Knowledge Problem

Lynne Kiesling

Last week’s quarterly earnings announcements made for a lot of wailing and tooth-gnashing about the profits of oil companies. I was too buried in other things to opine, but others said smart and useful things. Take, for example, this question from Russ Roberts to those who want to impose a windfall profits tax on oil companies:

… if they lower prices when profits are high, are you willing to make a charitable contribution to oil company stockholders when profits are low or negative?

Russ is right when he says that the true economic illiteracy is not the asymmetry of wanting to take their profits but not subsidize their losses. The true economic illiteracy comes in the lack of understanding of what prices do, where they come from, and how they work to induce optimal decisions on both sides of a transaction over time.

Then there was Jim Glassman’s interview with Dan Yergin at Tech Central Station. They touch on several interesting and important energy topics, including the windfall profits one:

What a windfall profits tax does is introduce a lot of distortions. It reduces investment, it increases a sense of political risk and it doesn’t achieve the goal that is intended, if it is to facilitate investment in new sources. It obviously responds to a political demand, but it has the opposite effect of increasing supply. It really will lead to decreased supply, not only here, but it will be something that will have an impact around the world. And this is a time when you want to increase and encourage investment, not provide disincentives to investment. …

I think that there are two things that we can do as we are heading into the winter that would be significant. The first thing is that we really ought to make sure that people really have the information and the knowledge about the minor changes in behavior that they can make that will not only save them money but in a total sense would reduce natural gas prices and take the pressure off. If all of us this winter reduced our thermostats by two degrees, homeowners, commercial establishments, we would save more natural gas than has been lost because of Hurricane Katrina.

The other thing we ought to do is not wait until a cold winter, if we do have a cold winter, and address now how to build flexibility into some of these environmental regulations so that for instance, in an area where a utility is only allowed to burn oil four days a months, perhaps in January if there is really pressure on prices they can burn oil eight days a month and reduce their consumption of natural gas. And there is no shortage of residual fuel oil, the type of oil that does get burned in utilities, so it wouldn’t add to the price pressure on oil but it would take pressure off natural gas.

Demand response and adaptable environmental regulations … yes, that’s the litany here at KP.

Then at Catallarchy, David Masten delivers the goods by calculating Exxon-Mobil’s profit margin, which was 9.85% for the third quarter. Healthy, but not outrageous.

From the Fortune Global 500 data, financial services company Bank of America is getting margins of 22.3%, General Electric had 11%, and Proctor & Gamble comes in with 12.61%. Big Pharma does quite well with Pfizer at 21.5%.

Note that the margin data are consistent with the higher costs that oil companies face due to cleanup and restarting Gulf resources taken offline due to hurricanes.

Finally, today Russ Roberts gave a commentary on NPR about the role of high profits:

There’s another benefit of high prices. They encourage greedy oil companies to pull oil out of the ground that isn’t worth pulling out of the ground when prices are low.

Getting oil out of the ground and into your car in the form of gasoline is an extremely expensive and unpredictable process. ExxonMobil spent almost $15 billion last year on equipment to find new oil and make refineries more productive.

As consumers, we want oil companies to take risks and spend money searching for new supplies. Profits are the reward for risk-taking and investment. Take away profits when they’re high and oil companies will take fewer risks and invest less. That means less energy in the future.

Lynne Kiesling

Last week Randall Parker had a neat post on LED lighting advances, and how much energy savings we could create by switching from incandescent to LED. The article he cites suggests that the switch would also save us $125 million/year in electricity costs. Randall wonders if that number is low, but I don’t think it is. Lighting doesn’t use as much electricity as you think, and if you take into account the technological changes to incandescent bulbs and the shift to compact florescent, I think that’s a reasonable estimate.

LED lighting is like the Post-It note in a lot of ways. It’s an innovation that is likely to have enormous implications, way beyond what we currently perceive.

LED lights give off lots of lumens in a very small package; in the KP household we’ve got several, for headlamps and bicycle lights. In the past couple of years the technology has advanced and been priced attractively. I bought the KP Spouse a fancy schmancy LED headlamp that has three level settings and a strobe setting, and it’s about the size of a pair of D cell batteries. His old headlamp made him look like a coal miner.

LED lights also don’t give off waste heat, because they do not emit light in the infrared spectrum (or at least I think that’s the reason). That’s another reason why they are so energy efficient; all of the energy input goes into producing lumens, not lumens+heat.

LED lighting is also like the Post-It note because of an interesting fact that Randall notes: the innovation he’s describing in his post, which is using quantum dots to create a coating that yields warm, yellow light from an LED, happened by accident. The researchers were exploring quantum dots for another application entirely, and it turns out to have this other nifty application. The history of technological change is littered with such accidental discoveries, many of which (like the Post-It note) have transformed our lives.

Lynne Kiesling

Todd Zywicki has an interesting post over at Volokh about post-Kelo juries. His argument is good: public choice theory is consistent with the political failure to protect private property rights in the Kelo decision, all the way up to the Supreme Court. In the face of these political dynamics, juries change their decisions, increasing their awards to those harmed by eminent domain. His hook for this discussion is a recent jury award in San Diego for more than double what the city had originally offered the property owner.

Interesting question: so we like juries when they do things we like, but then in other instances (Vioxx, for example), we don’t like them because they are swayed and decide emotionally. Should we be concerned about this? Jury reform? Or is this just the balancing of tradeoffs that we hope is net positive through our use of such a judicial institution?

Lynne Kiesling

U.S. auto manufacturers, sit up and pay attention: the long-run effect of these high gasoline prices may be a change in the preferences of customers. What brought this home to me this morning was this post from Glenn Reynolds about car shopping with his wife. They compared a Toyota Highlander hybrid and a Subaru Tribeca. Their conclusion is an example of the kind of change I’m talking about:

The winner: The Highlander. The mileage is actually better than the Passat, especially in town where I do most of my driving, it’s roomier and comfier, while driving amazingly well for something of its size. I doubt that it’s worth the premium for the hybrid on a purely economic basis — especially as old-style SUVs are trading at a deep discount now, with lots of “$5000 off” signs around the dealers, which would buy a lot of gas — but if you don’t want a minivan, and you do want room, and you’re offended by the idea of getting 16 miles per gallon, then it looks pretty good.

Yes. We were in the southern tier of New York this weekend, visiting my grandmother and aunt, and the Rochester airport had several cars on display from a local dealer. I have been lusting after a Honda S2000 convertible for some time, but the mileage is only 20 city/25 highway, which takes some of the bloom off of the rose. I’ll wait until they have a hybrid version, which will be good for both torque and mileage.

Lynne Kiesling

The Wall Street Journal reports this morning that “gasoline prices fall as imports rise, demand drops”. Naturally, I cackled gleefully and clapped my hands when reading this. The EIA weekly petroleum status report indicates that

Total product supplied over the last four-week period has averaged over 20.0 million barrels per day, or 3.2 percent less than averaged over the same period last year. Over the last four weeks, motor gasoline demand has averaged nearly 8.9 million barrels per day, or 2.2 percent below the same period last year.

Two important things there: first, total product supplied is down 3.2 percent, even though 20 percent of refining capacity is still offline. Among other things, this indicates both that imports are higher, and that refiners are squeezing more gasoline out of every barrel of crude (the WSJ article notes both points). Second, high prices have led to a decrease in demand; demand is not very elastic, but at the margin price increases have reduced quantity demanded. The combination of these offsetting factors has led to prices falling, although they remain above pre-Katrina prices.

Here’s the information about imports:

U.S. crude oil imports averaged 9.2 million barrels per day last week, up 588,000 barrels per day from the previous week. Over the last four weeks, crude oil imports have averaged 8.9 million barrels per day, a decline of 1.1 million barrels per day from the comparable four weeks last year. Total motor gasoline imports (including both finished gasoline and gasoline blending components) last week averaged over 1.5 million barrels per day, setting a weekly record for the third week in a row, while distillate fuel imports averaged 311,000 barrels per day.

In normal refining conditions we don’t import that much gasoline from Europe, but now, with refinery capacity still not fully online and continuing high prices (although they have declined), imports are attracted to the US market.

This example provides an elegant illustration of the dynamics of market processes. Exogenous shock. Production capacity falls, prices rise due to supply curve shifting in. Quantity demanded falls, and perhaps even demand falls, shifting demand curve in, leading to further price reductions. Simultaneously, other suppliers bring product to market, lured by the higher-than-usual prices, shifting supply curve out. Incrementally, quantity and price change until they reflect the prevailing costs and preferences.

[NOTE: the KP Dad is visiting, and I'm on his laptop, and because he's a security weenie his cookie setting doesn't work and play well with the WSJ website for a link to the story. It's on A2 of the print edition.]

Lynne Kiesling

According to Chicagoist, Cub Foods stores in Chicago will start using a biometric payment system in November. The Pay By Touch system will enable shoppers to debit their checking accounts through a device that scans your finger, and uses its unique measurements as identification.

The comments on the post are interesting, including melodramatic (and not serious) suggestions that thieves will chop off fingers, etc. The comments touch on the privacy concerns, and the extent to which stores will be able to protect the customer information in the resulting databases. Hopefully the biometric information will be considered similar to, say, ATM PIN and credit card number information.

Lynne Kiesling

To answer my own question, I’d say it depends on the model, and the stringency of the assumptions, and whether or not the model’s (and the economist’s) focus is on understanding human action, or on constructing an elegant, self-contained model.

I agree with Tyler Cowen’s list of ways that economics research can derive testable predictions from game-theoretic models. I think a lot of the interesting and valuable thinking is in the institutions (there’s a surprise!), because game-theoretic models that are most likely to have some explanatory teeth are likely to have multiple equilibria. Institutions are a way to explain how we end up at one equilibrium instead of another. Behavioral, evolutionary, and experimental research all deal with institutions and can shed light on this.

But I do have a snarky follow-up question for Tyler: to what extent do you think that our colleagues are interested in understanding human action? What about the extent to which we economists are enamored with our tools, and engage in “math for math’s sake” work? Just asking …