Market wonders

We’ve all seen gasoline prices rising; is that good news or bad news? Congress could enact price controls and “odd and even” days for gasoline purchases like they did in the 1970s. Sure we’d be paying lower prices, but the selling price of a good is just one element of its cost. The full cost of a good includes all additional resources expended for its acquisition. These additional resources might include time and travel that are by no means free. Say that Congress legislates gasoline price controls that sets a maximum price of $1 a gallon. As sure as night follows day, there’d be long lines and gasoline shortages, just as there were in the 1970s. For the average consumer, a $1.60 a gallon selling price and no waiting lines is a darn sight cheaper than a controlled $1 a gallon price plus searching for a gasoline station that has gas and then waiting in line. If your average purchase is 10 gallons, and if an hour or so of your time is worth more that $6, the $1.60 a gallon free market price is cheaper. Prices aren’t just made up. Prices are important market signals reflecting the relative scarcity conditions of any good. Rising prices imply an increase in the scarcity, or expected scarcity, of a good. In other words, if a good becomes scarcer or is expected to become scarcer, its price will rise. The opposite is true when a good becomes abundant or is expected to become abundant. When a good becomes scarce, there are several socially optimal responses: Consumers should economize on its usage and search for cheaper substitutes. Producers should increase production of the good and search for substitutes. Rising prices provide both consumers and producers with incentives to behave in socially optimal ways. Plus, they do so voluntarily. Another player in this economizing process are futures markets such as the New York Mercantile Exchange (NYMEX). One function of a futures market is to allocate goods over time. Let’s look at a simplified example of this process. People can buy or sell orders today for future deliveries of oil – for instance, December 2003. Say today’s oil price is $35 a barrel and people expect the December price to be $50. Speculators can buy oil today for $35, hold it and sell it in December for $50 a barrel, making a $15 profit. One effect of taking oil off today’s market, and holding it for a later date, is to reduce today’s supply and raise today’s prices. You say, “Williams, that’s what’s wrong with capitalism; greedy speculators rigging the market!” Imagine there were no futures market and speculators. In our scenario, it would surely mean there’d be more oil today at lower prices, but what about the future availability of oil? It would be scarcer and at higher prices without futures market and speculators. Without futures markets allocating goods over time, there’d easily be feast or famine. By the way, most of us are mini-speculators. If gasoline is $1.60 a gallon this week, and we expect it to be $2 next week, I’m guessing that the average person will fill his tank to the brim this week – which, by the way, would cause this week’s price to rise. Of course, the price might turn out to be $1 a gallon next week; we’d lose, just like our speculator would if the December oil price turned out to be $20 a barrel instead of $50. Markets are not perfect. After all, markets consist of millions upon millions of imperfect independent decision-makers like you and me. Abundant evidence, not faith, demonstrates that markets are far more reliable and predictable than a bunch of arrogant politicians and bureaucrats.