Reply To: Oil prices


What needs to be kept in mind in tracing cause and effects throughout the economy is that the economy is a single system of production under the division of labor integrated by the structure of prices. The goal of the system of production is to economize the use of people’s resources in the satisfaction of their consumptive ends. When people’s consumptive demands change it sets in motion a reconfiguration of the entire structure of prices and production throughout the economy. Without government intervention, the process of the market generates the most efficient use of resources and build up of capital capacity possible.

Two factors have been at work in fuels.

First, the natural process of economic development has been at work. Worldwide consumer demand for gasoline has been increasing driving up gas prices. This cause alone would increases the profitability of gasoline production leading entrepreneurs to increase their demands for oil and other inputs which, in turn, would drive up oil prices and the prices of other inputs, which in turn would increase the profitability of producing more oil. If profitable enough, other entrepreneurs would invest in technological innovation to increase oil production and use of the new technologies would increase production and the greater supply of oil lowers its price which moderates the rise in price of gasoline, given the initial rise in demand for gasoline.

Second, government intervention has been at work. Governments have increased taxes on gasoline depriving entrepreneurs of the funds to expand production. They have also erected legal restrictions of further conventional oil production. Governments have also destroyed the capacity for conventional oil production in their wars over the last twenty years. The resulting artificially high price of oil has made investment in alternative technologies to circumvent convention production even more profitable. Entrepreneurs have responded with the fracking boom, vastly increasing oil production and lowering its price.

The reason gasoline prices have fallen is not because they are determined by oil prices, but because speculators anticipate profit from moving gasoline supplies from the future to the present in the wake of the greater future production of gasoline they anticipate. The increase supply moves along a given demand curve to clear the market at a lower price for gasoline. The (now lower) price of oil and other (now lower) input prices are still determined by that (now lower) price of gasoline.