EclectEcon

Ironman, at Political Calculations, presents a graph showing,

In simpler words, we confirm that individual Americans are not
consuming an ever-increasing amount of oil. We can therefore eliminate
increased U.S. consumption of petroleum-based products as a significant
contributor to the recent spike in the world price of oil.... As we see in the chart ..., the amount of
finished petroleum products consumed by U.S. residents started at 2.572
gallons per day in February 2007 and peaked at 2.661 gallons per day in
August 2007 before plunging to 2.443 gallons per day in March 2008.

To see his chart and his analysis, click here.

The other day, Ms. Eclectic asked me what the best speed is to drive. As a good economist, I replied the same way all economists respond to all questions.
It all depends.
I said that I thought fuel usage declined the slower you went (turns out that was seriously wrong) but that it would take longer to reach our destination, so there would be a trade-off between our spending for gasoline, the risks of accidents and injuries at different speeds, and how much we value our time en route versus our time in its next best use.

My friend, Steve, says he used to do about 110 kmh all the time on highways (with speed limits of only 80kmh), but about two years ago he decided to reduce the risks of accidents and reduce his use of gasoline. He now rarely, if ever, goes over 90 kmh.

Most of the time on the highway I drive at speeds between 85 and 95 kmh (which, for the metricly challenged, is between about 53 and 60 mph). It turns out this speed is also roughly in the optimal range for fuel economy according to this item at Econobrowser. Here is a graph from that posting plotting average fuel mileage against speed for a sample of automobiles.
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Addendum: for more, see the ever-informative Political Calculations.

Dani Yatom, a member of the Israeli parliament, the Knesset, was invited to attend a NATO conference in Brussels last year. While reviewing the agenda, Yatom, a retired major general, was surprised to see that the meeting was titled “The Iranian Challenge” and not “The Iranian Threat.”

When a speaker with a French accent mentioned that a US military strike against Iranian nuclear facilities would be the most dangerous scenario of all, Yatom said, politely but firmly: “Sir, you are wrong. The worst scenario would be if Iran acquired an atom bomb.”

Given this position, Nouriel Roubini considers what might be the effects if Israel were to attack Iran:

First, even before Iran may try to retaliate to this action by trying to block the flow of oil from the Gulf, oil prices would spike above $200 dollar a barrel.

Second, Iran could react militarily to such Israeli action (that would be taken with the tacit support and the military logistic support of the US) by unleashing its supporters in Iraq against the US military forces there. That would trigger a military reaction by the US that would start a sustained air-led bombing campaign against Iran’s military capabilities (air force, anti-aircraft defenses, radar and other military installations, etc.)

Third, Iran would unleash its supporters in Lebanon and Gaza (Hezbollah and Hamas) in a military confrontation with Israel. A broader war will follow in the Middle East.

Fourth, Iran would use both the threat of blocking the flow of oil out of the Gulf and an actual sharp reduction of its exports of oil (an embargo) to spike the price of oil. Oil prices would rapidly rise above $200 per barrel and the US and global economy would spin into a severe stagflationary recession (like those triggered by the sharp spikes in the prices of oil following the staflationary shocks of the Yom Kippur war in 1973, the Iranian revolution in 1979 and the Iraqi invasion of Kuwait in 1990).

Fifth, while Sunni regimes may – in private – sigh relief following the destruction of the nuclear capabilities of the Shiite Iranian regime – the Sunni Arab street (the masses of poor Sunnis) from Algeria to Egypt and all the way to Pakistan, India and Indonesia may become even more anti-Western and anti-American leading to the risk over time of rise of anti-Western fundamentalist regimes in many Arab countries.

Sixth, the Bush administration whose hands have been tied by the new National Intelligence Estimate (that argued that Iran had suspended its program of development of nuclear weapons) would thus be able to strike Iran – via Israel - before the end of its term. Such October surprise by Israel would also certainly lead to the election of McCain and defeat of Obama as a national security crisis of such an extent would doom the chances of Democrats to win the White House. So both Israel – that prefers McCain to Obama and is hurried to act as it is wary of the constraints that an Obama presidency may put on its ability to act against Iran – and the Bush administration would guarantee the election of McCain.

A recent article in Popular Mechanics says [h/t to Instapundit],

Sorry, folks, but the SUV is dead ...

Sorry, Pop-Mech, but it isn't.

After having spent the springs of 2006 - 07 in England, where the price of gasoline/petrol was then the equivalent of about $2/litre or very roughly $8/gallon, I could see that even at those prices, many people still bought and ran the big gas guzzlers. Probably not as many, proportionally, as in North America during that same time, but there were still lots of them.

So even if the price of gasoline in the US reaches $5 or $6, the SUV is not dead.... at least not if the market is allowed to work. Some people will still want to use their income to buy and feed the big SUVs.

But watch for the elitist interventionist enviro-nazis to try to ban SUVs as being socially irresponsible. Those folks will never understand, much less accept, the possible benefits of a Pigou tax on gasoline, should such a tax be appropriate.

Tom Hanna argues quite convincingly that those who oppose opening up more off-shore oil drilling are really elitists who don't want their views "spoiled" and who really don't give two hoots about the environment:

We can let oil companies drill here, where they'll be expected to keep it clean and be proactive to prevent problems, or we can import more oil from Nigeria, which «has one of the worst environmental records in the world. In recent years, the country has seen the execution of a Nobel Peace Prize nominee, widespread social and environmental problems stemming from oil operations in the Niger River delta, and the world's highest deforestation rate.

We can have a few more oil rigs breaking the clean blue line of the Hollywood horizon or we can help finance the Russian exploration of the Arctic, leaving the Arctic Ocean to the devices of the country that «succeeded in wiping from the map almost an entire sea - the Aral, now largely a toxic desert - and turning the world's deepest freshwater lake, Baikal, into a borscht of cadmium and mercury deposits.» How do you think those Alaskan lichens will fare if the Russians repeat their recent history?

And, by the way, aren't our neighbors to the North a socialist paradise that can do no wrong? Yet, they also seem to be expanding oil production as fast as humanly possible - and selling it to us. If oil production is so bad for the environment, why are the sainted Canadians doing it and why isn't Barack Obama demanding they stop?

Let me add a question: Which is worse for the environment, off-shore drilling or converting Alberta tar sands into refineable crude?

When crude oil prices rise, gasoline prices rise, too. But not all the cost increase can be passed on to consumers. At least not without affecting the quantity of gasoline that people buy.

• When prices rise, the quantity demanded falls. Demand curves are downward-sloping. This is the "law of demand".


• People respond to incentives.

The oil companies can try to pass on the cost increases, but they cannot make consumers buy as much gasoline as they did before. My point is that gasoline is not a necessity. When it becomes more costly to use gasoline, people find substitutes, and they actually tend to do so fairly quickly, especially if they expect the price increases to persist.

• They buy smaller cars.
• If they have two cars, they begin to use the smaller car more often.
• They bicycle more.
• They walk more.
• They make greater use of public transportation.
• They take fewer trips.
• They make shorter trips.
• They move closer to work or closer to public transportation connections.

And all these things that economists have been saying for decades have been confirmed. From the USA Today,

Americans drove 30 billion fewer miles from November through April than during the same period in 2006-07, the biggest such drop since the Iranian revolution led to gasoline supply shortages in 1979-80.

The numbers released Wednesday may reflect more than a temporary attitude change in consumers toward high gas prices, Transportation Secretary Mary Peters said. Previously, she said, "people might change their pattern for a short period of time, but it almost always bounced back very quickly. We're not seeing that now."

... "It's not a blip," said Marilyn Brown, professor of energy policy at Georgia Tech, citing data showing surging transit ridership, dropping sales of sport-utility vehicles and sharply increased demand for gas-efficient vehicles. "I think the difference between now and 1979, when prices were comparable when you adjust for inflation, is there's a sense of sustained pain. There's a sense that the era of cheap energy is a thing of the past."

Clearly an important determinant of the price elasticity of demand for gasoline is the expectation that people have about future prices. If rising prices create an expectation that prices will soon fall back to their previous levels, and if it is costly to change consumption patterns, then the price elasticity of demand will be quite low. But if rising prices create an expectation that prices will remain higher and will likely even rise some more, then people will begin to undertake the costly changes in their consumption patterns.

After Katrina, gasoline prices were about as high where I live as they are now. But back then, we all expected the high prices were a temporary blip, and so we did not alter our consumption patterns very much. But this time, when people expect gasoline prices to remain high, people are changing their consumption patterns.

Addendum: Quite clearly, this difference in expectations helps to explain the higher short-term price elasticities from 1976-1980 than from 2001-2006. See this from former student, Paul Kedroski.

What is the price elasticity of demand for crude oil? If the supply of crude oil were to increase by, say, 3%, how much would the price of crude drop to restore equilibrium in the market? Alternatively, if the supply decreased by 3%, by how much would the price increase?

In the short run, the answer is likely that the price would change quite a bit more than in the longer run. But Jerry Taylor, of the Cato Institute, appears to believe the price elasticity of demand is one in the long run[h/t Cafe Hayek]. Discussing the effects of opening up more wilderness and northern areas for oil exploration and drilling, he says,

By the time those new fields would be producing, global oil production will probably be about 100 million barrels per day. Optimistically, the fields would yield about 3 million more barrels a day - for a long-run cut in the price of crude of about 3 percent.

I have no idea where he obtained that estimate for the long-run price elasticity of demand for crude oil, but it is probably not a bad guess. Overall, if in doubt, a guess that the price elasticity of demand for something is about 1 is probably a good starting point, especially in the long run.

It makes sense: As the price of gasoline rises, many people switch from buying large cars (and trucks and SUVs) to buying smaller cars. The result is that the price of small cars rises and the price of large cars plummets. This effect was first presented systematically by Ake Blomqvist and Walter Haessel in the Canadian Jl of Economics back in 1978 in "Small Cars, Large Cars, and the Price of Gasoline".

Now, thirty years later, we are seeing the same thing. From the Associated Press [h/t to Brian Ferguson],

``The small cars are very hard to get right now. The cars that were $5,000 are now $7,000,'' [said used-car dealer, Mike Haile].

In the past year, the average used small car price has gone up 2 percent, from $9,278 to $9,470, according to wholesale auto auction data collected by the National Automobile Dealers Association [NADA]. There's evidence that the prices are accelerating, according to recent data from J.D. Power and Associates.

Okay, so their numbers differ considerably, but they're in the same direction. And meanwhile,

The increases are in contrast to used full-size sport utility vehicles, whose prices have dropped $1,600 to $2,000 in the past year, said Paul Taylor, the NADA's chief economist. The average sale price of all used vehicles in the U.S. dropped 2.5 percent in the past year, the NADA reported.

If you don't drive much, and if you really want a big gas-guzzler, now might be a fun time to go shopping!

One would think that with approximate doubling of oil prices (in US$) over the past year, Iran would be gaining even more clout in the Middle East and on the world scene. Stratfor Analysis doesn't think so ($ required).

Stratfor points out that although Iran is a major exporter of oil, its production, exports, and reserves per capita are waayyyy lower than for the other major oil producers in the Middle East.

Also, Iran is not a rich country overall; it's per capita GDP is roughly only 40% of Mexico's!

In addition, Iran's absurd subsidies for domestically consumed gasoline and its inadequate investment in refining capacity, mean that Iran ends up importing about 40% of its gasoline. The result is that as Iran earns more from its oil exports, it pays more for its gasoline imports, and on net is not a lot better off — certainly nowhere near as much better off as other Arab oil producers; and whatever gains it experiences do not have a major per capita impact.

Stratfor opines that with a more secure investment atmosphere, western AND Chinese firms would be very active in Iran and their oil output would be much greater than it is. But given the low reserves, per capita, Iranian leaders might well be choosing to hold more oil in the ground and sell it later (i.e. speculating on even higher oil prices in the future).

The other interesting point made by Stratfor is that because Iran is not making as much on its oil production as are other Middle East countries, its influence (vis-a-vis the Sunnis) will continue to wane. And that might well be one reason that Syria and Israel are engaged in negotiations.

Note: Stratfor is an expensive service. However, I recommend that if you have the opportunity, sign up for their one-month free trial whenever it next becomes available. Once you have assessed it for a month, you might well decide it is worth the price.

Over the weekend, The NYTimes led with a story that as gasoline prices rise and are expected to remain high, many commuters are switching from driving to using public transportation.

Mass transit systems around the country are seeing standing-room-only crowds on bus lines where seats were once easy to come by. Parking lots at many bus and light rail stations are suddenly overflowing, with commuters in some towns risking a ticket or tow by parking on nearby grassy areas and in vacant lots....

Some cities with long-established public transit systems, like New York and Boston, have seen increases in ridership of 5 percent or more so far this year. But the biggest surges — of 10 to 15 percent or more over last year — are occurring in many metropolitan areas in the South and West where the driving culture is strongest and bus and rail lines are more limited....

The national average for regular unleaded gasoline reached $3.67 a gallon, up from $3.04 a year ago, according to AAA.

If nothing else had changed, then a roughly 20% increase in the price of gasoline appears to have led to maybe a 10% increase in the demand for public transportation. The cross-price elasticity of demand appears to be approximately +0.5.

But these numbers are for now. Remember when gasoline prices were so high shortly after hurricane Katrina? At that point, people did not expect them to remain high, and so there was a much smaller switch to public transportation. The two situations reflect the importance of expectations and the importance of long-run vs. short-run shifts.

In the earlier case, because we did not expect gasoline prices to remain high, we did not alter our behaviour much; the cross price elasticity of demand between gasoline and public transportation was very small. In the current case, because we expect gasoline prices to remain high and quite possibly to rise in the future, more people are shifting away from driving toward the use of public transportation. This is more indicative of a long-run effect.

How can something that cooks so much food at such a low heat possibly not be a money-saving appliance? Here is one answer [h/t to Jack]:

When a crock pot is cooking, it runs on very low energy, cooking at low temperatures - hence slow cookers. An oven works on a more cyclical basis, where it cycles on and off, but cooking times are much shorter than crock pot cooking.

Some ovens run at 120volts, some 220, 240 etc... Lets say we're using a stove with 220volts X 10amps = 2200watts in an hour. The oven's heating element is controlled by the temperature of the oven (which you set), so it's turned on and off to maintain a desired temperature. The heat is kept in the oven by the insulation. So during one hour, the heating element is turned on and off a few times. Depending on your oven and the temperature, the heating element may only be used for a fraction of an hour, say 10 or 15 minutes. So, really, your energy consumption is only 1/4 X 2200 = 550 watts (maybe more, maybe less).

Crock pots run at 120volts with low amps. If we cook with a crock pot that runs at 120v X 1.5amps = 180 watts (This is about medium heat). If we let the crock pot cook for 8 hours, you get 180 X 6 = 1080.

Even if the oven element is on twice as much as this person says it will be, the oven and the crockpot come out about even.

Crockpots are great for some things, but it looks as if they might not be great at saving energy!

The price of gasoline in England is roughly twice what it is in North America. As a result, people drive smaller cars and drive less. Many people have chosen to take the train and ride bicycles, as is obvious in this photograph taken at the bicycle parking area of the Oxford train station:

No foolin'.

Following the recent increase in the price of gasoline, more people seem to be taking public transportation. This result emphasizes not only the substitution effect, but also the fact that gasoline/petrol is NOT a necessity and that even in the short-run, demand curves are downward-sloping. When the price goes up, some people cut back on the quantity demanded to some extent.

From the Trono Glob & Mule, aka The Toronto Globe and Mail [long gone behind a price wall now, unfortunately]:

Gas prices are up across the country, but no major city has been hit harder than Vancouver with an average pump price of $1.272 a litre for regular unleaded gasoline. It's been climbing steadily toward that record since February. But as gas prices continue to rise, so does the number of people who use public transit.

I expect that the comparatively higher price of gasoline in Europe also helps to explain why public transportation systems are used so much more here. Helps.

Brian Ferguson at Canadian Econoview takes note of a story that carrots and other vegetables may become important in many manufacturing processes:

Can you imagine it? Driving around in cars that are eighty per cent carrot? Flying in aircraft made out of turnips?

Clearly there are policy issues to be considered here. For example, give the immense potential of curran, it'll be important that we not be dependent on foreign, and possibly hostile, producers of carrots. There will have to be Pigovian subsidies to encourage the production of curran, and indeed of carrots themselves. And since industrial uses will compete with demand for carrots for human (not to mention rabbit) food uses, we'll need a central carrot governing body to allocate the crop between the various uses. Carrots are, after all, too important to be left to the market. And obviously we're going to need a strategic carrot reserve.

There's no time to waste. We've got to hop to it. Right now.

I have really been disappointed with the US Republicans; I had hoped they would support market solutions more than they seem to do. Here is some very good insight from John Lott, first on Ethanol:

Ethanol costs well over $100 per barrel. Oil costs about $50 per barrel. You are throwing out $50 for each barrel of ethanol you buy (actually it is even more than that since the energy produced by burning a barrel of ethanol is apparently less). Bush’s and the Democrat’s policy on this will just make us much poorer. I know the responses: that the price of ethanol is coming down. But that doesn’t justify a subsidy. Firms can take that into account just as they do with any other product. If they think that cost will come down enough that it will pay for them to produce the product, they will start producing the product.

Right. If ethanol is such a great product, why won't private enterprise bring it to market? And don't tell me about CO2 emissions -- they'll be at least as bad with ethanol, all things considered.

Next, here is John Lott on energy security:

If gas is risky because oil might get cut off in a war or if there is a boycott, that causes the current price to rise to reflex that future higher price. That higher price then will be taken into account to see whether because of that risk we should be relying on other energy sources. The only justification that I can make for this last claim is that the threat of price controls prevent gas companies from profiting from those higher future prices and thus eliminate their incentives to do things such as store more gas today. The problem here then is the threat of government intervention in the market that is then used to justify more government intervention. There is no reason to believe that the government is going to get anywhere near to picking the right levels of investments here.

If there is concern that we are using "too much" gasoline, as I have said before, let's just tax the snot out of it (and cut taxes somewhere else, keeping the tax revenue neutral).

The typical analysis applying the prisoners' dilemma to cartel theory concludes that as the number of players increases, so does the incentive to cheat, especially when there are weak or ineffective additional enforcement mechanisms. Paul Kedroski of Infectious Greed (and PhD from UWO's bizskool) provides a telling example:

OPEC had announced a cut of 1.2 million b/d in October, and another 500,000 b/d production cut is scheduled to take place in February. Our analysis suggests that only about 65% of the agreed October cuts have been implemented.

By not cutting back on production by the agreed amount, each of the players (producers) is cheating on the agreement. If all the other producers cut back on production, and one doesn't, then that one producer can sell more at a higher price. But of course all the producers either think that way or expect the others to think that way with the result that all or nearly all of them cheat on the agreement and produce more than the agreed upon amount.

But this is a repeated game, and surely each of the players has learned to anticipate this response from the other players. If so, then it makes sense to state a nominal amount that production will be reduced with the full expectation that no one will abide by the agreement. The only scope left for cheating on the cartel, then is by how much one does not stick to the nominal agreement, and that uncertainty gives rise to more incentives to cheat.

This is surely not a stable cartel in the long run without additional enforcement mechanisms.

The Emirates Economist says it very well:

Iran's oil usage is growing at the fastest pace in the world. Its capacity to produce oil is declinging rapidly, and its reserves could be depleted in a decade.

I guess those in charge are focused on short term contentment of the domestic population. Nuclear power will not be able to replace all the domestically consumed oil. But nuclear weapons might.

Iranian prices for gasoline are so laughably low, and Iranian refining capacity is so comparatively small, that Iran imports refined gasoline at considerable expense. How the current leaders expect to cope with the anticipated future shortages due to this grotesque under-pricing is anybody's guess, but being able to threaten neighbouring oil producers with nuclear anihilation might be one possible strategy.

As I have written before, it might be a good idea for Canada to develop nuclear weapon capability itself.

One of the very best criticisms I have read of ethical food positions appears in this/last? week's leader(editorial) in The Economist [$]. Here is an excerpt:

Buy organic, destroy the rainforest

Organic food, which is grown without man-made pesticides and fertilisers, is generally assumed to be more environmentally friendly than conventional intensive farming, which is heavily reliant on chemical inputs. But it all depends what you mean by “environmentally friendly”. Farming is inherently bad for the environment: since humans took it up around 11,000 years ago, the result has been deforestation on a massive scale. But following the “green revolution” of the 1960s greater use of chemical fertiliser has tripled grain yields with very little increase in the area of land under cultivation. Organic methods, which rely on crop rotation, manure and compost in place of fertiliser, are far less intensive. So producing the world's current agricultural output organically would require several times as much land as is currently cultivated. There wouldn't be much room left for the rainforest.

Fairtrade food is designed to raise poor farmers' incomes.
It is sold at a higher price than ordinary food, with a subsidy passed back to the farmer. But prices of agricultural commodities are low because of overproduction. By propping up the price, the Fairtrade system encourages farmers to produce more of these commodities rather than diversifying into other crops and so depresses prices—thus achieving, for most farmers, exactly the opposite of what the initiative is intended to do [EE: note the assumption the price elasticity of demand is less than one; and how is it possible for high prices to cause low prices? there must be some rationing of production quotas going on — ugh (Update: it is apparent from the article, linked below, that they are concerned that more farmers will raise coffee, hoping to receive the higher, FT, price but end up having to sell for the lower, regular, price -- still sounds odd to me and flies in the face of rational expectations)]. And since only a small fraction of the mark-up on Fairtrade foods actually goes to the farmer—most goes to the retailer—the system gives rich consumers an inflated impression of their largesse and makes alleviating poverty seem too easy [this is the key here].

Surely the case for local food, produced as close as possible to the consumer in order to minimise “food miles” and, by extension, carbon emissions, is clear? Surprisingly, it is not. A study of Britain's food system found that nearly half of food-vehicle miles (ie, miles travelled by vehicles carrying food) were driven by cars going to and from the shops. Most people live closer to a supermarket than a farmer's market, so more local food could mean more food-vehicle miles. Moving food around in big, carefully packed lorries, as supermarkets do, may in fact be the most efficient way to transport the stuff.

What's more, once the energy used in production as well as transport is taken into account, local food may turn out to be even less green. Producing lamb in New Zealand and shipping it to Britain uses less energy than producing British lamb, because farming in New Zealand is less energy-intensive. And the local-food movement's aims, of course, contradict those of the Fairtrade movement, by discouraging rich-country consumers from buying poor-country produce. But since the local-food movement looks suspiciously like old-fashioned protectionism masquerading as concern for the environment, helping poor countries is presumably not the point.

Here's a link to their special report, "Food Politics", appearing in the same issue and which is probably available on-line at no charge.

There is a minor squabble in the economics blogosphere between those who favour raising taxes on gasoline and those who .... criticize them. Greg Mankiw has even begun a club called, "the Pigou Club" made up of those who favour imposing taxes on those activities which generate a negative externality.

The idea behind Pigouvian taxes is simple and straight-forward .... on the chalkboard: when marginal social costs exceed marginal private costs of an activity, (and ignore general equilibrium and second-best considerations) then it is efficient to impose a marginal tax on that activity equal to the divergence between the marginal private and marginal social costs [and a subsidy if the externality is positive].

I happily teach this stuff all the time, so I guess that makes me a member of Professor Mankiw's club. I even posted some things here in the past in which I said that if people are so worried about the greenhouse gas effect and if they believe it comes from burning carbon-based fuels, then they should favour increasing taxes on the use of all carbon-based fuels. That is straight-forward Pigouvianism at its very basic level.

That is easy to say. Now to operationalize it. How much should the tax be to promote efficiency? How big is the gap between marginal social and marginal private costs, and how do we know the level of taxation currently in place is not sufficient to promote efficiency?

Greg Mankiw guesses that a proper Pigouvian tax on gasoline would be $1 U.S. per gallon:

With the midterm election around the corner, here’s a wacky idea you won’t often hear from our elected leaders: We should raise the tax on gasoline. Not quickly, but substantially. I would like to see Congress increase the gas tax by $1 per gallon, phased in gradually by 10 cents per year over the next decade.

But how does he arrive at this precise amount for the tax? The simple answer is we don't know for sure. We have to guess. One would hope the guess is well-informed and documented by people who know what they are doing. And this is the heart of the criticism of Mankiw's Pigou club: it is easy to draw these things on the chalkboard, but measuring and identifying the externalities (not to mention the general equilibrium effects) precisely is probably not possible with today's knowledge and technology.

So where does that leave me? My best guess is that my children and grandchildren will be better off if we implement a higher Pigouvian tax on gasoline. I once wrote, "We should tax the snot out of gasoline." I suppose that puts me in the Pigou Club. But I do not hold these views very strongly, and I fully agree with the concerns of those who question whether such a tax could ever be revenue neutral or who question how much the tax should be. I am open to new information and arguments.

But let me emphasize that just because we don't know what the exact size of the optimal Pigouvian tax should be, that doesn't mean it is zero. We must choose some number, positive or negative, and my current best guess is that Professor Mankiw is probably not far off the mark.

For more, see the articles by Brian Ferguson at Canadian Econoview, by Gabriel Mihalache at Economic Investigations, and by Stephen Gordon at Worthwhile Canadian Initiative.

I am unable to find the link now, but when I suggested raising the tax on gasoline in a piece on The Western Standard's blog, many commmenters objected. Some were opposed to giving the gubmnt more money even though I had intended the tax to be revenue-neutral; others, from Alberta, just saw the proposal as another Easterner trying to grab their oil wealth. Pigouvian taxes are not as easy in the real world as they are on the chalkboard.

To give credit where credit is due, last year when the price of oil was up over $80/bbl and many were forecasting even higher prices, The Emirates Economist was bucking that trend. Here is one of my links to his forecasts and analyses.

I confess to being surprised that the spin doctors with the NYTimes and the Guardian have not yet run the above headline with this photo:



The photo is very striking and is generally used to point out the differences in degree of economic development between South Korea and North Korea, as for example in this item from the Daily Mail. [h/t to Scoop]

We struggle, year in and year out, to teach our students the difference between a change in demand versus a change in the quantity demanded, and we are undercut at every turn by people who say things like the following:

[I]t is becoming clear that the laws of economics still apply to the world oil market. High prices should reduce demand and encourage new investment in supply capacity, and we can see that happening.

The above quote is from Steve Polos, writing about oil markets.

High prices did NOT cause a reduction in demand, though. What happened was that time passed. The short-run demand curve for oil is steeper than the long-run demand curve. It is now and it was a year ago. All that has happened on the demand side of the market is that we are now seeing those longer-run effects, namely a much larger reduction in the quantity demanded in response to higher prices. the short-run demand curve has shifted, but that is in response to the passage of time.

The rest of Steve's piece is interesting and good analysis about other influences on both supply and demand; too bad it confuses a change in demand with a change in the quantity demanded.

Phil Miller takes on the agriculture lobby and its support for biofuels:

Me-thinks someone needs an education in the principle of comparative advantage.

For as long as I can remember, I have been hearing these claims:

"The technology exists for cars to get 200 miles to the gallon, but every time someone tries to produce cars like that, they get bought off by the big oil companies."

Brian Ferguson has an excellent retort:

If Ford, or any North American auto manufacturer knew how to build an affordable and efficient electric, or hybrid, or fuel cell car, or even a gas driven car that could get a couple of hundred miles to the gallon, how likely is it that they'd be suppressing that technology today? Patent that sucker and get it on the market and the world is yours. Even the oil companies couldn't pay you enough to make it worth your while to suppress that technology. If those storied breakthrough cars aren't coming on the market now, it's because they simply don't exist.

From the back pages of The Economist, where they publish weekly data and interesting little tidbits:

In America it is cheaper to make fuel ethanol from maize because of the high domestic price of sugar. The Agriculture Department forecasts that America will use 34% more maize in ethanol production next season, some 20% of the harvest. Prices, up by a fifth this year, look set to rise further.

And of course the reason for the "high domestic price of sugar" in the US is?
Protection of the US sugar industry.

Add to that the huge incentive US corn farmers have to support protection of the US sugar industry (plus a ban on the import of Brazilian ethanol), and it is easy to see why the international trade talks are stalled because of various agriculture policies. From Slate's Today's Papers:

The New York Times leads with the collapse of the five-year-old world trade talks. Known as the Doha round because that's the city they started in, the negotiations broke down over agriculture policies: The U.S. has been pushing for the E.U. and others to end their agriculture tariffs, with others responding that the U.S. first needs to cut back its farm subsidies--and that is a no-go.

For more on the inefficiencies of US policies regarding ethanol see here and here.

There are lots of economics problems surrounding the use of ethanol in automobiles. Here are a few:

• Producing ethanol requires a lot of energy. Some studies take this into account, but some don't.
• If gasoline is bad and ethanol is good, why don't we just tax the snot out gasoline? Then let consumers decide how much ethanol they want.
• If ethanol is so blessed good, why do we have to force people to use it?
• If ethanol is so blessed good, why do we restrict imports of it from foreign countries, which seem to be able to produce it much more cheaply than we can in the US and Canada?
• and that highlights this point: Much, and maybe most, of the support for using ethanol comes from farmers.

From Reuters, via Yahoo, courtesy of Jack.

In late April, the government announced measures to promote biomass as it seeks to rapidly expand the proportion of Britain's energy needs derived from renewable resources.

"We are going to need everything we can lay our hands on if we are going to reduce our carbon footprint in the world," said Ben Gill, a former president of the National Farmers' Union who leads the British government's Biomass Task Force.

No vested interests there. Nope. No siree. Not a one.

Having the former president of the National Farmers' Union help make ethanol policy is like asking a fox to guard the hen house. Talk about the "capture theory of regulation"!

This morning's NYTimes reports that the US Federal Trade Commission has found that high gasoline prices during the past year have been the result of market forces. Note the NYTimes skepticism in the lead sentence:

Despite suspicions among consumers about rapidly rising gasoline prices and record oil industry profits, a federal investigation concluded Monday that the jump at the pump over the last year had not been the result of unlawful price manipulation.

The Federal Trade Commission said the sharp increase in fuel costs was attributable to market forces — namely big drops in supply and production and runs on inventories after major damage to refineries, ports and pipelines. In a report that Congress ordered last year after hurricanes struck the nation's refining hub on the Gulf Coast, the commission found no evidence of price collusion or improper reductions of inventory or supplies to increase company profits.

"The evidence collected in this investigation indicated that firms behaved competitively," the commission said.

... "In light of the amount of crude oil production and refining capacity knocked out by Katrina and Rita, the sizes of the posthurricane price increases were approximately what would be predicted by the standard supply and demand paradigm that presumes a market is performing competitively," the report said. "Evidence gathered during our investigation indicated that the conduct of firms in response to the supply shocks caused by the hurricanes was consistent with competition."

Well, duh. That's what economists have been saying all along. Good grief.

But not content with these findings, the NYTimes finds a way to make a mountain out of a non-sequitur:

Since the report did not find an industry villain, it was not likely to quell voter anger over the high gas prices. That is likely to add political pressure on Congress to take steps to lower prices or reduce the earnings of some oil companies. It could also provide some impetus for legislation, already adopted by the House, to outlaw price gouging and impose high penalties for violations.

Translation: The FTC did not find a villain, but people are still going to blame the oil companies. So is the NYTimes.

And don't even talk about Senator Schumer:

Senator Charles E. Schumer, Democrat of New York, also criticized the commission.

"It just defies belief that they didn't find price gouging because there is simply no price competition," he said.

Translation: There simply is no price competition. I know that because.... uh.... I think gasoline prices should be lower.... uh .... for all the poor people who don't have cars ..... uh..... and for those with big gas guzzlers, too.

In an editorial in Today's NYTimes (reg reqd), Tom Daschle and Vinod Khosla advocate

...a new CAFE: Carbon Alternative Fuel Equivalent. This new CAFE will measure "petroleum mileage" and give automakers incentives and credits for increasing ethanol consumption as a percentage of fuel use of their vehicles, not least by promoting flex-fuel vehicles, which can run on either gasoline or E85 fuel, a blend of 85 percent ethanol and 15 percent gasoline.

This is, for the most part, a bad idea.

• If it will be a good idea for people to switch toward using ethanol, let the price of gasoline rise. The higher price of gasoline will induce people to use less gasoline and will induce them to buy more fuel-efficient and more flex-fuel automobiles. Politicians will not need to decide which technologies are best; supply and demand forces in the market will make that decision.
• If it will be a good idea for people to switch toward using ethanol, let auto producers develop and negotiate long-term market contracts to provide more flex-fuel vehicles and service stations to provide for them.

It is not clear that Messrs. Daschle and Khosla have the answer to carbon emissions or to high gasoline prices. If they do, let them spend their time developing the contracts and products necessary for meeting market demands and let them spend less time trying to convince legislators and voters to subsidize their ventures.

Update: for more on gubmnt interventions, rent-seeking behaviour, and ethanol, see this by Phil Miller.

In the midst of all the hair-brained schemes to "do something" about high gasoline prices, the one scheme I have not come across (yet) is to put a ceiling on the price of gasoline. The U.S. did that back in 1979, and it led to massive excesses of the quantity demanded over the quantity supplied, i.e. shortages, something we have not seen in the past year except in those few isolated instances where price ceilings were imposed after hurricane Katrina. If there is one thing the wildly fluctuating prices have done over the past year, it is bring the quantity supplied and the quantity demanded into equilibrium on a continuing basis. From an article I quoted last Friday, the CEO of Shell makes the point very well, though, oddly, in a different context.

Mr Van der Veer said that there was no need to panic because there was not a shortage of oil.

"From a physical point of view, there is no reason for any panic," he said. "There is nobody waiting at a gasoline station in the world because there is a lack of gasoline. No lorries are waiting at the refinery gate because of lack of refining capacity.

"We can see more than $100bn of basically what is called speculative money in the oil market. Those are the orders of magnitude. They certainly play a role on the price of oil."

That's right. There is nothing like the price system for getting rid of shortages and surpluses. That is why I always make my students say, when talking about a shortage, "There would be a shortage at a specific price..."

You can always get rid of a shortage by letting the price rise.

Why are crude oil and gasoline prices so high these days compared with a year or two ago? It is all because of speculators, according to the CEO of Shell Petroleum.

Blame oil traders for prices says Shell
By Christopher Hope, Industry Editor (Filed: 05/05/2006)

Traders have gambled $100bn (£54bn) on the price of oil going up, helping to keep the price of a barrel - and so a litre of petrol - close to record levels, according to Royal Dutch Shell boss Jeroen van der Veer.

The news comes amid increasing evidence of the impact of speculators on the cost of major commodities. This week it emerged that commodity traders have contributed to the soaring prices of metals traded on the London Metal Exchange. Last week BP chief executive Lord Browne of Madingley said the recent spike in the oil price was due to increased trading by hedge funds.

These speculators are doing us a favour. They are risking their own funds, gambling that the price of oil (and other commodities) will be higher in the future. To carry out this gamble, they must buy up stocks now, driving up current prices (thus inducing us to save more for the future). And then in the future, these speculators will release more of the resource to the marketplace than would otherwise have been available.

These folks deserve a hearty "thank you" from everyone. They're doing more to help us conserve energy, plan for the future, and alter our lifestyles than all the gubmnt plans combined.

James Hamilton, the Econbrowser, has a very succint and superb analysis of proposals to help consumers deal with the rising gasoline prices. Anyone who has studied the rudiments of supply and demand analysis can follow what he is saying.

Regarding the proposal to reduce the federal tax on gasoline, he demonstrates that under almost all plausible conditions,

... the result would be essentially no drop in price and a big increase in oil company profits.

And regarding the plan to give everyone $100, he quite rightly asks where it would come from, with some very cogent discussion.

My own issues are longer run. I see absolutely no reason for gubmnts to cushion the blow of higher gasoline prices. We, as consumers, have known for a long time that there was a risk that oil (and gasoline) prices might rise. On average and in general,

• We could have chosen to buy smaller vehicles.
• We could have chosen to own fewer vehicles.
• We could have chosen to live nearer our work or work nearer our homes.
• We could have gotten in shape and been prepared to bicycle and walk more.
• We could have saved more money to cushion ourselves.

If we didn't do these things, why should other taxpayers be forced to bear the risk and bail us out?

For another perspective on oil/gasoline policy, see Tyler Cowan's piece at Marginal Revolution.

It all reminds me of the story of the Ant and the Grasshopper.

From the NYTimes teaser for John Tierney's column (I don't subscribe to the pay portion):

A gas tax is a far better way to encourage conservation and combat global warming than more fuel-efficient cars.

Let me add that a higher gas tax would, in fact, induce more people to switch to more fuel-efficient autos. In the UK, where gasoline prices are roughly double those in North America, people tend to drive much smaller, more fuel-efficient cars; there are few big pickups and SUVs on the roads here.

Update: I meant to include a link to this piece by Don Boudreaux at Cafe Hayek:

...just a few years ago there were only three venture-capital firms focused on energy companies; today there are 76 such VC firms. So much money seeking ways to find new sources of energy!

Those entrepreneurs and investors who succeed will become fabulously rich; those who fail will be poorer than they would have been had they not entered the quest.

And those of us who do nothing but freely choose which fuels to purchase will benefit enormously.

I love this market process.

Me, too.

I just read Phil Miller's brief posting and graph, showing that US energy expenditures, as a percentage of total US consumption expenditures, while rising recently are well below historical highs and, this ratio is roughly in the same neighbourhood it has been in much of the time over the past fifty years. Instapundit has more on this relationship. However, be careful when you look at the chart he references. Things don't seem as rosy to me as they do to Insta.

Phil's piece prompted me to visit EconBrowser, where there have been two excellent pieces in the past couple of days. The first one asks "Who's Afraid of $3 gasoline?" and has a pretty pessimistic outlook for the US (and world?) economy.

The second addresses the role that speculation might or might not have in driving up the world price of oil. The conclusion is that speculators most likely are driving up the short-term futures prices because of concerns about fundamentals, namely a risk of disruption in supplies. A comment to that piece links to this graph of short- and long-term oil futures prices (it is a thumbnail; to see it more clearly, click on it):



What is going on here? I realize it isn't much in dollars, but why do longer term oil futures prices drop off like that?

Demand curves are downward sloping. For example, if energy users face the prospect of rising energy prices, they will reduce their use of energy.

Furthermore, aside from some minor theoretical anomalies that appear in textbooks, supply curves are upward sloping, especially at the industry-wide level. In this example, higher prices for energy will induce people to provide more energy, whether by conventional or by alternative, renewable and non-carbon-emitting, means.

Also, when substitution in production is possible, when the price of one input rises, entrepreneurs will shift to using less of that input and more of others. In the case of electrical energy, this means that as the prices of oil and natural gas rise, electricity producers will shift toward making greater use of solar and wind energy, inter alia.

In other words, market forces and changing prices will induce consumers and producers to conserve oil and gas and invest in alternative energy programmes. We don't need no stinking incentive programmes. The market will provide efficient incentives.

But, no, in Ontario, politicians and bureaucrats think they can pick the winners better than private investors can [h/t to cmt]. So they have changed the incentive structure:

Ontario is offering to subsidize homeowners and businesses that switch to renewable power sources like solar panels or wind turbines.

The government will pay an inflated price for the energy for 20 years to help make the project attractive: 42 cents a kilowatt-hour for solar and 11 cents for wind, biomass, or small hydroelectric projects.

Fortunately, the programme might primarily be posturing:

The program is also being pitched to homeowners, but the upfront costs – as much as $30,000 – are substantial. Experts say it could take 20 years before homeowners pay off their initial investment and turn a profit.