The old rules of supply and demand teach us that when the quantity supplied at a particular price is the same as quantity demanded, we have found the magic “equilibrium price.” Producers are willing to produce said quantity at said price, consumers are willing to purchase, and the “invisible hand” will inevitable drive the market to this price. The lines of supply and demand cross as illustrated thusly:
Those are the old rules. This is the economic theory I studied in high school and college. If the price is set too high, quantity demanded will be less than quantity supplied (surplus in the graph above). If prices are too low, quantity demanded will exceed supply (shortage). Supply and quantity supplied are not the same thing. Also true of demand and quantity demanded. Changes in supply will affect price in relation to demand. Let’s use some examples.
Just a few years ago the factory that produces Slim Jim’s was destroyed. The company couldn’t change the quantity up or down a few units to reach the equilibrium price because the factory was gone; there was no more supply. It didn’t matter what demand was doing, for a while no one could buy Slim Jim’s at any price. On the other hand, when Microsoft introduced Vista it turned out the consumers didn’t want it. They could have supplied one copy for each person on earth, but there was not a demand. Microsoft couldn’t pay people to use it.
What About the Price of Gas?
Economics is largely theoretical; it’s considered social science not a natural science. Sometimes people do not behave they way they are “supposed” to. Supply is fine. We weren’t buying that much from Libya, and Saudi Arabia has easily replaced that amount. OPEC is only operating at about 85% capacity. Demand is down; amazingly Americans are carpooling, cutting trips and even canceling vacations to reduce consumption. Supply is up, demand is down, so why is gas pushing $5/gallon? Why are some predicting $6.00 by the end of summer? And the answer is: speculation.
Speculators set the price of gas not based on what’s happening right now but what could happen in the future. Revolutions in northern Africa or a mid-east war could upset supply. So could an earthquake or hurricane if refinaries were hit, and it’s getting to be that time of year. We have plenty of oil right now; but what if something happens? And that’s driving up the price to perhaps the highest levels ever in the United States.
In the 70’s there was an oil embargo. More recently Hurricane Katrina shut down refineries. Those things actually happened and prices went up. Prices are now the highest ever because something could happen, but in the meantime oil companies and oil company executives are making record profits. President Obama has appointed a task force to monitor price gouging, and even House Speaker John Boehner has suggested cutting tax breaks to big oil. It will take outrage on the the part of the general public to motivate politicians to act. So come on, let’s hear some rage people.