In the technical era we are in it almost seems as if the laws of economics have been repealed. When you make mass produced computer hardware [and especially if you make software] there is practically no limit on how much supply can be made available . That is why the laws of supply and demand don't seem to exist in parts of our present economy . The setting of prices is far more consumer driven in these industries . But does this mean that these laws have been "repealed" and have no further value ?
The answer is found in the definition of the discipline of economics . Economics is the study of the distribution of scarce goods and services . The key word is scarce . If what you are producing can be made in nearly unlimited quantities with only minor marginal cost increases then applying the laws of supply and demand is a very different process . But , if the product you're producing is limited by availability you must fall back on the old ways of determining prices . We may be in the computer era but petroleum is not subject to that type of voodoo price manipulation . The supply curve for petroleum is a well defined upward sloping line of quantity with price , in other words , old fashioned economics .
But there is one more wrinkle in old style economics which applies to petroleum prices . If supply becomes restricted then it can no longer expand to meet increased demand . That situation is referred to as inelastic supply and it shows distinct patterns in the supply curve . Such things rarely ever happen with computer software pricing .
How do our partisan politicians deal with oil prices ? Sometimes they play the blame game . For example I have witnessed those on the left claim that it is greedy capitalist speculators who are causing sudden spikes in petroleum prices . They don't explain why the volatility has changed though . If their speculating could cause price changes now why wasn't it causing those problems in the past ? And why am I so confident that it was not speculators who were causing this price volatility ? Because they don't need to make large price changes to make a killing in the market .
For example :
There have been some speculators charged with manipulating petroleum prices and making huge profits when they did .
Here is an article from last year about that subject .
But if you read it carefully , you will see the following revealing excerpt :
" The price of crude during the months of the alleged misdeeds changed very little, generally staying within a $10 range but the traders made their money off the daily fluctuations. Crude traded at $99 a barrel Jan. 2, 2008, and ended March 2008 at $101 a barrel. "
There it is . It is possible to make small manipulations in the price and still make large profits . That's what these speculators did . But they did NOT drive large changes in the price . And that is the point . It is not possible to create long trends in the price by manipulations unless you are someone who controls a major amount of supply [like OPEC] . The most that can be done by speculators is to day trade on small changes . But that has no effect on longer trends and larger price changes . One more thing : These were no ordinary speculators . They were able to manipulate the price because some of this cooperating group were in the energy business . They knew the details of how to buy petroleum and how to dispose of it .
That seems to have eliminated speculators as the cause of the large volatility in oil prices but what does cause it ? For the right side of politics they seem to believe in the miracle of high office intervention . For example in the following link :
there is an indication that G.W. Bush used his influence with the Saudis to get more oil into the system and thereby get the price to drop . Did that work ? It may have appeared to but the sudden drop in prices was more about a decrease in demand from the US driving public . [Most of the oil used in the US goes towards transportation fuel .] It is possible that approach did work in the past . But the bad news is it will not work anymore . And it did not work in 2008 . What makes me so sure of that ?
Here is a summary of an important commentary article recently published in the journal Nature .
The conclusions it makes are unambiguous and not just a little scary . Here's one of them :
the economic pain of a flattening oil supply will trump the environment as a reason to curb the use of fossil fuels.
"Given our fossil-fuel dependent economies, this is more urgent and has a shorter time frame than global climate change," says James W. Murray, UW professor of oceanography, who wrote the Nature commentary with David King, director of Oxford's Smith School of Enterprise and the Environment.
The "tipping point" for oil supply appears to have occurred around 2005, says Murray, who compared world crude oil production with world prices going back to 1998. Before 2005, supply of regular crude oil was elastic and increased in response to price increases. Since then, production appears to have hit a wall at 75 million barrels per day in spite of price increases of 15 percent each year.
"As a result, prices swing wildly in response to small changes in demand," the co-authors wrote. "Others have remarked on this step change in the economies of oil around the year 2005, but the point needs to be lodged more firmly in the minds of policy makers."
The rest of their explanation has to do with the details of the supply of oil and the problems with the recent discoveries as well as the economics involved . If you are at all interested in this subject read the link . To conclude , the graph which summarizes their work is at the top of the page . Those who understand scatterplots will find it compelling and hard to ignore . It shows a clear case of "inelastic supply" in the petroleum industry .
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