Saturday, September 17, 2011

The paradox of the economic impact of rising production costs

In my previous post I claimed that the impact of Peak Oil arose from the change of production cost of oil, rather than the change in price. I still think that is correct. However the detail of how it was expressed was wrong.
In the case where the price rises with no production change, there is just a transfer of money and consumption from buyers to sellers with no net economic change. But then I said that when there is a change of production cost then the extra cost of production disappears out of the economy. That is clearly wrong. Money flows to the producers, but instead of flowing on to consumer purchases it flows on to production expenses, like oil rigs and oil workers. But in so far as it flows to more oil workers it is no different to when it flowed to the owners of the oil resevoir. Similarly when it flows to the workers and owners making oil rigs.
Either way the money flows through the oil production process. So what difference does it make to the economy whether it flows through to owner consumption, or it flows through to production costs?
Obviously I think it does make a big difference, though not in the simplistic terms of the previous post. My intuition is that it flows through with more resistance when it flows through to production costs instead of owner consumption.
So my challenge to economic theorists is to find a way of talking about the economics of resource, and particularly energy, production and use, that correctly explains the impact of rising production costs on the economy. If it is only comprehensible to mathematicians that will be better than nothing, but bonus marks will be awarded if it is comprehensible to politicians and voters (and me).