product. This was seen in the form of Hurricane Otis, which drastically reduced the amount of rooms available.

The demolition caused by Hurricane Otis (negative supply shock) decreases the supply due to the lack of rooms, where the quantity demanded exceeds the quantity of rooms supplied at the original equilibrium price. Because the market experiences this sudden change, there's no time to adjust the price change within the immediate market period to correlate with the decrease in output of rooms.

Therefore, though price should increase, in reality it stays at the previous price equilibrium. Consequently, a shortage occurs because of price remaining stationary, as well as quantity supplied being significantly less than quantity demanded. The market was not able to correct itself because the supply of rooms was so low, and because Acapulco has an over-dependency on tourism. This in turn emphasized the need for government intervention and restoration of the market to its previous equilibrium state. López Obrador opted to provide financial aid, allowing hotels to pay back interest rates on loans. In other words, the money acted as a subsidy for resorts

If the subsidy is successful, it will revert the change previously experienced from the supply shock through increasing the supply. This occurs because the subsidy reduces the cost of production for the resorts. The increase in supply minimizes the market price for consumers, as quantity increases, the price received by sellers is higher than that of consumers. Therefore, the quantity demanded is able to satisfy the quantity supplied.

Conclusion

Ultimately, government intervention as seen through a subsidy is able to incentivize production through offsetting the costs for the resorts. This in turn protects the hotel industry and promotes the usage of the local facilities, as opposed to people seeking refuge in a foreign environment. Prices are also lowered for consumers, while still allowing resorts to supply more rooms at any given price, thus correcting the shortage. This is especially necessary for Acapulco, as its economy heavily relies upon the tourism influx and hotel usage. However, disadvantages are present… the most notablebeing welfare loss; the portion of the subsidy that isn't given to producers or consumers, and instead is used to “pay back” the net increase in societal costs. This form of intervention also takes away from tax revenue, which affects both groups. The requisite of tax revenue further cements the limitations, as enough must be raised to even be able to finance the expenditure. Moreover, there are also opportunity costs that arisefrom funding subsidies, such as using the tax revenues for direct provision of public goods, or a smaller tax burden on taxpayers.