More on expensive gasoline
In my article
about climate change, I mentioned in passing that "anybody who thinks
the current price of gasoline has anything to do with 'peak oil' does not
understand economics." Now, to be fair, some people really don't
understand economics, which I guess is actually to be expected if you
haven't studied it.
But you really can't understand gas prices without it, so here we go with some
ECON101.
Introduction to price optimization, without even using calculus
Let's say I'm a widget vendor in 1999, and my company is the only company
able to make widgets. (Because of a monopoly, patents, whatever.) I'm
selling widgets to you for $0.50 each, and people buy 1000 widgets this
year. Now let's say, as an experiment, that I raise the price a bit each
year, so that by 2007, widgets are $1 each, and because of the increased
prices, people are now only willing to buy 750 widgets a year. Quiz time:
1. How much money did I make in 1999 vs. 2007?
2. Did I do the right thing by raising the price?
3. What does this say about the trends in worldwide widget production?
Answers:
1. $500 in 1999 and $750 in 2007 (or $625 in inflation-adjusted
1999 dollars).
2. Absolutely. You made more money, but wasted fewer worldwide resources
and did less work, which means you could get away with hiring fewer people
and therefore ditch some unproductive middle managers. If you hadn't had a
monopoly, or people hadn't needed widgets so badly (less price
elasticity), you might have been in more trouble.
3. As the only producer of widgets in the world, I will have
reduced my production rate because I'm selling fewer widgets and I
don't want to fill warehouses with extras - that costs me money. This
doesn't mean the world is running out of widgets, it means I'm smart enough
to cut the supply of widgets because I make more money that way.
And back to oil
Now replace "widgets" with "1L of gasoline in Canada" in the above example,
and you have the story of the worldwide oil market.
The only difference is... did people really reduce their gasoline
consumption to 75% of its initial value just because the price per litre
doubled? Actually no, I just made that up. Here's what it actually looks
like (the red line is U.S. oil consumption; the green (or is it black?) line
is irrelevant for our purposes, but click the image if you're interested):
(It doesn't matter whether we graph supply or consumption; they'll be about
the same, because as with widgets, nobody wants to keep around warehouses
with billions of barrels of oil.)
Wouldn't you love to run a business where consumption goes up even
though you doubled the price? Okay, actually, as wlach points out,
consumption (production) has actually been flat for the last couple of
years, suggesting that maybe prices are high enough now.
But just as a thought experiment, imagine that gas prices doubled one more
time. Would you drive less than half as much as you do right now?
Really? If not, it's in their best interests to do it all over again. And
you'd surely see the production actually go into decline
as they make more money while you buy less gas.
Oh yes, the world is running out of oil, all right. But that has
nothing to do with its price.
September 3, 2007 17:28