Marginal
What is the importance of marginal cost?
Let's examine this by use of an analogy: Let's say you want to fill a natural basin with water. If you want the level to be high without having to completely fill the basin, you can't do it. Or if you want a certain volume without having so much height (depth), you can't have that either. The volume of water is related to the height (depth) of the water by the shape of the edge of the basin. You could get more height (depth) by building an artificial wall, but all you have done is replace the natural container with an artificial shore. Or maybe you want to get a certain volume without increasing the depth: you could do this by digging out the shore, but again all you have done is artificially changed the shoreline. You are still constrained by the container.
But the price is equally set by the subjective value of the last barrel purchased, too. Not everyone values oil the same, nor does any one person value all barrels the same way. You need a gallon of gas to get to work, and another to get back. Beyond that, you can put your purchase off until tomorrow. Plus, you have other expenses that require your attention, like rent and groceries. At some point, another dollar spent on oil will be of less value to you then a dollar spent on other things. So that first barrel might be worth $60 to you, then the next $45, then $30, $20, $10, $5, $2.50 and so on. You will never spend a penny on the 10th barrel, much less the millionth - for one thing, where will you put them? In this way, you will buy two barrels of oil if the selling price is $30 or less. Note that price acts as the coordinating agent between how many barrels may be produced and purchased: if it rises, more may be produced, but less purchased, and if it falls, more would be purchased, but fewer produced. Hence, price determines the equilibrium point.
Bill: you and other people made those choices on the basis of cheap oil. Oil isn't cheap, anymore. That isn't the fault of oil companies; they haven't been forgoing returns on their investment for dozens of years in the hopes of hooking you and reaping the profits today. You still have oil to burn in your big house and your big road hog, even if you don't like the price. You should just thank them and be on your way. Besides, you call yourself an environmentalist: the high gas prices are a sure way of getting people to change their habits.
Let's examine this by use of an analogy: Let's say you want to fill a natural basin with water. If you want the level to be high without having to completely fill the basin, you can't do it. Or if you want a certain volume without having so much height (depth), you can't have that either. The volume of water is related to the height (depth) of the water by the shape of the edge of the basin. You could get more height (depth) by building an artificial wall, but all you have done is replace the natural container with an artificial shore. Or maybe you want to get a certain volume without increasing the depth: you could do this by digging out the shore, but again all you have done is artificially changed the shoreline. You are still constrained by the container.
In the analogy, water depth and volume substitute for price and quantity. Let's say you are trying to deliver a volume of something like oil. It would be nice if you could fulfill the demand at any given price with $4 oil from Saudi Arabia, but you can't. You have to pump the $10, $20, and $30 oil, too. Couldn't you sell the $4 oil to people who need it but can't afford the other, while selling the $30 oil to people who can afford it? Unfortunately, no. It may be illegal (price fixing), but it's definitely hard to pull off. How do you determine who is whom? Everyone will claim to be the $4 oil buyer, so you have to come up with some other mechanism. And even if you do manage to work it out, some or perhaps even all of the $4 oil buyers will buy their oil, sell it at market rates (above $30), then turn around and try to buy the $10, $20, or $30 oil for their own needs, pocketing the difference. The same thing happens if you try to auction it: consumers will bid the price of the first, middle, and last gallon up to the market rate of $30 or more. You could try to come up with other schemes, but the problem remains the same: the cost of producing the very last barrel will determine the sales price of all barrels sold. The lucky few who own wells that produce $4 oil will reap a larger reward than the poor chap who owns the $30 well.
But the price is equally set by the subjective value of the last barrel purchased, too. Not everyone values oil the same, nor does any one person value all barrels the same way. You need a gallon of gas to get to work, and another to get back. Beyond that, you can put your purchase off until tomorrow. Plus, you have other expenses that require your attention, like rent and groceries. At some point, another dollar spent on oil will be of less value to you then a dollar spent on other things. So that first barrel might be worth $60 to you, then the next $45, then $30, $20, $10, $5, $2.50 and so on. You will never spend a penny on the 10th barrel, much less the millionth - for one thing, where will you put them? In this way, you will buy two barrels of oil if the selling price is $30 or less. Note that price acts as the coordinating agent between how many barrels may be produced and purchased: if it rises, more may be produced, but less purchased, and if it falls, more would be purchased, but fewer produced. Hence, price determines the equilibrium point.
Just as you might want the water level to be high without having to supply a large quantity, the oil producers want oil prices to be high. They may try to construct artificial tanks, but these also have a cost. For example, many oil producers might try to create a restrictive cartel. Each cartel member has a common desire for high prices, but each also has a conflicting desire for larger market share. Therefore, they will all put holes in their tanks and cheat by selling on the side. The system is thus driven back to the original container/shoreline. Or they may want to produce more at the same price level: technology is a way of digging out the shoreline, but it requires R&D investment.
Lately, Bill O'Reilly has been demonstrating how poorly he understands not only the marginal concept, but how many bad economic cliches he can make when bloveating in full populist mode. Last week, he was telling us that they are obviously price fixing because oil only costs $4.50 for the Saudis to pump. That's the low cost oil, but we can't have all of it at that price. Last night, he advocated the "don't pump on Sunday" meme, exploded here. He didn't see how the hurricane in Louisiana has an effect on prices elsewhere, a problem exploded here. He seems to think that oil is different than any other commodity because, "I have to (heat my house, drive my car, etc.)." Have to. Apparently, neither O'Reilly nor the people he is looking out for own sweaters, have the ability to add insulation to their houses, couldn't live closer to work, can't carpool, can't buy smaller vehicles, can't buy smaller houses, couldn't prepay their gas last year, etc.
Bill: you and other people made those choices on the basis of cheap oil. Oil isn't cheap, anymore. That isn't the fault of oil companies; they haven't been forgoing returns on their investment for dozens of years in the hopes of hooking you and reaping the profits today. You still have oil to burn in your big house and your big road hog, even if you don't like the price. You should just thank them and be on your way. Besides, you call yourself an environmentalist: the high gas prices are a sure way of getting people to change their habits.
You know how you can tell if gasoline is still extremely cheap? Look at sales of SUVs. Note how many large vehicles pass you at 65, 75, or even faster on the highway.
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