The guys over at Environmental Economics are becoming two of my favorite economists…which is interesting since I’ve never been particularly into the whole environmental thing. I obviously understand that it’s important to save some whales and panthers and polar bears and whatnot (yup, all cute animal examples), it’s just not what I study. What I *do* study, or at least write about, is the disconnect between (good) economics and (less than good) politics.
In general, conservatives tout themselves as being opposed to most forms of government interference in markets. This viewpoint seems to come both from a “stay out of my business” ideology and the concept that interference in well-functioning markets is economically inefficient. However, they apparently don’t let this viewpoint stop them from criticizing others for allowing markets to reach what they feel are undesirable outcomes. From Tim Haab at Environmental Economics:
I’m fairly conservative when it comes to letting markets do their thing. I don’t like it when governments interfere with and regulate fairly well-functioning markets. That’s why it bugs me a little when conservatives blame the President for simple fluctuations in markets that are a result of basic economic adjustments*. Like this:
Gas up $1 a gallon on Obama’s watch: Pressure rises for exploration
Gas prices have risen $1 since just after President Obama took office in January 2009 and are now closing in on the $3 mark, prompting an evaluation of the administration’s energy record and calls for the White House to open more U.S. land for oil exploration…
This excerpt is from the Washington Times, which is known for being a conservatively-oriented publication. (Don’t worry, my notion of an unbiased media died long ago. If yours hasn’t, might I suggest you pick up a copy of Matt Taibbi’s Spanking the Donkey.) It’s nice to see that they don’t let either the principles of economics stand in the way of criticizing the current administration. I also love how the article can basically be summarized by “drill, baby, drill,” since the authors seem to be using market fluctuations as an excuse to push this part of the conservative agenda. (I say this mainly because there are a number of non-drilling ways to get gasoline prices down, for better or for worse.) So is something about the gasoline market broken? The article continues…
John B. Townsend II, a spokesman for AAA Mid-Atlantic, said price increases are a result of the cost of crude oil, thanks to a decision by the Organization of the Petroleum Exporting Countries not to raise production even as economic growth in countries such as Russia and China spurs more demand.
“From all indications, we’re going to see $3 gas again this summer,” he said.
Oh OPEC, how you introduce asterisks and footnotes into the world of the well-functioning market. Furthermore, I want to think that you are all big and evil and restricting supply and whatnot (which you are), but I can’t help but also think that you are inadvertently doing your part to avoid overharvesting a nonrenewable resource for short-term profit at the expense of long-term sustainability.
I am not entirely clear on how OPEC sets production quantities (I am not convinced that they are clear on this either, for that matter), but for the most part the quantities don’t seem to depend all that much on market price, at least not in this case. On the other hand, non-OPEC producers respond to the higher prices by producing more, since the higher prices make oil a more lucrative business. When we look at the entire world supply, then, it is somewhat responsive to prices, just not as responsive as it would be if OPEC wasn’t doing its whole cartel thing. So we get the following supply of crude oil:
Now, I don’t entirely understand how it’s not profit-maximizing for OPEC to raise its collective output somewhat in response to the increased demand, but they’re gonna do what they want to do, so I just take it as given. When you couple this with increased demand for crude oil, you get the following market for crude oil:
Hey, look at that- crude oil got more expensive, just like the article said. Now consider the rise in crude oil prices. Crude oil is what is used to produce gasoline, so if the price of crude oil goes up, gasoline is more expensive to produce. If gasoline is more expensive to produce, it’s less attractive to produce it and companies are in fact going to produce less of it.
Because of the reduction in supply, you get a picture that looks like this for the gasoline market:
Not surprisingly, gasoline prices go up. It could be the case that gasoline prices go up even more in response to increased demand as well, since I find it counterintuitive to think that China and Russia are adding to the demand for crude oil but not to the demand for gasoline. (Maybe they’re making their own gasoline with the crude oil they buy, who knows.) In any case, what you see in this model is a graphical representation of “If something gets more expensive to produce and/or more people want it than before, that thing is going to get more expensive.” It’s not like there’s an evil genius out there (yeah, I’m sarcastically talking to you, Obama) who’s messing with gas prices so as to put those blue-collar workers who drive 20 miles to their jobs into the poor house. Furthermore, I find it funny that in all likelihood these same people would start waving around the Socialist card if Obama DID do anything (at least do anything other than drill) to bring gas prices under control.
My main point is that people can’t have it both ways. If you want the government out of your free markets, then you get to absorb the market fluctuations that come along with that. I do understand that conservatives see the easing of drilling restrictions as leading to a more free market, which it does, but the problem comes in when they start using price stabilization as a justification for the change. While it is true that increased drilling, if successful, should lower the average price of gasoline somewhat (by increasing supply, assuming that we could profitably produce gasoline from the new areas), it would not insulate U.S. consumers from market fluctuations*. Instead, we’d just be complaining about how gasoline went from $1.50 to $2.50 rather than from $2 to $3. I say this mainly because it seems that it’s specifically the abrupt changes that generate the public outcry, and it’s specifically the abrupt changes that the increased exploration would not prevent.
Technical note: This is because the added supply isn’t likely to make supply more price elastic, and this is what would be necessary to have smaller price increases in response to increased demand.