Friday, January 16, 2009

A Willing Suspension of Disbelief

I've been slowly working my way through a textbook by a certain hack economist, and I was inspired to make these slides.

The basic idea is that in a hypothetical "free" market the supply and demand will find an equilibrium at a certain price. Movements in the "curves" will change the equilibrium price. Changes might be caused by increasing raw material costs, more efficient production methods, waxing and waning popularity, appearance or disappearance of competing producers, or other factors.

In reality the supply and demand curves are not linear, and there is always some kind of tax in the mix. Demand or supply is considered elastic if it is very sensitive to price changes. Inelastic supply or demand is the opposite.

This is a terribly simplistic model of the global oil market. Demand is inelastic at lower prices and elastic at higher prices. Supply is the opposite. There isn't one production cost for oil because there are many sources, each of which required different levels of investment to develop. Ghawar, the world's largest field, has extremely low production costs, meaning the Saudis can make money even at very low prices. Tupi, the new ultra deepwater find off the coast of Brazil, is still being analyzed for viability and may never be put into production. On the consumption side, there isn't one price to end users due to different contract lengths and different levels of taxation. Venezuela, a major producer, takes the rather stupid step of subsidizing gasoline prices, pushing up demand which reduces the amount available for export. Norway, another major producer, was the poorest Scandinavian country until oil was found in the North Sea. Given their history, Norwegians are very conservative with their oil use and oil revenues.

Here's the basic argument for the gas tax: current prices don't reflect true costs. Some of the costs are immediately related to the production of oil, such as spills, or its consumption, such as smog. Other costs have a less direct connection, such as 9/11 or the Iraq War, or won't be felt for a while, such as global warming or potential scarcity. Costs that are not reflected in the price of a good or service are called externalities, and oil use has a lot of them. Raising the gas tax would "price in" some of those externalities, even if the revenues didn't flow directly towards solving them.

It's a no-brainer to me and other people who care about the future.

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