It's Tough to Beat the Law of Supply and Demand

There's been talk of blaming high oil prices on speculators, on banks, on the Chinese, on anything except where the real blame belongs - on politicians who have not let oil companies drill for oil where we know we can get it.

We've written about the risks of running out of electricity unless we start to build some new electric generating facilities.  We've written about demand for gasoline going up as Indians and Chinese buy cars, we've pointed out that Indians want air conditioning even more than Americans do.  With all this increased demand, it's no surprise that the price of oil products is going up.

Supply and Demand 1.01

The law of supply and demand is one of the fundamental principles of economics - if people want more of something than is available, the price goes up as suppliers cash in on higher demand.  The higher price persuades some potential users not to buy it.

As the price goes higher and higher, more and more customers stop using it.  Eventually, the price levels out where supply and demand are precisely in balance.  This process is called "clearing the market" and it happens when supply and demand are in balance at the "clearing price."

If the clearing price is high enough, more suppliers will get into the business.  As supply increases, the price falls.  With lower prices, customers start to use more of the product until demand for the product balances out the new supply, and the cycle goes on.

It's really, really tough to beat the law of supply and demand although politicians keep trying.  The usual political response to an unpopular price increase is for the politicians to pass laws limiting the price producers can charge.  When that happens with a product which can't be shipped to other countries, producers simply stop making the product if the price isn't high enough for them to make a profit.

This happened in New York City during WWII.  More people wanted to live in New York than the available stock of rental apartments could handle, so the price went up.  Renters screamed and the politicians passed rent control laws.  As costs rose faster than allowable rents, landlords simply abandoned hundreds of buildings so that parts of the South Bronx looked like the bombed-out portions of Berlin.

The politicians realized their mistake to an extent and promise that new apartment buildings will not be subject to rent control, but nobody trusts them.  Builders are reluctant to build apartments and build condos instead.  The supply of New York apartments will never clear the market.

As a result, the middle class has a hard time making it in New York: the underclass lives in collapsing dumps, and the plutocrats can buy whatever they want, but there is a very limited supply of decent, halfway-affordable housing for teachers, nurses, police, middle managers, and so on.

Price controls won't work with oil, of course, because the oil producers will simply ship oil to China, India, or Europe if Americans aren't allowed to pay enough for it.  Not even the Democrats have proposed price controls; maybe liberals can learn from history after all.  It helps that it was Republican President Nixon who tried them during the oil crisis of the 70s, leading to the gas shortages and lines remembered even today.

The Universality of Supply and Demand

Supply and demand works for pretty much everything, including marriage.  Despite a number of young ladies deciding they don't want anything to do with men, some women want to get married.  Their desire for matrimony constitutes the supply of potential brides.

Unfortunately for women, supplies pile up in the absence of demand.  No matter how badly women want to get married, the supply of potential brides won't clear the market without demand which is represented by men who want to get married.

We've written of a situation in Europe where a number of women and men want to get married but there's an obstacle to clearing the market - many of the men demand that their brides be virgins.  Given how "liberated" many European women have become, the demand for virgins exceeds the supply, particularly in Islamic circles.  This leaves a number of potential grooms frustrated; their desire to marry represents unfulfilled demand for which the market demands a supply.

Our article explained that market forces are persuading a number of young ladies to undergo hymen repair surgery which restores the illusion of virginity.  This augmented supply of virgins may help the market clear.  Supply and demand operate even in the area of romance.

Supply and Demand in Oil

Politicians to the contrary, supply and demand works on oil prices, too.  In an article "Oil falls on surprise stock build, soft demand", Reuters reports:

Crude oil prices dropped sharply for a second day on Wednesday after a U.S. government report showed a surprise increase in inventories and continued weak demand in the world's top consumer nation. ... U.S. crude futures fell $4.14 to settle at $134.60 a barrel, adding to Tuesday's drop of $6.44 and bringing oil close to $13 below last week's all-time peak. London Brent crude fell $2.56 to $136.19 a barrel. [emphasis added]

The article went on to explain that the available stocks of gasoline are 3 million barrels greater than expected.  Why is that?  Did gasoline suddenly appear out of nowhere?  Fox News reports:

Soaring prices at the pump apparently are having such a dramatic impact in the U.S. that annual gas consumption is expected to drop for the first time in nearly two decades - meaning Americans not only are driving less, they're doing it more efficiently.

The Transportation Department reported Wednesday that Americans drove 1.8 percent fewer miles in April, compared with the same month last year, the sixth consecutive month driving miles figures have declined.

Those numbers represent a significant shift in consumer behavior, ...

Transportation Department report found that Americans drove 30 billion fewer miles - about a 1 percent decline - from November 2007 to April 2008, the largest drop since the gas shortages of the late '70s. [emphasis added]

Golly wow, who'da thunk?  Prices go up so people drive less.  People drive 1% less, gasoline stocks go up by 3 million barrels, so the price goes down about 10%.  That bears repeating - a 1% drop in demand led to a 10% drop in price.  This has been going on for six months, but nobody noticed, especially the politicians who've been wasting time pontificating about speculators, banks, oil companies, and other non-perpetrators.

Hey, increasing the supply of gasoline by using less made the price go down.  What would happen if we increased the supply of gasoline by increasing the supply?  The price would go down without our having to drive less.

Mr. Bush recently rescinded an executive order that kept oil companies from drilling for oil on our continental shelves and in Alaska.  Nancy Pelosi, the Speaker of the House of Representatives, recently said,  "The economy is bad, yet the President distracts us about drilling in Alaska."  A more monumentally ignorant remark would be difficult to imagine.

High gasoline prices are bad for the economy; increased supply would bring prices down.  Pelosi's Democrats are the only obstacle to lowering oil prices by increasing the supply.  Do you think that the Republicans might get around to mentioning this teeny weeny little fact a time or two during the upcoming Presidential campaign?