August 24, 2005
Are higher oil prices good?
I was listening to Boortz on my way home for lunch today, which may have been a repeat as his Information Overload hour definitely was, but I heard something that piqued my interest. A caller suggested that higher oil prices were a good thing. Here was the crux of her argument:
Higher oil prices make it more profitable for American oil suppliers to actually drill and produce more oil domestically. Those oil tycoons become much more wealthy, and are then able to purchase and stimulate the economy. If the oil prices weren’t so high, those people wouldn’t be able to make that money, and thus the economy as a whole would suffer.
Specifically, she referred to it as a wealth effect. Boortz, who seemed a little preoccupied, didn’t quite understand the point she was making, and let it slide. In fact, for some reason he said that spurring domestic oil production was a “good point”.
It was one of the dumbest exchanges I believe I’ve ever heard.
Now, most of my readers know exactly where I’m going with this. Many of you can name the economic principle I’m about to cite. But I’m going to do it anyway (for Wilson’s sake).
This is a variation on the Broken Window Fallacy. A baker has his window broken, and passersby think that while his broken window is a bad thing, the fact that he will have to pay a glazier to replace the window will stimulate the economy. Think about it this way. Oil has gone up, so now Americans, in addition to Saudis, are profiting off the increased price. Sounds pretty good, doesn’t it? After all, people are making money that they can spend!
Not so fast. A few tycoons down in Texas are becoming very wealthy, and they are doing so by selling oil to the rest of the country. The real question is what happens to the rest of the country. High oil prices, in this case, are our broken window. Americans are paying much higher prices for oil and gasoline than they were a year ago, and that is money they cannot spend elsewhere. The money they are currently spending on oil or gasoline could be saved, invested, or spent elsewhere.
It’s very simple. Lower prices are better. If energy could be completely free, it would be ideal. However, without the ability to repeal the laws of physics, we can look at making it less and less expensive as a beneficial thing. Before the baker’s window was broken, he had a window and $100. After the window is broken, he has to have it replaced, and thus has a window and $0. If it costs me $30 to fill my gas tank and I have $50, I can have a full gas tank and $20 left over to spend on other things, and “stimulate the economy” in other ways. If it costs $50 to fill my tank, I have a full gas tank and $0.
So how exactly are higher prices a good thing?
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Higher prices are not a good thing.
The caller obviously sees economics through a mercantilist lens. Good thing for us that Henry Ford didn’t agree with her thoughts on the topic.
Brad Brad Brad.
Your window is broken b/c your boy was playing baseball. You fix the window now, a $100 investment, and a few more times, b/c he keeps playing baseball. He gets really good and leads his east Cobb high school team to the state championship. Then when he signs his Braves first round baseball contract out of high school. After that, he buys you a big house with titanium windows so you never have to replace a window again. And he gives you a new Hummer. And he gives you a few thousand dollars in QT (Atlanta gas retailer) gift cards. So the pockets of the window fixer, Home Depot, the Texas oilmen all get lined, and you end up with a big house, a big car and lots of gas.
Its all good.
The increasing price of oil is not a good thing in itself. However, if the increase spurs people to investigate alternatives, such as e85 or propane, then the increase in the price is a good thing. E85 and propane pollute much less and don’t contribute to middle eastern wealth as much as gasoline.
I agree with otho while adding that those “tycoons down in Texas” will now put more cash into production facilities that will still be there once the price levels out (or even drops) because of the glut of production. Prices will lower when new production happens and will stay lower in the long term because the new production facilities will continue to operate.
Otho,
While I agree that alternative fuels are a good thing, the best situation is if those fuels are actually less expensive than oil. If they cost, say $1 per unit and oil costs $0.25 per unit, people will still use oil. Ideally, we want to bring the price of the alternative down to $0.25, not push oil up over $1, to force the switch.
Sinner,
I agree, in that increased production is a good thing. Someone tell me why we’re not drilling in ANWR again? I think oil doesn’t have to be $60/barrel to make it financially sound to drill up there, while in certain Texas fields it does need to be that expensive.