Don't be fooled by the title of this blog. I don't discuss herbs very much here. This blog is general-purpose, although I do like ranting about politics and religion.

Wednesday, September 21, 2005

Bill O'Reilly Ticks Me Off

I was listening yesterday as Bill O'Reilly raked one caller across the coals for the claim that The Market was determining the oil prices, as he put it, "upstream." Bill said that The Market doesn't call up and set prices, and that the mysterious stuff behind the scenes (implication being something immoral like price-fixing) was setting the prices in order to gouge consumers and raise oil company profits to an unconscionable level. And that Something needed to be done about it.

To put it kindly: Bull Puckey.

Did he ever take Econ 101 in college? He might have -- lots of people do -- but he might have forgotten about some of things taught there.

When somebody says The Market sets prices, people ought to know that the term "the market" is just a euphemism for all the various market factors working in a semi-random manner. And one of the most important market factors is the relative scarcity or abundance of a commodity, in relation to the demand for the item. To make the matter clear, imagine you are a farmer who is growing rutabagas. It sells OK and you devote one-third of your acreable to it. Over the last few seasons you have been getting about $1 per pound for rutabagas.

Harvest time comes. Your crop for the year is ready for harvest but not yet sold, and now it comes to selling it. But just before this happens, an article appears in a prestigious scientific journal, and in that article the authors show that rutabagas, if eaten regularly by someone, will increase their lifespan by 10 - 20%. Suddenly, people want more rutabagas, but your harvest (and the harvest of all the other rutabaga farmers) is fixed, for this year at least. What happens next is the same thing that happens in any auction where the item being sold is very popular: the various buyers try to get as much of the product as they can, and the only way to do so is to be willing to pay more for it than the next guy. When it gets to the bottom line, some buyers will go rutabaga-less, and others will not, and the price you get is suddenly triple what you are accustomed to. But did your expenses in producing the rutabagas go up? No, they didn't, they remain the same. So your normally modest profit has gone way up -- and there's Bill O'Reilly having a fit saying somebody ought to do something about it. O'Reilly may want the government to step in and price-control rutabagas, but you have a better idea. You like the profitability of rutabagas, so the next season you plant ALL of your acreage in rutabagas. And with your increased profits, you buy some more land and plant it in rutabagas. So when the next season rolls around, you will have more rutabagas to sell, and will be making money hand over fist. In fact, all the rutabaga farmers get the same message, and they all do similarly -- on top of that, some other farmers who have never grown rutabagas will be getting into the act. But next harvest what happens? Since the supply of rutabagas has increased considerably, suddenly the price goes down, perhaps dramatically, because now the supply is getting closer to fulfilling the demand. Eventually, things even out to a higher production of rutabagas that meets the demand and the price stabilizes.

The same is with the oil! Hugely increased demand in China and India and other places is causing the demand for oil to go much higher, and the "market forces" due to the more or less flat supply (the production is somewhat elastic, but not THAT elastic) and the resultant increased relative scarcity is causing prices at the oilfield to go up. Who's pumping that oil? Exxon, for one. But Exxon's expense in producing the oil isn't going up, so its profits go up dramatically (and so does other companies in the industry). The prices at the consumer level rise too. But eventually, when they ramp up to meet demand, the prices will return to a more reasonable level and will stabilize. That is how the market works, and that is how it MUST work.



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