[phaster]

I've been looking at an analog of "peak oil" the drought here in the west (california) and in southeast (georgia), to see if I could build a computer game and I've run into a brick wall of sorts (basically no formal education in economics).

I started off by thinking of the problem of peak oil as an supply/demand imbalance. Next I noted droughts are not a purely a physical phenomenon that can be defined by the weather. Rather, at its most essential level, drought is defined by the delicate balance between water supply and demand. Whenever human demands for water exceed the natural availability of water, the result is drought.

I've noticed in the news that as low as water supplies are in the Georgia area it has been business as usual (in that water still runs out of a tap), but I'll bet that if/when the water taps run dry there will be a non linear response.

In other words water which only costs a few pennies a liter if even that, is leveraged many times over to create products that can be sold for an order of magnitude more. Coke for example might have to shut down production lines, which is a bad thing for the local economy. There is also a cascading effect, for example if Coke based in Georgia cannot make the syrup because its plant had to shut down, this could have an adverse effect on global production.

In general I'm betting the economic pie shrinks dramatically when a basic building block (such as water or oil) of an economy suddenly becomes hard to obtain.

I'm thinking a vulture investor would be able to make lots of money shorting stocks (like coke) located in the area that is experiencing shortages. But I'm thinking the money made in the stock or commodity market is orders of magnitude less than the money created by an economy that is operating normally, producing products for sale to a global market.

As it stands, even with supplies of water running low, the market here in the west and in the south east has not re-priced water to reflect its scarcity. From what I understand of economic theory, if water were more expensive then two things would happen: demand would go down and the water that was being used would be used much more efficently. I also think if the market set the price for water to refect its scarcity, then the water crisis would not be as big a problem.

So my first economic questions are: does this train of thought have any holes in its logic? Second what would you conside the best way to distribute the remaining water? Would you introduce a system of rationing system? Would you try and reprice water to reflect its scarcity, with something like a consumption tax? Or do you have another alternative that I have not mentioned.

PART II

From what I’ve seen of traditional economic models, they assume there are no boundary conditions or upper limits. In other words if the cost of a product is lowered, traditional economics suggest that demand for that product would go up until the market is saturated.

Let's look at popular product like the iPod for example.

When Apple makes an iPod they can produce every single component in their iProduct: from the small LCD screen, to the RAM chips and they could put everything in an injected plastic case. Since Apple can make every single component in an iPod, the market would expand the market until it is saturated. In other words, every single person on the planet earth all 6 billion plus of us would have the opportunity to buy an iPod, because traditional economic models suggest that as more iPods are made the cost would go down.

My second set of economic questions revolve around the the idea of limits, as in a limit found in basic calculus. Does the idea of a limit exist in economics?

What I'm thinking about might be better illustrated if I continue on with the iPod example.

Lets suppose, LCD screen were a non-renewable natural resource and suppose there were only 100 million of them on the planet. In this case Apple would be a happy company and the stock price would corresponding go up, while there was an a supply of LCD screens they could get their get hands on. As time moves forward the limited supply of LCD screens would get used up, while at the same time more people would become aware of the iPod and want to own one. Starting to get the point, as demand for the iPod grows there would be a limit of 100 million iProducts that Apple or any other company could built.

When the 100th million iProduct was built, a person lucky enough to have an existing iPod would be able to sell it for more than they paid for it (this is because it is now a rare item that has a demand and economics tells us when supply goes down, the price goes up). At this time anyone with an iProduct would also have to guard it carefully because some young punk or a street gang might want to steal it. As for the company, after they built and sold the 100th million iProduct, the price of Apple stock would tank because they no longer could build and sell any iProduct with an LCD screen. If Apple or any other company could not find a replacement for an LCD screen, those companies would cease to exist...

Business or economics as usual to me means people assume that we have a limitless supply of basic stuff like water and oil.

What few people seem to appreciate is something the Apollo astronauts saw when they looked down on the planet earth from space.

A person looking down from the void of space would see a planet and would realize that there are limits, huge as they may be, on natural resources. While a person standing on the surface of the earth might be fooled into thinking natural resources are limitless because that is all they can see.

I understand a big business player such as the oil or the auto industry, has a vested interest in keeping up their economic advantage. But a big business player trying to keep their economic advantage, forces an unsustainable economic equilibrium point and this in my mind creates an economic bubble which in the long run is not sustainable.

From what I've been reading there is a long history of economic bubbles that eventually pop: the from the "Tulip and Bulb Craze" from 1634 to 1637 in Holland to the latest subprime real estate bubble that went on from 2002 to 2006 in the United States and in many other parts of the world.

I'm thinking just like an economic bubble if we ignore the natural resource demand imbalance for too long, there eventually will be pop (or put another way, bad shit will happen to lots of people).

So how do you model something with a limit in economics? What economic steps would you take to try and prevent a drought? I'm guessing observations of what happens in a drought model have some relevance needed to address problems associated with peak oil.

[Andrew_S]

$this->bbcode_second_pass_quote('phaster', '
')I'm thinking just like an economic bubble if we ignore the natural resource demand imbalance for too long, there eventually will be pop (or put another way, bad shit will happen to lots of people).

So how do you model something with a limit in economics? What economic steps would you take to try and prevent a drought? I'm guessing observations of what happens in a drought model have some relevance needed to address problems associated with peak oil.

[mattduke]

Economics is a social science. You can't model it.

[MrBill]

phaster you are biting off more than you can chew. The bigger and more complicated the model the more 'assumptions' the modeler has to make. Every one of those assumptions adds to the uncertainty of the outcome. Especially as individual decisions form a matrix with feedback loops that are both predictable and unpredictable. Simple models hold all other variables constant and then change one variable to predict the outcome. That is not possible in a fluid economy.

Start readin The Economist cover to cover every week. They often cover such topics as you mentioned in your pre-amble. Like drought. There was a recent article on drought in the USA last week.

Gripped by drought, America's West is rethinking how it uses water

Basically, like any necessity in limited supply, you ration water use (demand) by making it more expensive. As the article states the vast majority of water used in the southern states goes towards agriculture and not residential use. Urbanites spend many times more per unit of water than farmers. This leads to waste when crops like rice are grown where they do not need to be grown.

As water becomes more expensive then it also increases the incentive to save or conserve water by, for example, not watering golf courses in the middle of the afternoon or changing from flood irrigation to drip fed plant irrigation systems. Those systems cost money, so the price of water has to be high enough to justify that investment. Also lining irrigation cannels and fixing leaks save water.

As for your iPod example there are goods that act as substitutes that limits unlimited demand for any one product. Especially as an iPod, unlike water, is not an essential good. Also, the law of diminishing returns and consumer preference tends to ration demand as discretionary spending can be split amoung many perceived needs that outweigh buying an iPod. A complimentary good like music supports demand for iPods, but also has to compete with substitutes such as movies and other forms of entertainment.

Micro-economics tries to explain simple economic choices like the decision whether or not to buy an iPod. Whereas macro-economics tries to explain entire economies and how they interact with one another through exchange rates for example. There has never been one grand unifying theory to explain everything.

Economics is not a social science any more than the study of medicine is a social science. Although the medical practioner can gather data on the patient and make a diagnosis (or prediction) based on that information the outcome is always uncertain. And certainly doctors can disagree not only about the diagnosis, but also on how to treat the patient even if they do agree on the diagnosis.

We usually make economic assumptions based on X or Y happening and then assign a likely probability to such an outcome. If X & Y happen, and then Z as well, then it generates a new outcome. Like predicting growth in 2008 assuming there is or is there is no economic recession in the USA, and then throwing in a worldwide avian influenza epidemic for good measures. Clearly you get one result is you assume recession or no recession, and a third result if you assume a low probability, but high impact event such a bird flu pandemic.

Understanding the economic implications of financial decisions is the first step to modeling them. But as always, I will end with a caveat.

Supply is not unlimited. Supply is limited. Therefore, price rations demand. High prices can only bring new supply into the market in so far as there is physical supply to be had. Money is not a substitute for physical supply. We have always lived on a finite planet. Fortunately, many of the inputs we need to survive are renewable. However, that does not mean we can use those resources faster than we can replace them. That is unsustainable. We are using some resources in an unsustainable manner. That means that no matter how high prices go that we may run out of them or find readily usable supply is less than potential demand. And so it goes! ; - )

[phaster]

$this->bbcode_second_pass_quote('MrBill', 'p')haster you are biting off more than you can chew. ...

Micro-economics tries to explain simple economic choices like the decision whether or not to buy an iPod. Whereas macro-economics tries to explain entire economies and how they interact with one another through exchange rates for example. There has never been one grand unifying theory to explain everything.

[MrBill]

I liked that piece on Abu Dhabi. Good foresight. Let's see what becomes of it? At least they have German partners! ; - )

[Kingcoal]

The way I look at Peak Oil is as a social problem. For example, if you travel back in time and snatch a typical 18th century farm family and transplant them into modern rural America, they would hardly notice the detrimental effects of running out of oil. They don't use electricity, they grow their own food, they chop their own wood for heat, etc. One thing they would notice is the hoards of free loaders looting their resources. The problem isn't running out of oil, it's our personal dependency on it. We've used oil as a panacea to satisfy huge legions of relatively useless people. As oil runs out, the uselessness and parasitic nature of those people becomes very apparent.

You have to understand that the modern worldwide economy is basically just a huge jobs program. We use cheap energy to create and support those jobs. Keep a person employed and they won't have time to sit around thinking about rioting and whatnot.

[MrBill]

Exactly, Kingcoal. The global economy has expanded to include a lot of surplus labor, but they are not needed. However, they will be a social problem once that global economy starts to contract. You can turn a tractor off and park it in the barn until you need it again. People you have to kept fed and watered whether they're producing anything of value or not. Talk about a negative EROEI! ; - )

[Egomancer]

Another thing that I think that should be mentioned is the fact that like 15% of the workforce can provide the basics for the living of the entire population.

In other words, the world would be just fine with let's say 33% of the population and the drop of 66% won't dramatically alter the standard of living.

Egomancer

[MrBill]

$this->bbcode_second_pass_quote('Egomancer', 'A')nother thing that I think that should be mentioned is the fact that like 15% of the workforce can provide the basics for the living of the entire population.

In other words, the world would be just fine with let's say 33% of the population and the drop of 66% won't dramatically alter the standard of living.

Egomancer

[Doly]

$this->bbcode_second_pass_quote('MrBill', '
')One of the stupidist stats thrown about here on peak oil dot com is calories of energy used to produce a calorie of food. Nine to one. What we should just ingest petro-carbons? Idiots! Would you consume less calories producing food manually? Huh? I think not!

[MrBill]

And in any case comparing the calorie intake of humans to the calorie content of an external energy source, such as petroleum, is absolutely meaningless.

I am burning 2000 calories a day whether I produce anything or not. So is a junkie!

Also, that transport statistic is simply wrong! We burn more energy going to the local store to buy groceries than the energy needed to ship tightly packed food in containers from farmgate to the supermarket. The supermarket likely uses more energy to heat and cool the store as well as keep the lights on and the refrigerator cold.

Of the $11 per bushel for wheat only about 50 cents goes towards local transport. Another 50 cents a bushel will ship clear across the Continent. And another 50 cents to export it around the world in a ship. Then another to deliver it to a foreign end-user. A total of $1.50 per bushel (ex-local transport) or about 13-14% of the cost of the grain in the first place.

According the Norfolk Southern Railway is takes just one gallon of diesel to move a ton of freight 400 miles. Transport by barge, laker or ocean going vessel is even more fuel efficient. But in A-trains railways can compete with barge freight in volume. That is on a cost basis, not comparing fuel usage.

Naturally, volume and weight make a huge difference in cost as well as fuel consumption. Shipping live cattle is less efficient than shipping tightly packed cut and packaged beef cuts. Alfalfa pellets cost less to ship than hay bails.

So this one to ten fuel to food ratio is a fib. Not to mention it actually measures energy consumption pre-peak oil by definition there is more and more energy, so it is correspondingly a cheap substitute for more expensive inputs of labor. If something is cheap then we use more of it as an input. When it gets more expensive, or scarcer, we use correspondingly less.

How many farmers use 4-wheel drive trucks to just run into town to pick-up a pack of cigarettes? Is that a cost of production? Does that energy get measured in this type of analysis? How many times have we just let the tractor run because it is a hassle to warm it up each time when it is cold outside? Ditto for refrigerated tractor-trailers. They run all night long just to keep the vegetables cool. Is that energy efficient?

There is a role for locally produced food, but realistically there are energy gains to be had elsewhere in the supply chain. Including buying food that is already preserved versus everyone using energy to prepare canned goods at home or bake their own bread. Those are nice skills to know. They do not save energy! ; - )

[LoneSnark]

Hi phaster!

I have not read all of what Mr Bill said, so I may be repeating information.

You gave an example of a finite resource, using iPod LCD screens in your example (only enough X to make 100 million). This is a poor example of a common economic reality. The normal example used is that of beach front property: everyone wants it, but no more can be had.

You probably already know how this market works: a large number of buyers finding a limited number of beachfront houses will bid against each other until the number of houses matches the number of buyers.

So, the question is, if you are a company and you own all the beach-front property, what should you do? Obviously you should not sell all you can, as it is not yet a status symbol to live on the beach. This makes demand vary upward with time, and as a monopoly you should adjust your behavior to maximize your own benefit. As such, what you should do is try and lie: convince buyers that the little bit of property you are selling this year is all there will ever be. Using government to temporarily lock up your own property would be useful, as it tends to be convincing without being binding.

Therefore, as time passes your descendants will always have property available for sale, while at the same time appearing to your customers that the property currently for sale is all there ever will be. Of course, this is a century old economics debate, as customers are not stupid and will recognize your behavior and respond accordingly. As such, a cat and mouse game ensues, with uncertain ultimate results.

[bonehead]

Here's one they won't teach you in school,one percent of the world's population holds eighty percent of it's wealth.I don't see too much "trickle down" economics going on.

[LoneSnark]

trickle down was a political theory, not an economic one.

Most economists accept that it works in the opposite direction: when investors invest it creates jobs today, flooding cash and prosperity from the richer towards the poorer immediately, while returns for the investment trickle back to the investors slowly over time.