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Markets Are Forward Looking (And That’s Good)

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Here’s an e-mail to a promising young freshman in my principles of microeconomics class at GMU.

Unknown
………

Dear Mr. ____:

You ask why gasoline prices are already starting to rise even though all of the gasoline that motorists buy today was refined from lower-priced crude oil that refiners purchased before the recent rise in crude-oil prices.  Great question.

One part of the explanation is that gasoline refiners are likely now switching to the production of summer-grade mixes, which are more costly to produce than are winter grades.  But even if such switching is not taking place, we nevertheless expect prices at the pump to rise the moment crude-oil prices start to rise regardless of the prices that gasoline retailers paid for the fuels that they are currently selling.  Furthermore, it’s good that prices at the pump rise as soon as crude-oil prices start to rise.

The reason – as we discussed in class – is that markets are forward looking.  If crude-oil prices start to rise today, this fact means that crude oil is today more scarce, relative to anticipated demand, than it was yesterday.  Given this reality, we want consumers to start immediately to economize further on their use of gasoline, and we want refiners to have adequate incentives to refine enough gasoline to satisfy consumers’ anticipated future demands.  Rising prices at the pump today promote both of these desirable responses.

But there’s an even deeper point: the value of something is not what the owner of that something paid for it or what it cost the producer of that something to produce it.  Instead, the value of something is what people are willing to pay for it.  And there’s nothing at all unfair or economically harmful about an owner of something selling that something for more than he or she paid for it.  Suppose that today you buy 10 shares of Apple, Inc., at $100 per share.  Further suppose that one year from today the price of Apple stock rises to $150 a share.  Would you be wrong or unethical to sell your shares next year at $150 a share (or at any price higher than $100 a share)?  After all, you paid only $100 a share to get them.

Of course you would not be wrong to sell your shares at a price higher than what you paid for them.  What’s true for you and your Apple shares is true for all economic goods.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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