Tuesday, June 02, 2009

Another Journalist Misunderstands Supply And Demand

The article is Oil Is Plentiful, Demand Weak. Why Are Gas Prices Going Up? by VIVIENNE WALT. Here is the opening paragraph which illustrates the problem:

"Storage tankers across the globe may be brimming with oil that no one is buying because of the global economic downturn, but the traditional laws of supply and demand don't always apply to oil prices. Drivers have faced rising prices at the gas pump in recent months, as investors and oil-producing countries hoard supplies in anticipation of a global economic recovery later this year."

Actually, the "traditional laws of supply and demand" do apply. Price is determined by the intersection of supply and demand curves (or lines). But those curves can shift to the right (an increase) or to the left (decrease). One factor that causes a shift is "expectation of future price." Most, if not all, introductory textbooks have this factor. If sellers expect the price of their good will go up in the future (like if there is going to be an economic recovery), then they reduce the amount they offer for sale today. So the supply curve moves to the left and price rises. This is exactly what we teach in principles of economics courses. The graph below illustrates this:

Now the article does discuss the role that OPEC plays. Certainly when cartels are present, and they act like a monopoly, price will be higher. But the basic textbooks predict that, too.


Carl said...

After reading the Times article and I agree that Walt does not support his initial comments in his article very well. I agree Cy and fear power of oil futures to quickly increase the price of oil well ahead of the actual demand. Are those trading in oil futures doing anything positive for the world economy? Why does it seem that oil futures are able to get so far ahead of the economy? The futures system seems to work for other commodities, why is oil so different?


Cyril Morong said...


Thanks for dropping by and commenting. Hope things are going okay for your.

The prices might be rising so fast now because the anticipated increase in demand (and therefore price) is very high. The more you think the price will rise in the future, the faster it will rise now.

This is good because when the boom comes, more oil will be available since some is being held back now. The faster the price rises, the faster people try to conserve and use oil more efficiently.