Channon

Top Stocks to Buy in 2009

On Jan 23 02:00 PM BMW62009 wrote:
>
> oversupply leads to a cut in supply, that
> eventually leads to a rise in demand b/c of no more production, that
> leads to a rise in price.
>
> Am I wrong?

Keynesian or Classical, a cut in supply does not lead to a rise in demand. Says Law that "demand is a function of supply" is largely discredited. Generally, supply and demand are two different curves. A cut in supply (shifts the demand curve) will increase price, for most given demand curves.

Generally speaking and within normal ranges, demand is independent of supply. There will be cases where this fails: a concern over falling supply sparks investment demand and/or hoarding. At the other end, an inconsistent supply may reduce demand as substitutes are found. But, in your explanation above, just say "a cut in supply should lead to a rise in price."

Getting to your true question, your logic excludes "game theory" considerations; individual producers have incentives to cheat, and asymmetric information, etc. These real-world realities (that game theory tries to model) lead to real failures of the simple supply-demand analysis, and conclusions should be hedged to recognize this.

Right now, the oil supply curve appears to be completely vertical, and a shifting demand curve is moving the market price. Oil producers are receiving less revenue per barrel and are paralyzed at the thought of reducing the number of barrels. Fixed costs are often high, and in the short run it may be more profitable (less losses) to continue production even though the marginal revenue is short of marginal costs. Without looking at oil producers' cost structures, one cannot even say whether these producers are better off with lower volumes and higher prices, or higher volumes and lower prices.

With any luck, the U.S. Government will finally get serious about alternative energy and shift the U.S. demand curve for oil. This will be a long, slow process. But, so might be the economic recovery.