Exxon: The Market's Favorite Lover
Everytime a cable company wants to change it's prices, it has to go through a government procedure to do so. Oil companies are subject to no such regulation. Think about that one for a few minutes...........ok........now you're starting to formulate a question...........
Why?
The answer seems quite simple at first, because the cable prices in areas where there is no competition would be subject to abuses, while oil, on the other hand, is priced based solely on the market. The oil industry does not set it's own prices and therefore are not at fault when they are forced to reap enormous profits. How much is enormous? Exxon posted third quarter earnings (that's all profit folks) of $9 Billion. So why am I writing an article about this. Exxon is only making that much money because the market says they should, right? Well, yes.....and no.
The Market Stole My Cheese!
The market-price is set by the current meshing of supply and demand. This works well in most industries as it ensures an efficient use of resources and helps foster fierce competition between suppliers to lower costs. The problem with oil is that it does not follow the standard rules.
Does this make the oil-industry evil?
Not really. They are acting in their shareholders best interests by maximizing profits. It is, after all, very possible that this is an example of the market mechanism working exactly as it should. As this resource becomes scarce the price-pressure forces us to become more efficient in our use of it and to search for other options. Certainly this is better than having price controls which would lull the world into complacency about efficiency and alternative energy sources and ensure a massive depression when the pumps dry up.
The Question
It is possible that there is corruption in the oil-industry that would have them manipulating supply to keep prices high, but that is a question of legality, not of economics, so let us leave it alone for now. Therefore, knowing what we now know, what is the correct course of action? Should the market be left to work its magic? Should society intervene, and if so how? These are questions that are being asked in this article, not answered. That is your job.
Why?
The answer seems quite simple at first, because the cable prices in areas where there is no competition would be subject to abuses, while oil, on the other hand, is priced based solely on the market. The oil industry does not set it's own prices and therefore are not at fault when they are forced to reap enormous profits. How much is enormous? Exxon posted third quarter earnings (that's all profit folks) of $9 Billion. So why am I writing an article about this. Exxon is only making that much money because the market says they should, right? Well, yes.....and no.
The Market Stole My Cheese!
The market-price is set by the current meshing of supply and demand. This works well in most industries as it ensures an efficient use of resources and helps foster fierce competition between suppliers to lower costs. The problem with oil is that it does not follow the standard rules.
- The supply of oil is inelastic. Capacity is finite and at the present time is almost always running at maximum.
- The demand for oil is also rather inelastic. Whether price goes up or down, people go to work, planes fly, and trucks........ummm, truck.
- There is no incentive to create more capacity. This point relates to the above point in that since demand is inelastic there is no reason to invest in new refineries or oil-exploration. Another investment-discouraging factor is the complete lack of supplement goods. There are, at this time, no commercially viable alternatives. It is oil or nothing. Therefore, there is no risk of reduced demand and insufficient incentive to increase it; no reason to invest in increased capacity.
Does this make the oil-industry evil?
Not really. They are acting in their shareholders best interests by maximizing profits. It is, after all, very possible that this is an example of the market mechanism working exactly as it should. As this resource becomes scarce the price-pressure forces us to become more efficient in our use of it and to search for other options. Certainly this is better than having price controls which would lull the world into complacency about efficiency and alternative energy sources and ensure a massive depression when the pumps dry up.
The Question
It is possible that there is corruption in the oil-industry that would have them manipulating supply to keep prices high, but that is a question of legality, not of economics, so let us leave it alone for now. Therefore, knowing what we now know, what is the correct course of action? Should the market be left to work its magic? Should society intervene, and if so how? These are questions that are being asked in this article, not answered. That is your job.
posted by SpacemanSpiff at 10/31/2005
3 Comments:
It has been said that necessity is the mother of all invention.....I suspect the market will provide the successor to the economy of oil. Just don't expect the oil companies to regulate themselves along the way, that would get ugly.
curz
I doubt that supply and demand for oil are unelastic. The higher the oil price is, the more oil can be reached profitably. Also, if the oil price is high, people will try to get around buying it, searching for alternative solutions. Also consider the golden rule of scarcity: There is never enough for everyone of anything.
And the cheaper oil is, the more it will be used. If it's too expensive, it won't.
The doubts that you express regarding the elasticity of oil supply and demand are unfounded. There is empirical evidence that shows these established facts.
1. While normal goods would be produced in greater quantities with high prices, oil is not manufactured, it has to be found and pumped out. Capacity cannot be increased at will.
2. People do try to get around buying it, but there is little that they can do. You have to go to work, goods have to be shipped, and there is one option for powering this commerce, oil.
Inelastic Demand
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