Wednesday, December 3, 2014

Never Reason from a Price Change: Zach Weiner Edition

SMBC author ZW:
Every economist who has ever walked the earth:
Never reason from a price change.
Why? Well, in a picture:
 Oh man. I drew that awful thing (yes, in MS Paint) and even I'm going googly-eyed looking at it.

Okay. Start with the Supply and Demand curves (in black). Where they meet (I labeled it 'C') is what we call the equilibrium. Buyers and sellers of petroleum are pretty much matched, and since this is for the whole enchilada, so to speak, this includes spot prices for injection mold pellets as well as the guzzlerough low-octane gasoline futures traded in Chicago.

Economists say "never reason from a price change" because that means that the evidence you have is price went from point 'A' to point 'H', and there's not enough information there to tell you if there was a shift in the demand schedule (in red) or a shift in production (in blue). And as you can see on the Quantity axis, points 'F' and 'G' depict very different volumes of exchange. Zach is curious about measured GDP, and since oil is an input product to a kaleidoscopic array of products and services, a move from 'B' to 'G' means more vigorous economic activity overall (higher real GDP), while a move from 'B' to 'F' means a reduction in economic activity (lower real GDP).

All else equal, of course.

Zach's rider about elasticity is not something I pressed him on. I think he meant the price elasticity of demand, which is consistent with the common usage, but as you can see, we care about that only for the blue-shift of a supply adjustment, in which we move along a relatively steep demand curve. But since it ain't clear what exactly is adjusting in the market (particularly when there's a thick, well-developed futures exchange), we could just as well be shifting the demand curve along a relatively steep supply curve, in which case we ought to worry about the price elasticity of supply.

Put another way, it's clear from that one tweet that Zach Weiner is pretty gung-ho about the Keystone pipeline, and I don't think there's much you can do to dissuade him. He has hardened his heart against visions of oil-soaked caribou and Kevin Costner shedding a single tear in the desolate, despoiled Montana wilderness. The risk of uncompensated environmental devastation is immaterial to his maniacal fixation on an aggregate economic statistic. Obviously.

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Do you have suggestions on where we could find more examples of this phenomenon?