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SPOTLIGHT
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Acquire a basic understanding of economics

Published on -9/28/2012, 9:59 AM

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Here's a question: If there's a disaster, a war, a severe drought or some other calamity that restricts future supplies of a commodity -- such as oil, coffee or corn -- what is the intelligent thing for people to do right away?

If you said "use less now and try to produce more," you'd be absolutely correct. That's not rocket science, but understanding the machinery involved in getting people to do so is a bit more challenging.

The best way to get people to use less and produce more is to allow prices to rise. For example, say a Middle East conflict restricts oil supplies and causes prices to rise. The effect of higher prices for oil is that it gives individuals incentive to eliminate or reduce the low-valued uses of oil. For example, a low-valued use of oil is for homeowners to allow the heat that it generates to seep through walls and leaky windows. Higher oil prices create incentives to homeowners to install insulation.

Higher gasoline prices force motorists to economize by taking measures such as carpooling and taking fewer low-valued trips.

Suppose that in the wake of a natural disaster -- in the name of anti-gouging or some other nonsense -- government officials mandate prices cannot rise. What's the economic message?

The mandate encourages people to continue their consumption as if the disaster didn't happen. Let's use gasoline as a concrete example. Suppose a family is fleeing a pending hurricane and has a half-tank of gas, plenty to get them to a safe destination, but they would feel more comfortable topping off the tank. If the price of gasoline remained at a pre-hurricane price of $3 a gallon, they might do so. But if the price shot up to $5, they'd wait until they arrived at their destination. Their decision has the effect of making more gasoline available for others.

So here's my question: Which alternative is preferable for a family, fleeing the hurricane with their gas gauge showing nearly empty, gasoline available at $5 a gallon or gasoline unavailable at $3?

You might say that when there's an emergency, the government should step in to prevent prices from rising by establishing price controls. During the 1970s, the Nixon and Ford administrations, in reaction to a jump in fuel prices caused by cuts in production by OPEC, did just that.

Price controls led to massive shortages, long lines at gasoline stations and massive misallocation of resources.

Whenever there are expected shortages of a commodity, there are millions of wonderful nongovernmental people who enter to help. These people, often vilified and called every name except child of God, are the speculators. Efficient allocation of resources requires allocation over time. If speculators guess there will be future shortages, they will buy the commodity now in the hopes of making a personal gain when prices rise. Their purchases have the effect of raising the commodity's price now and making more available in the future -- and at a lower-than-otherwise price.

In April, President Barack Obama called for his Department of Justice to lead a task force to root out manipulation of the oil market and gouging of consumers at the gas pump. U.S. Sen. Bernie Sanders, I-Vt., introduced legislation called the End Excessive Oil Speculation Now Act. White House and congressional attacks on oil speculation do not alter the oil market's fundamental demand-and-supply reality.

What would lower the long-term price of oil is for Obama and Congress to permit exploration for the estimated billions upon billions of barrels of oil off our Atlantic and Pacific shores, the Gulf of Mexico, and Alaska -- not to mention the estimated billions, possibly trillions, of barrels of shale oil in Wyoming, Colorado, Utah and North Dakota -- but doing that would offend the sensitivities of environmental extremists who have the ears of Congress and the White House.

Walter E. Williams is the John M. Olin Distinguished Professor of Economics at George Mason University, Fairfax, Va.

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