Another vote of thanks to James Hamilton (principal author of Econbrowser and an economics professor at the University of California, San Diego): I cite him again in this column for The Atlantic on the impressive irrelevance (for now) of the price of oil.
The oil market is not a bubble--fundamentals of supply and demand, not self-reinforcing speculative frenzy, are driving prices--but nonetheless I am intrigued by the fact that the dearer the stuff gets, the calmer we appear to be about the economic implications. That thinking has bubble-like characteristics. You recall how fears about irrational exuberance in the stockmarket were more to the fore in 1996 with the Dow at 6,000 than they were a few years later, after it had risen another 4,000 points. Accustomed to an oil price that would have seemed terrifying very recently, we now seem to worry less, the higher it goes.
Financial bubbles often do not burst until the last skeptics—the ones who called them bubbles early on, and rolled their eyes as speculation raged—have capitulated to the mania and bought in. Once nearly everyone is convinced that the rise in prices has some real economic foundation after all, and not before, the whole thing goes pop. The pattern repeats over and over. A parallel suggests itself. When even the people who were worried about $40 oil have stopped worrying about $100 oil, it may be time to panic. As the price of oil goes ever higher, we seem to get ever less anxious about it. In the June 2006 Atlantic, I explained why oil at more than $50 a barrel was having so little effect. But now it’s almost double that. What ought to be obvious might therefore be worth restating: The higher it goes, the more likely it is do real harm.
You can read the rest of the article here.
Isn't there a huge difference between an increase in oil prices that is caused by high demand (the current situation) instead of a decrease in supply (the scenario in the 1970s)?
In the case of a decreased supply, oil consumers suffer both decreased quantity and higher prices, thus decreased consumer surplus. In the 1970s, this was aggravated by some moderately crazy price control and rationing schemes.
In the case of increased demand, consumers consume higher quantities at higher prices. But as long as there's any elasticity to oil supply at all, THE INCREASE IN PRICE IS LESS THAN THE INCREASE IN THE WILLINGNESS TO PAY. Otherwise, there wouldn't be an increase in quantity consumed. Ergo, there's been an increase in consumer surplus.
Posted by Mike D | December 17, 2007 3:38 AM