The Economic Way of Thinking

The Peak Oil Fallacy

Take a good look at this graph:

Projections like this have been around for decades.  Take a look at the "peak oil" discussions at World Without Oil and Scenario Thinking, for example. To expose the fallacy, we provide a similar one in the appendix to chapter 6 of our EWOT textbook.  Notice that the graph predicts a shortage of oil over the next twenty five years.  It uses supply and demand curves -- the language of the economist -- but those cannot possibly make sense.  Supply and demand represent the plans of sellers and buyers at differing prices a scarce good on the market.

But where are oil prices in this graph?  There aren't any.  Price, and its role in adjusting quantities supplied and demanded, is nowhere to be found.  Should demand grow and/or supply fall over time, the price would rise to capture the greater scarcity of oil, and oil would therefore be conserved or economized in response.  All that is absent in this type of model.  In short, the model is economic nonsense.

It seems like this type of model undergirds the new "biophysical economics:"

The new field shares features with ecological economics, a much more established discipline with conferences boasting hundreds of attendees, but the relatively smaller number of practitioners of biophysical economics believe theirs is a much more fundamental and truer form of economic reasoning.

These physicists, ecologists and a few weak economists focus only on the projected quantities of oil, and energy, that are expected to exist in the world, and have no understanding or appreciation of the use of market prices to coordinate the plans of its producers and users.  I call their approach the Peak Oil Fallacy, and I've discussed it for years in my EC 101 course.  While "biophysical economics" seems to examine quantities alone in its so-called supply-demand model, economics is about choices and decisions in a world of ever-present scarcity.  When will they learn?  Have the economists among this group ever learned the coordinating role of markets and prices?

EWOT Question Of The Day

In 2008 both John McCain and Hillary Clinton proposed that the 18 cents per gallon federal tax on gasoline should be temporarily suspended, to help the American consumer.  Evaluate the following argument against their proposal:

"Repealing the tax will give oil companies an additional incentive to raise prices.  If skyrocketing gas prices are due to supply and demand factors, as oil companies argue, a reduction of 18 cents will increase demand on a product already in short supply.  The increased demand will contribute to increased pump prices."

Where is the mistake in this argument?

Coffee Shop Economics

Everybody's an economist.  The other day I overheard this at a coffee shop in Wisconsin:

"Yah, we can't produce ethanol at the current price.  Farmers need a price above three bucks a gallon before they can make a profit, you see.  Above three bucks, they make a profit.  Below three bucks, like it is today at one ninety six, they just can't do it.  That's why the gas companies are keeping the price below two bucks a gallon, to squeeze the ethanol producers and farmers out of the market."

"Dem sonbitches!"

Always a conspiracy.  It makes the rough-and-tumble market process easier to explain.  I kept my mouth shut, but I could've told them it has something to do with the price of oil falling from a high of over $100 a barrel to just breaking below $40 a barrel recently.

Substitutes For Everything

Could T. Boone Pickens be right?

The Most Common Confusion Between Demand and Quantity Demanded

I put this into my Google search five minutes ago: "lower gas prices will stimulate demand."  This was the first item that appeared in my search results:

With the supply of gasoline pretty much fixed (at least in the short term), the increased demand triggered by the price cut will lead consumers to bid up the price of gas. Len Burman of the nonpartisan Tax Policy Center says eliminating the federal tax won’t actually lower the price of gas because “supply constraints will push pump prices near their pre-holiday levels.” He goes on to warn that “if that didn't happen, there would be shortages.”

So easy to find an example of sheer confusion. This was an attempt (May 2, 2008) to offer an "analysis" of the McCain and Hilary Clinton proposal to temporarily suspend the 18.4 cent federal tax on gasoline. You can find the rest here.

Can you tell me what's wrong with this statement? 

Gasoline Prices Continue to Fall

An anecdotal observation from so many people:  "Gas prices go up more quickly than they fall.  It happens every time."  (How many times have I heard this?)   "They're trying to keep us addicted. We will feel assured of a while.  Make new plans and commitments.  Once locked in, they'll jack up the prices again."

Well, this time the fall has been quick and also significant. If they're trying to keep us hooked, that emerges in the global market for oil and oil futures.  But do our conspiracy theorists know that the U.S. contribution to the global market is somewhere around an 8% share. So those who want to keep us "addicted" to gasoline must be all those outside contributers.  OPEC, I suppose. Or is it?

Look at the commodity futures market.  I suppose those in power are also trying to keep us addicted to the S&P 500 stocks, corn, wheat, beans, copper, lead, aluminum, zinc, gold, silver, and cattle feed.

I guess the conspiracy die-hards will now claim "That all makes sense to me." It gets tiring.