Does An Increase in Supply Lead to Higher Prices
By David Henderson
Last week, I received an e-mail from the son of a friend of mine. The son is a student at a school in the Northeast. Here’s the relevant part of the e-mail:
I took a globalization class this past semester and didn’t agree with my teacher all the time. The semester’s over, but there’s a question over which we’ve been emailing back and forth. If you don’t mind, I would like to hear your answer.
“Why is it profitable for Saudi Arabia that Canada extracts oil from its tar sands?”
I’ve been arguing that it’s not. Here’s why: Canada’s production will raise global supply. Since supply is independent of demand, with demand unchanged and supply increased the world price should decrease. Therefore Saudi Arabian oil production would be less profitable.
My teacher, however, believes that because Canadian production is more expensive, the world price will increase. I don’t think this is true, because Canada will only produce if their cost is below the world price. Just because they produce oil doesn’t mean that anyone has to buy it.
Here was my answer:
You nailed it. Your teacher got it wrong. He/she is confused. I’ll call your teacher “he” or “him” from now on. He starts by looking at the fact that Canadian production is more expensive than Saudi production. That’s true. My guess is that he then forgets the context and is implicitly thinking that Canadian production was cheaper and now has become more expensive. If that were right, his bottom line would be correct because the now-more-expensive Canadian oil means that the supply curve of Canadian oil has shifted to the left and, therefore, the world supply curve has shifted to the left, raising the world price and benefitting the Saudis.
But that’s not at all what happened. Instead, new technology INCREASED the supply of oil from Canada, increasing the world supply and driving down the world price, if only slightly.
I then asked my young friend whether the teacher was an economist and whether I could post about it. His answer:
Because this is a basic example of supply and demand, I’m sure glad I wasn’t missing something. And yes, you may blog about it.
I just looked up my teacher’s background. Her Ph.D. is in computer science. I think it may be a good idea if I research more about teachers before I take their classes. But it does raise the question, why is she an economics and not computer science professor?
By the way, I’ve used your encyclopedia quite frequently. Its articles are terrific. It’s certainly one of my most-read books.