Truck and Barter: Paul Krugman on Oil

May 07, 2004

Paul Krugman on Oil

By Kevin

Paul Krugman warns that the supply of oil is finite; and the demand curve keeps rising, yielding ever higher prices and adaptation. This simple framework is only the beginning of the story, however.

Stephen Karlson notes that short-term price spikes have aleady yielded some adaptation--as people shift towards smaller automobiles--in spite of "fuel-efficiency" regulations.

Don Boudreaux notes one potential alternative supply of oil, to offset the long-run price rise.

Steve Verdon insists that we will never run out of oil, and discusses problems of some of the alternatives out there.

John Quiggin agrees with Steve, and notes the exchange rate causes of higher oil prices, although he believes prices are likely to rise further.

I say that if the only way we can run automobiles, factories, and offices is with oil, then clearly higher long-run gas prices are unavoidable, and we will all be worse off in the future because of it. But such a scenario means that little adaptation is possible or economically feasible, and I don't believe that.

What is adaptation? It means that--in the near and distant futures--we use less oil or none at all. Still, in current uses, we must assume that oil is the most efficient means of power production. So even if we assume adaptation to the most efficient alternative, any and every adaptation is a net cost.

But is that true for tomorrow? Next year? In 2025? Can any economist predict how the individuals, firms, and governments will respond in the short-run or long-run? Can we predict the long-run relative price for oil compared to all alternatives? I highly doubt it.

Higher oil prices, and consumer and producer adaptation to them, might put us onto a energy production timeline that yields lower energy costs in the future than if oil prices stayed low and we didn't adapt.

Regardless of the high current prices, in the future, making energy with factor X might be cheaper than making energy with oil. But factor X might not come about unless we adapt today.

Higher spot prices make R&D into oil alternatives far more lucrative. With luck, persistence, and the proper economies of scale, our adaptation to higher prices today can help drive energy prices lower tomorrow than they would have been if oil prices were still low today.

What this means is that at some point in the future, high oil prices might be irrelevant because we will be using something else that is cheaper. That is how market economies have adapted in the past. Asking how much better off we all could be if whale oil were $15 a gallon is not relevant to today's economy. In the future, asking how much better off we all could have been if oil were still $20 a gallon might be just as irrelevant.

Do high prices make us worse off in the short-run? Yes. In the long-run? Who the hell knows? Dr. Krugman doesn't tell his readers that market economies routinely solve seemingly intractable problems like this one, and that market economies have persistently beat the pants of pessimists willing to lay down their money.

(Also see the rest of the bunch who've discussed Krugman's latest.)

Posted at May 7, 2004 04:45 PM

Comments

Well my point is that we wont run out, but at a certain point we wont be using much of it anymore either. Like whale oil. Basically I agree with your analysis: Today's higher prices will make us look for factor X.

Do high prices make us worse off in the short-run? Yes. In the long-run? Who the hell knows? Dr. Krugman doesn't tell his readers that market economies routinely solve seemingly intractable problems like this one, and that market economies have persistently beat the pants of pessimists willing to lay down their money.

That is because Dr. Krugman is not honest with his readers...unfortunately.

Oh and good move switching to MT. The comments with the other blog were too limited for my long winded style.

Comment by Steve at May 7, 2004 05:08 PM | Permalink

I thinks thats the main point which Krugman doesn't take into account. The higher price induces research into other sources of energy. A good example would be the stuff stuck in the sand up in Canada, I think the number is $40 a barrel for it to become economically feasible to get it. Of course, money could go into other areas as well. So, energy costs will be even lower in real terms 15 to 20 years from now.

Comment by Bob at May 9, 2004 06:50 PM | Permalink

You seem to overlook Tom Gold's evidence showing that oil is NOT a fossil fuel and that there must therefore be huge amounts of it.

I mentioned the matter recently on:

http://antigreen.blogspot.com

Comment by John Ray at May 10, 2004 08:20 PM | Permalink

Good point, John, but it's not the amount of oil I'm concerned about, it's the relative cost of extracting and using it to make energy compared to alternatives.

If Krugman's right about oil demand far outstripping supply (even if supply manages to increase--as it has done with even most "finite" resources), in the future, oil will probably not be the lowest cost way of meeting demand for energy.

Comment by Kevin Brancato at May 26, 2004 12:04 PM | Permalink