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Aren’t markets excellent?

Record high fuel prices and a weakening economy are starting to hit demand for oil, according to the International Energy Agency (IEA).

Summat’s in short supply. Price rises, people demand less of it, alleviating the shortage.

Cool, eh?

15 thoughts on “Aren’t markets excellent?”

  1. You forgot:

    And Guardian editorials demand the government forces the price lower so more people can buy the unavailable summat.

  2. Not just short supply.
    Don’t forget the government’s around the world have been printing money like crazy.

  3. Summat’s in short supply. Price rises, people demand less of it, alleviating the shortage.

    You’re usually good at explaining economics stuff but that is just bollocks.

  4. And would create extra supply as well . . .

    Jim supplied the demanding explanation.

    . . . if the State hadn’t stopped that happening too……….

    The oil companies being on board with the green scam is why I wasn’t too upset about the windfall tax the government stuck them with.

  5. Dennis, Just Guessing...

    Richard Murphy demanding oil producers be either taxed into oblivion or nationalized in 3, 2, 1…

  6. @PJF

    Strictly speaking, the demand (curve) itself doesn’t fall, but the quantity demanded does. So Timmy’s explanation is fine: even if supply is fixed, price rises are often good enough at damping demand to prevent the good completely running out . I mean the alternative, for example if government is stupid enough to respond to a shortage/price rise by subsidising the good (which in fact has been happening in some countries), often descends into chaos as the good becomes unavailable except to those who “pay” by the art of queuing, or via the black market.

    But yeah, Jim’s explanation is the other side of the equation. Useful to put the two together really.

  7. Strictly speaking, the demand (curve) itself doesn’t fall, but the quantity demanded does.

    If you and Tim want to make the argument that people being priced out of energy and the economy going into recession is an example of the excellence of markets alleviating a shortage, I’ll leave you to it. But don’t be surprised if no one buys into that, either.

  8. @PJF

    In general markets don’t deal with a shortage by returning production back to its original level. Higher prices drive new suppliers, but also do reduce demand, so the new equilibrium does look different for both reasons – settling at a higher price and lower quantity than pre-shock. If you want to sell capitalism to idiots then yes, focus on the supply side makes things sound more gee-whizz. “Prices went up, so more suppliers entered the market, and soon the shortage was gone and we all lived happily ever after!!” So if your job is doing PR work for the Capitalist Party, then sure, by all means focus on that side of the equation. But it’s not a serious answer.

    If you don’t think Timmy’s point is important, just think about a situation where demand can’t respond. For example if the government fixes or caps the prices paid by consumers, while stumping out part of the national budget to pay suppliers to produce more. In essence, consumers and suppliers face different prices, with the consumers shielded from the effect of the price rise so that demand does not respond to price incentives. You don’t need to think very long to see how badly this policy is going to end, and why it’s a bad thing this is basically the approach some countries have taken with the current energy crisis.

    An unstated part of what Timmy’s saying is that consumers make appropriate substitutions as part of their response to changing prices, it’s not a one-good world where the only effect is that consumption of that one good falls. If the price incentives they face no longer correspond to the costs of their decision, then consumers will opt for an inefficient bundle of goods, which makes their society poorer overall. Producers of substitute goods will not experience a rise in demand since consumers won’t switch their preferences, so the producers aren’t incentivised to make more of the stuff that would actually make everyone richer in this scenario. That’s pretty obviously a Bad Thing, yet if you focus your story only on the supply side of the equation then you miss this important effect entirely.

  9. Can I tell a story where noise in these figures fuels momentum traders, so irrational expectations based on noise really drive prices not physical supply and demand of oil itself?

  10. . . . if you focus your story only on the supply side of the equation then you miss this important effect entirely.

    It wasn’t me focussing on one side of the equation. I don’t think Tim was making that particular a point, I think he just explained badly. If that was his point, then it’s toss. Just because people are priced out of a market doesn’t mean a shortage has been alleviated.

    People can’t afford food – ∴ – food shortage alleviated!

    (hey, why are people eating economists?)

  11. “If you don’t think Timmy’s point is important, just think about a situation where demand can’t respond. For example if the government fixes or caps the prices paid by consumers, while stumping out part of the national budget to pay suppliers to produce more. In essence, consumers and suppliers face different prices, with the consumers shielded from the effect of the price rise so that demand does not respond to price incentives.”

    That misses out the rather important element that it’s Government which has intentionally restricted and messed up the supply side with all of its Net Zero bollocks, sanctions, etc.

    “You don’t need to think very long to see how badly this policy is going to end, and why it’s a bad thing”

    Well, quite.

  12. @PF

    “That misses out the rather important element that it’s Government which has intentionally restricted and messed up the supply side”

    I already made clear I think both the supply and demand sides matter and that Timmy’s argument would be more complete if (like Jim and others said) he had mentioned the supply side too. But his point about the demand side, unpleasant and unjoyful as it may be, is still actually correct. Given that society has been landed with a government that’s buggered up the supply side (and yes, we would rather we didn’t have that and said governments were replaced, but right now that’s what most of the western world is facing) then what actually is it that we would like the demand side to do? The rational thing we would hope consumers to do in order to maximise whatever can be recovered of social welfare when faced by rising fuel prices would be
    – cutting down mileage by prioritising certain journeys and reducing unnecessary ones,
    – making more use of public transport or virtual meetings where possible and appropriate,
    – giving more weight to considerations of fuel economy as a factor when replacing their vehicle.

    If consumers don’t do these, or do the opposite of these, then it makes a bad situation even worse. But glory be to the market gods, it turns out that when prices rise, these are exactly the changes in consumption behaviour that get incentivised! This is A Good Thing, which is Timmy’s point.

    And I’m not sure people realise just how much of a good thing it is. This is why I’m saying, as a counterfactual, consider those places which have buggered the supply side up (I am not ignoring the fact it has been buggered up) and then proceed to bugger the demand side up as well, by responding to price rises with government subsidies or price caps. This is where we start to see real shortages start to bite – a gap between what consumers are willing to buy at the current price and what producers are willing to sell at the current price, which has to be bridged by mechanisms like queuing or rationing.

    @PJF I think the above is the kind of shortage avoided that Timmy was referring to. If you’re taking “shortage” to mean “not as much available as consumers would like” then we are in perpetual shortage of just about everything. If you mean “not as much available as there was before the shock” then even with a fully functional supply side, that’s going to happen.

    Let’s say the supply curve gets shifted by a cost-increasing shock, producers respond by raising production – eg farming marginal land during a drought period – and consumers move along the demand curve, the new equilibrium still involves less food than before, at a higher price than before.

    Again, if consumers hadn’t moved along the demand curve, then things would be even worse, because there would be a gap between desired consumption and production so need some sort of non-price mechanism (queuing, rationing etc) to allocate the food.

    If, as you say, people get totally priced out of the food market so that they cannot afford what they need to survive, then some more drastic government intervention is going to be necessary. But before we get to that point, people’s responses to rising prices of drought-hit domestically produced food can still be helpful. “Correct” welfare-maximising responses to this change in prices would include consuming fewer other goods and services to spend more on food; within food purchases, to substitute foreign for domestic food, within domestic food to switch to those sources less affected by drought (eg seafood), and – since many will be priced out of high-end artisanal food – to switch to cheaper (more calories per dollar) fare.

    All of these consumption changes would be incentivised by a price rise in drought-hit domestic produce. So the demand side is doing constrained optimisation in a dismal (who wants to be told what they can’t afford?) but ultimately beneficial (utility maximising, shortage reducing) way.

    If drought makes food more costly but for biological reasons you can’t survive without food, then the bad news is that you’re now poorer, and a greater proportion of your spending is going to end up allocated to food with less available for other stuff. Them’s the breaks, as someone said. But that reallocation can still be done in better or worse ways. And the market mechanism of people responding to prices can work better than a state official doing the allocation on your behalf.

    The fact people are priced out of something they desire wouldn’t normally be described as a shortage – lots of people would love a Ferrari, if they could afford but one, but can’t get one. The fact people are priced out of something they could previously have afforded doesn’t mean there’s a shortage either – if the price of a Ferrari goes up due to the need to pass stricter regulations or a rise in the prices of raw materials, then some Ferrari fans who could previously just about have afforded one are going to be disappointed. If people are getting priced out of a necessity for survival, like food or heating, that is a serious problem. But giving people who need it extra welfare payments is the approach most economics would recommend on the demand side, rather than trying to fiddle with the price mechanism, precisely because this leaves the price incentives intact. Obviously “don’t screw up the supply side” is good advice too, but the demand side prescription is still worth thinking about.

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