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August 26, 2005
Kudlow makes a common misstatement concerning supply and demand
Larry Kudlow writes the following at the NRO
On the oil-price shock, I say at least two cheers for higher prices. Why? Because I believe in markets. When the price of energy goes up, demand falls off and supply increases. This is the case today and it represents nothing short of a tectonic shift.
OK, Kudlow does seem to understand that the supply curve has not shifted inward but what does “demand falls off” mean? Larry – try this: an outward shift of the demand schedule, which has led to the dramatic increase in the price of oil. Kudlow also suggests a higher elastic supply schedule for energy:
The part to which PGL refers is this:
As Dan Yergin, president of Cambridge Energy Research Associates, recently wrote in the Washington Post, rising energy prices today will cause energy supplies to explode tomorrow.
Allow me to make a helpful clarification.
Kudlow's statement, "When the price of energy goes up, demand falls off and supply increases." is the kind of thing I see a lot of as a person who teaches principles of economics. It is a horrible way to say it. Usually, the person saying something like this knows what they are trying to say, but they are easily misunderstood. And in my principles class, I'd tell him to re-write it.
He's obviously talking about long run supply and demand, both of which are more elastic than short run supply and demand. But not every reader will catch that, so at best it sounds awkward. At worst, it sound contradictory since a few sentences later Kudlow says,
The spread of global capitalism to places like China, India, and Eastern Europe is the main cause of the spike in energy prices. It’s a market signal that the new and prospering world economy needs more power. Consequently, this is not a recessionary supply crunch like we had in the 1970s. It’s a growth-oriented demand increase.
Are you dizzy yet? "Demand falls off," and "It's a growth-oriented demand increase." Which is it? Well, it's both... but with a short run vs. long run distinction.
Examples of this sort of imprecise language in public discource are too numerous to mention... and it knows no party lines.
Now, the question of how elastic long run supply might be is another question entirely, one which PGL properly raises. But it would be a lot easier to have that discussion (and Kudlow's readers would be better served) if the good economic terminology (principles level is all I ask) were used.
Mark Thoma piles on about the monetary policy aspect of Kudlow's column.
Posted by William Polley at August 26, 2005 9:05 PM
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Comments
To be fair to Kudlow, I think he has the market model right - sort of (the long-run large elasticity claim is questionable). You kindly note Kudlow's error is writing skills that a lot of economists often fall into. Bill - great post (as usual)!
Posted by: pgl at August 26, 2005 11:06 PM