The Power of Price

By David Frum
AEI

In this week of financial panic, we can already begin to see hope for economic recovery.

In trading Friday, the price of oil fell below US$65 a barrel, down from US$145 only four months ago. This dramatic price collapse will act like a massive global tax cut. Along with the huge monetary stimulus delivered by the U. S. Federal Reserve and other central banks over the past few weeks, it should jolt the world's major economies back to health over the coming months.

People got the oil market wrong because they assume oil is immune to market discipline. It's not.

The only thing surprising about this price collapse is that anybody could be surprised. Some forecasters asserted that because oil had gone from $50 to $100, it must therefore double again to $200. These must be the same forecasters who predicted that because a detached house in suburban Las Vegas had doubled in price between 2003 and 2007, it must therefore double again between 2007 and 2011.

The price of oil is declining for the same reason it always does: Econ 101. If the price of something rises, consumers demand less and producers supply more. With falling demand and rising supply, price declines. When people use less, supplies increase. It happens so regularly, you might almost think it was a law or something! READ MORE.