Saturday, August 27, 2005

What to do about the price of oil?

Capital Freedom had some very insightful observations on Hawaii's dangerous price controls on gasoline, including, "I should hope that the shortages of the 70s are recent enough for most politicians to remember." Sadly, in a specific example of George Santayana's truism, history is replete with politicians who never learn from past mistakes (theirs or predecessors'). Condemned to repeat them, they typically have the people's support. Capital Freedom noted a week ago that most history books today are terrible at explaining the full sides of political and social issues. New generations grow up supporting politicians in bad policies that "sound good," unaware that such policies have failed disastrously -- sometimes only a few decades ago.

Einstein reputedly said, "Insanity is doing the same thing over and over, expecting different results." What can our leaders be but out of their minds when they resurrect such failed policies?

OPEC's initial embargo predated me by a couple of years, and my father had no personal experience about the embargo's effects on the U.S. that he could impart to me. (I was born overseas during his business sojourn in the Philippines, and our family didn't move to the U.S. until 1983.) So like most American schoolchildren, I learned about the 1970s oil crisis from schoolbooks. While they mentioned a few facts and threw in pictures of cars lined up at pumps, I never learned the full, true story until studying microeconomics. The embargo produced higher oil and gasoline prices, that much is true. However, oil's scarcity was not the crisis. The crisis was its shortage, caused by Nixon's wage-price controls.

It's important to note that a "shortage" in economics is not simply scarcity (defined as when a resource is both limited and wanted). Velocity in physics requires both speed and direction, and similarly a true shortage is insufficient product to satisfy all who want to buy it at a certain price. In the free market, the price for a scarce resource is bid up to an equilibrium point where supply perfectly matches demand. The price system may not eliminate scarcity, but it will eliminate shortages. A scarce resource must be expensive, to discourage people from using it unless, to the supplier, it's worth their own resources that they can and wish to trade for it. Meanwhile the higher prices will encourage both old and new suppliers to produce more, or seek out substitutes that were previously too expensive to be worthwhile.

It may seem mere semantics, but the difference is critical. When a high price discourages people from looking for something unless they really value it, that greatly minimizes the time that society wastes in looking. Remember, you incur search costs whether or not you are successful in finding and buying it. Consider filet mignon. At $10 per pound, not as many people will buy it as when government sets a maximum price of, say, $8. More people will want it at $8 than $10, but supplies will become even more limited because some suppliers may well leave the business, since this venture is not as competitive in profits as others.

The same principle applies to oil. The federal government could claim to "help people" by setting a maximum price of $2 per gallon of 87 octane gasoline, but like the attempts in the 1970s, that would do nothing to check the consumption of oil, and we'd wind up with shortages. Worse, there would be no encouragement for suppliers to find new oil fields. Perhaps the produced gasoline might have to be sold at $2.20 per gallon to make the same profit, but many people would still consider that worthwhile. In fact, many people still consider it worth paying the current nationwide average of $2.583 per gallon of regular; if they didn't, they wouldn't be paying it. It leads to CF's excellent point about what price controls do: "They do not allow bargaining between consumers and suppliers to negotiate a mutually beneficial exchange in which the consumer does not waste his time in line and the producer may profit. Such bargaining, even though both parties benefit, is illegal in a price control system."

Then there's what most of my fellow gentlemen and I have cursed as the worst form of alleged price gouging: the price of roses leading up to Valentine's Day. But for the reasons above, we can't really complain, especially in terms of minimizing search costs. Higher prices prevent someone from buying out a store's stock of roses because they're only $10 per dozen, when the rest of us would have gladly paid more. I've done my duty and have spent well over $100 for an arrangement of a dozen roses, because at the time I thought they (and she) were worth it. This year I got off fairly easily.

Most Americans today are unfortunately unaware of such basic microeconomics. I customarily read the New York Post when taking the train home from Manhattan. Some of the letters yesterday just dismayed me (they're available online here):
Instead of punishing American SUV owners further with $3 gas, why not cut off the billions in foreign aid to oil-producing nations ("Feds: Plan Will Pump Up Mileage," Aug. 24)?

Also, how about raising the price of our wheat and other food products?

Then watch how fast the price of oil drops.
Evidently the letter writer is an SUV owner or sympathizer, who's unwilling to pay more for a resource that others value more highly. While eliminating foreign aid is not a bad idea, his second is more than questionable. So we must threaten other nations, who will then retaliate themselves? Or if they do pay higher prices, remember that their income is finite, so they must cut back on other purchases; in the end it's only a shift in consumption. (See my entry on the yuan revaluation for a description of the "death spiral" of protectionism.)
I find it so typical of our society that we do little or nothing about matters that affect us so profoundly, such as the weekly increase of gas prices.

If this were any other product — hamburgers, newspapers, movie tickets — our politicians would be on the front page of every newspaper addressing this problem.

Why is the constant price increase being disregarded?
While it's true the price of oil affects all Americans in one way or another, I wonder what planet he lives on. Oil prices for a long while now have been a dominant subject in every major news source. What's clear is that the politicians cannot "address" higher oil prices except by trying not to address them. They couldn't in the 1970s, so what makes us think they can now?
People need to stop crying about these high gas prices.

We live in a weak, modern-day America, an America that spends $60,000 on SUVs and then pouts about the $100 it takes to fill up the gas tank.

We need gas, and Americans need to prioritize.

The price of gas may be an infringement on the luxuries we have and want, but they are only luxuries.

Get your priorities straight, and stop crying about gas prices.
This is an eminently sensible letter from someone who obviously has a firm grip on reality.
There is a simple way to reduce fuel consumption and demand — and maybe even impact prices at the pump.

Slow down a bit.

America's security, like charity, begins at home.

Saving money is good.

Being safe is even better.

Driving slower can achieve both.
It's a very good point, but some people do value time more than gasoline. Driving 80 mph will certainly burn a great deal more fuel than driving at 60 mph. However, some people accept that as worth arriving in three-fourths of the time (depending on the distance, of course).
Readers attack oil companies for record profits, but how much of those profits are subject to federal and state corporate income taxes?

It's a large percentage.

Figures should be published to document this new revenue that's flowing into the treasuries across the country.

We'd be better off paying $100 per barrel while having the price supported by legislation. In a few years, we will be producing most of our own oil. The dollars will stay here, and the filth that is the membership of OPEC will be bankrupt.
Oh good heavens. Does this fellow not understand that if government taxes him less, he will be free to spend (and more efficiently) that money? Or can he promote such an absurd idea because he benefits more from government spending than he pays in?

Oil at $100 per barrel. What a superb idea...if you want to wreck the American economy. It would not merely be a surge in the Consumer Price Index (see my entry "What is free? And what is inflation?" for why that's not true inflation). What he's advocating is hamstringing Americans who would like to use a resource that is still fairly plentiful at a price they can afford. Pump prices would be so high that people would resort to inefficient ethanol, or they'll pull a Jane Fonda and use vegetable fuel oil. There's nothing wrong with either, at least when you ignore that the natural price of gasoline is far lower. Ethanol has poor fuel economy and isn't worth its true unsubsidized price. Vegetable oil works for some farmers, but it's too costly to produce for large-scale use, and there isn't enough to power the U.S. economy.

And if we import our oil, so what? As I wrote Thursday night/early Friday morning about my confrontation with Larouchers, it's not a bad thing at all to import something that's cheaper than if you produced it domestically.

The answer is still this: government must not attempt a thing and instead let the free market work.


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