Supply and Demand Are Just Like That, I Guess:
Here's the lead story today in the Wilmington (DE) News Journal, the local paper where I grew up:
GAS PRICES DIP AS DRIVERS CONSERVE: Analysts Say More Relief At the Pump Could Renew Demand — Meaning A Rise in CostRemember, kids, supply and demand are not just a good idea: They're the law.
Why have prices fallen? It seems initially, the reason is because people adjusted to the news (i.e. not the reality, which was quite evident before) of economic slow down, and bid down the price of oil.
I think that it was pretty obvious before that that previous price levels were simply unsustainable. So, the real question is why were prices higher before?
I bet if you made a graph of actual oil consumption changes (i.e. physical supply changes) versus prices, there would be more fluctuation in prices, thereby indicating the short-term prices are not always a simply product of supply and demand, but also a product of other factors. (Irrational market sentiment.)
By the way, was the housing bubble merely a matter of supply and demand too? I am afraid the story is not so simple. Supply and demand are nearly always central actors, but they are often not the only actors.
But, I bet you cannot draw a sensible supply and demand curve that fully explains the price fluctuations we have experienced lately.
Consumption should indicate where the supply and demand curves meet.
It seems like you distinguish "Snarky's rasonable demand" from "demand." If people want houses because they think the houses will double in value in two years, and not to live in, that adds to demand. If people want a big house because they're confident that they can refinance their mortgage when...
hold on...
BLERG! the donkey hit a two outer on the river...
...anyway... when their ARM with a teaser rate goes up, that increases demand. So, I guess the aggregate demand function doesn't distinguish between stupid and smart demand.
And if investors want oil because they irrationally think that enormously high prices are economically sustainable and will not lead to an eventual massive substitution effect, I suppose you could say that is "demand" as well.
I would say there is something different from genuine demand (i.e. I want to buy this house to live in it. I need this gas to drive to work.) versus speculation. (i.e. I will buy this house and drive up prices because I am convinced that housing prices only go up, and never come down. This is more than I would pay just to live there though. Or, I am buying this place as an investment and will not live there.)
Maybe this distinction does not fit into your supply and demand diagrams. I think that is a major weakness of such diagrams for explaining prices.
Yeah, maybe such a graph can show that demand has shifted. But why? (Is it due to irrational speculation or an increase in population, or more onerous zoning regulations?)
I would say that the real story is in the reason for the shift. And I would further say that some shifts are more justified than others. We should respect some shifts more than others.
The point. Supply and demand alone isn't the whole story. Or even necessarily that interesting.
So a price drop will cause a price rise?
I think some people need to think more carefully about supply and demand.
To do the math, estimate your gasoline cost per mile, the percent decrease in travel time, and your opportunity cost of driving. Suppose gas went from $3 to $4 per gallon in your 20 mpg car. Gas cost went up 5 cents a mile. Suppose drive time dropped by 10%, you averaged 40 mph, and your time is worth $20 an hour. Time cost dropped by 5 cents a mile. If these numbers are reasonable, everybody who values their time at more than $20 an hour will bitch about gas costs but drive more.
Where's that dang jury nullification when you need it?
To quote the noted author Gary Allen, "None Dare Call it Conspiracy."
But all that is beside the point on gas prices. There is no material speculation in gasoline. No one is buying up large amounts of gasoline for reasons other than consumption. It's all what you call genuine demand. There is speculation in oil futures markets, true, but they don't set prices for gasoline.
Snarky knows his econ, but he appears to conflate short term fluctuations with basic supply and demand.
In the longer term [the typical business cycle, for example], supply and demand rule.
Supply &demand curves are a Tinkertoy model for visualizing tendencies. If supply increases while demand remains constant, then suppliers have an incentive to lower prices rather than be left with unsold goods. Etc. But yes there's more to it--like, anticipation of future supply, demand, and prices. If I think the price will go up, I have an incentive to hang onto unsold goods for awhile. If I think demand will go down, I have a incentive to sell out quickly, rather than get less later. Where there is a lot of uncertainty, as with oil in a turbulent international world, it shouldn't be surprising that prices vary substantially, beyond what one might expect based merely on quantities themselves.
If a non-renewable resource is being used up, owners of that resource have the incentive to hold out NOW for a higher price. So the price goes up in advance of depletion of the resource. That stimulates conservation, searches for new supplies, and development of alternatives. At least, it does if the market is allowed to work.
By the way, the same principles explain why, if increased drilling is permitted now, the price is likely to go down well in advance of the new supplies coming on the market.
Yes, I grew up in a place to be somebody.
$5 (or whatever arbitrary number you want to select) a gallon gas is wicked if the money ends up in the private sector, but suddenly becomes virtuous if the money ends up in the hands of Big Government.
But a law devised by arrogant, unelected economists, so it doesn't count.
So a price drop will cause a price rise?
I think some people need to think more carefully about supply and demand
And we have a winner. If gas prices rose because of an inward shift in the supply curve, and if they've now fallen because of a movement up the demand curve, then there's no reason to expect renewed demand, nor therefore a rise in price.
It's possible that long run dynamics will be more complicated, but leaving that aside, I think it's fair to conclude from this example that the laws of supply and demand can be mis-applied just as much as the laws of the land can.
Hmmm... correlation or causation?
At the prices we have experienced, I agree. However, we don't know what the curve looks like above about $4.25. European experience might be a good place to explore this, but I haven't seen anything on it. But it's a non-linear elasticity curve, and it's reasonable to expect the slope to increase as price increases. That's what we have seen in the $3.50 to $4.25 range. By how much? I don't know. If I did, I'd be booking my flight to Stockholm.
"But, I bet you cannot draw a sensible supply and demand curve that fully explains the price fluctuations we have experienced lately."
Of course not. Don't forget to include the supply and demand for financing in the analysis, and its effect on lowering barriers to entry.
There are lots of factors that influence the price of a good, but those factors act through the mechanism of the supply and demand curves.
If bad weather cause a poor wheat crop, for example, the price of wheat will rise, and it would be reasonable to say "wheat prices rose due to bad weather." But the mechanism is that the bad weather shifted the supply curve back (reduced the amount of wheat for sale at any given price), thus moving the equilibrium price (the intersection of the S and D curves) higher.
There is nothing academic or complex about this. It just means that prices are determined by people's willingness to buy and sell at various prices. Common sense, really.
This statement is a great example of one of the many misconceptions people have about economics concepts like supply and demand. In this case, the poster fails to realize that the "other factors" are part of demand, such as disposable income, vacation plans, carpool usage, etc.
There is a difference between the level of demand, which is the current rate of consumption, and actual demand, which determines, along with supply, the level of demand. The problem is that the media uses the term interchangeably. If consumers buy 5 million more barrels of oil today that doesn't mean demand has changed. It could mean that the supply has changed, affecting the level of demand (if gas became 1/gal. you would expect a steep increase in "demand", meaning the level of consumption). A change in supply doesn't necessarily change what we perceive to be the value of gasoline, which determines our demand for it.
Poster Doc W does a good job of summing up the rest of the issue. Nevertheless, I feel its important to point out how terribly some people misconstrue economic theory, to the point where they become false premises in important policy discussions.
Actually, much of the high price for gasoline does end up in "the hands of Big Government," just not American governments.
But if you want America's roads and bridges maintained to at least their current state of disrepair, you too should be concerned about the drop in gas tax revenue.
But back to Professor Kerr's point. Actually, until very recently, gas prices had very little effect on driving. When it came to gas prices, the "law of supply and demand" was as well enforced as, say, the speed limit.
Lower than what? Lower than last year's actual tax revenue, or lower than what would be collected at this year's higher prices using last lear's miles? higher price?
CA has both a per-gallon tax and a sales tax "at the pump". It also has income and other biz taxes and fees.
The total sales tax rate depends on the county and city. In San Jose, it's currently 8.25%. I think that the state's cut is around 6%.
Let's say that gas went up from $3 to $4 while consumption dropped 10%. The sales tax revenues go up as long as the product of the price per gallon and the number of gallons sold goes up, which it has. So, the cities and counties are making more money. As far as the state is concerned, the increase in revenue from sales tax would exceed the loss from the per-gallon tax as long as the per gallon tax is less than $0.36/gallon, aka around 10% of retail price.
The federal gas tax is a tax per gallon, so when consumption drops, the federal revenue from the tax does indeed drop--which is what the news is referring to. Of course, the federal gas tax, which funds highway and transportation programs, is much too low, as is demonstrated by the sorry state of our transportation infrastructure (e.g., interstate highway bridges falling into the Mississippi River).
I don't understand what this statement means. The relevant price that affects miles driven, is, of course, the cost of driving miles. If gas is cheap then other costs, such as the opportunity cost of time spent driving, predominate. Increases in gasoline costs won't change the cost of driving much. Only after a certain point does the gas price become a predominant cost.
Also, adjustments always take time. When I throw a paper airplane, it doesn't fall to earth immediately. But no one views this fact as a contradiction of the law of gravity.
Do we have another liberal urban legend, like domestic violence during the super bowl? The bridge seems to have collapsed due to an engineering error that was made before it was built.
Amusingly enough, the bridge collapsed on that day rather than the day before or after because there was heavy construction equipment and materials on it because they were doing major work on it that day.
-dk
Professor Kerr was mocking the fact that the article noted that demand was responding to price. My point (which you seem to agree with) is that demand sometimes does not respond to price for a very long time. Here, the article noted the reality that demand was finally responding to price.
So, as your airplane analogy shows, it was Professor Kerr, not the article's author (or headline writer), who got supply and demand wrong here.