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Friday, October 21, 2005

Econ 101  

In a brisk demonstration of how fundamental economic illiteracy leads people to propose policies with predictably counterproductive (if sometimes counterintuitive) outcomes, Taranto at OpinionJournal sayeth:
Several readers wrote to ask why, in an item yesterday, we dismissed George Packer's call for 'energy independence' as an 'utterly pointless dispute.' Packer, who was urging a new Democratic agenda, didn't really explain what he meant by 'energy independence,' but our understanding of the liberal conception of it is as follows:
  • The government should establish policies aimed at reducing the use of oil (fuel-economy standards, higher gasoline taxes, incentives or coercive measures to encourage use of public transit, etc.).

  • This in turn would reduce our dependence on foreign oil, helping to starve the Arabs and thus reduce terrorism.
For the sake of argument, let's take the first part of this argument--that the government could reduce oil consumption, effectively a reduction in demand--as a given. Basic economics tells us that a reduction in the demand for a commodity will lower the price.

What happens when the price of oil goes down? High-cost oil production becomes uneconomical, which means that low-cost producers end up accounting for a greater share of the market. The lowest-cost producer of all is our friends the Saudis. Thus 'energy independence,' if effective at all, would actually make America more dependent on 'foreign' (Arab) oil.
You don't need an advanced degree to grok this stuff; just an introductory class and the willingness to think things through. Supply and demand, incentives, marginal utility ... pretty elementary concepts. The fact that so few voters seem to see through these partially-baked ideas is another reason for despair over the public school system.

Extra credit: Taranto assumes for argument that demand would actually fall significantly. It wouldn't, easily, because demand for energy is fairly inelastic in the middle run, once the low-hanging fruit is picked. The replacement cycle for automobiles is around five years; it would take that long for immediately higher CAFE standards to make a meaningful impact (longer for the phased-in ones usually proposed). And what's the replacement cycle for furnaces and water heaters? How about for new job or housing choices that reduce commuting distances?

However, that doesn't mean the policy would have little effect. It would almost certainly increase inflation, lower productivity, slow down the economy, increase unemployment, and (with the help of the Federal Reserve) increase interest rates and (probably) the deficit. Which would lead to calls from the policy supporters to dig harder and faster and deeper, and rely more on coercion and less on incentives.

For the next class, Applying Supply and Demand concepts to Healthcare Policy: Universalizing access to health care by reducing the numbers of the uninsured will logically mean that prices move in which direction? Bueller? Anyone?

posted by Kelly | 3:18 PM link