AboutWarren D. Miller, CFA, ASA, CPA Expertise My in-depth knowledge of economics is confined to three sub-disciplines: Austrian economics, industrial organization, and evolutionary economics. Other questions dealing with macroeconomics, the traditional neoclassical paradigm, labor economics, environmental economics, agricultural economics, health economics, and so on should go to those who have the appropriate expertise.
N.B.: I DO NOT ANSWER QUESTIONS MARKED 'PRIVATE' because I believe that knowledge should be shared, not hoarded. I also believe that such questions are likely to come those trying to cheat. Similarly, as one who was a full-time academic for half a decade, I can recognize test and homework questions several time zones away. Therefore, please do not demean yourself by submitting such questions to me. Those who do so are cheating, pure and simple, and I WILL call you out publicly if I believe you are doing so. I have a zero-tolerance policy where cheating and dishonesty are concerned.
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Finally, please DO NOT ask for investment advice. I am not licensed to provide such advice. If you want such advice, check with your financial planner or other financial adviser.
Experience I work with Austrian economics (which is different in major respects from the traditional neoclassical model), industrial organization (which is about industry structure, conduct, and performance), and evolutionary economics (almost, but not quite, the economic analog of its biological counterpart) everyday in my work. I appraise closely-held businesses, provide exit-planning services, and offer high-level strategic analysis, advice, and clients to CEOs and owners of mid-sized businesses. Understanding, applying, and writing about these disciplines is an essential part of how I have made my living since 1993.
Organizations CFA Institute, Strategic Management Society, American Society of Appraisers, Institute of Management Accountants, Academy of Management, Culver Legion
Publications CFA Magazine, Strategic Finance, Valuation Strategies, Value Examiner, Journal of Advanced Property Economics, Harvard Business Review, American Fly Fisher, CFA Digest, CPA Expert, and Business Valuation Review, among others
Education/Credentials MBA - Oklahoma State (1991)
BBA - U. of Oklahoma (1975)
Chartered Financial Analyst designation (2006)
Accredited Senior Appraiser (2006)
Certified Management Accountant (1992)
Certified Public Accountant (1992)
Question Dear Warren,
Thank you for your kind reply. I asked you two questions ago which are as follows.
1. I want to know more about Inflation. When there is increase in Inflation things get costly and consumer`s purchasing power decreases. People spend less money. But what is effect on companies? Does companies decrease there supply to meet less demand of consumers or companies decrease profit margin and sell cheap to keep same supply? I think it would be different from industry to industry but can you give idea about effect of inflation on competitive market, monopoly market and oligopoly market. Or major effect of inflation on type of products - basic products or living, leisure products, etc. Or in the way you think best explains effects of inflation.
2. I read article about Oil on BBC which says that there is no precise assumption about demand and supply of Oil. How much can be produced and how much will be the demand. Oil is not a free market. Price of oil is decided by organisation of few oil producing countries. But moreover prices of oil are affected by different global issues and speculators. Yesterday Inflation of India was 11%. Oil prices have effected Inflation allover. Increase in oil prices have put cut in profit margins in aviatoin industry and other such industries. What I want to know is how increase in oil prices effect oil producing companies. For example some oil producing companies stocks went down approximately 5-6% yesterday in India. When oil prices have increased it is benefit for oil company then why its stock prices went down. I would like to know what is effect of increased oil price on profit margin of oil companies.
I will be glad if you give reply of one excellent answer instead of two mediocre answers. I appriciate your response and will difenately reward you for your answer.
Regards,
PARIMAL
Answer Dear Parimal--
Thank you for the clarification, and thank you for using AllExperts.com. I appreciate the fact that you recognize you have raised two important, but very complicated, questions. Economics is about scarcity, and the scarce resource at my end of this conversation is time.
Before I respond to your second question, I want to address the issue of inflation. By themselves, rising prices are NOT a definition of inflation. Instead, inflation is the loss in purchasing power of a unit of currency (e.g., a dollar, a rupee, a euro, etc.). The fact that energy prices have shot up in the last couple of years is not, in and of itself, an indication of inflation. Over any span of time, prices for some goods and services are rising, and for other goods and services, prices are falling. It is through the rise and fall of prices that an economy adapts itself to changes in supply and demand. To say that high energy prices constitute inflation is to say that high waves cause a rising tide. Neither of those is true. Inflation is an across-the-board increase in prices for goods and services.
Before leaving this subject, let's also understand that there are beneficiaries of inflation. Who might they be? Well, the biggest single group of beneficiaries is debtors. That is, those who have borrowed money and are repaying it at a fixed rate of interest. In essence, they are repaying their obligations with "cheaper" dollars. Governments also tend to benefit from inflation because they seldom have their tax tables indexed for changes in the overall price level.
Conversely, who loses? The largest group of losers is those who live on fixed incomes, whether from pensions, bond income, or other fixed and unadjustable sources.
Finally, what is the biggest cause of inflation? Economists generally agree that expanding the money supply faster than the rate of growth in the economy as a whole is what causes inflation. In essence, more dollars (in the U.S.) chase relatively fewer goods and services, and that causes prices in those goods and services to rise. THAT, Parimal, is inflation.
Now, let me respond in more detail to your questions about oil. First, let me disagree with your statement, "Oil is not a free market." I'll grant you that oil is not as free a market as most of us wish that it were. But, as we have seen in the meteoric rise in oil prices over the last 18 months, not even OPEC (the acronym for the Organization of Petroleum Exporting Countries) can control the price of oil. OPEC is a cartel - that is, its member countries DO collude and agree on how much oil each country is going to produce. Of course, enforcing those production agreements is very difficult for a cartel because one barrel of oil looks like every other barrel of oil, and oil doesn't come with a tag that says where it came from. So poorer OPEC members tend to exceed their production limits. Even so, energy prices continue to rise. Why?
The biggest single reason is sky-high economic growth in two countries that, between them, account for almost 40% of the population of our planet: India (1 billion people) and China (over 1.3 billion people). Those countries are experiencing economic growth in the 8-10% range. In the U.S., by contrast, economic growth in the last 12 months has been an anemic 1%. The balance of supply in and demand for oil, which has been very precarious in recent years, has been tilted towards the demand side. That is, increases in demand for oil are outstripping increases in the supply of oil. That alone will cause an increase in oil prices as well as substitutes for oil, including natural gas and coal.
A second reason for the increase in oil prices is that those prices are expressed in U.S. dollars (USD). In general, the purchasing power of the USD has DEcreased in the last 18 months. Therefore, the prices of commodities that are denominated in USD must rise, too.
A third reason for higher oil prices is that, in the U.S. especially, environmentalists and other groups have managed to block oil exploration in some of the most productive areas of our country: offshore (from Florida and California, especially) and the Arctic National Wildlife Refuse (ANWR, pronounced "An-war"). There is currently a federal law on the books that forbids U.S. companies from drilling offshore from any state that has a law that prohibits such drilling. The two states with large offshore oil reserves where exploration is not allowed are Florida and California. However, as gasoline prices now top $4/gallon in most parts of the U.S., the people in Florida and California are changing their minds; polls in both states now show majorities in each now supporting offshore drilling.
A fourth reason for higher oil prices is that, back in 1995, then-President Bill Clinton vetoed legislation passed by both houses of Congress opening up ANWR for oil exploration. The amazing thing about all the fuss about ANWR is that the "footprint" of the drilling area there is smaller than Dulles Airport near Washington, D.C. It's not as if oil is going to be soaking up the entire Arctic Circle.
A fifth reason for higher gasoline prices, at least in the U.S., is that not a single new refinery has been built here since 1978. And, in the 30 years since then, the population of the U.S. has increased by over 65 million people (27%). Nearly 80% of the increase is in "urban" (city) areas. And, of course, a significant portion of our increase in population has come from illegal immigrants.
A sixth reason for higher gasoline prices is that, in some major countries of the world, the price of gasoline is subsidized. That is, it is held down by order of the governments in such countries as Iran, China, and Saudi Arabia, where it is sold "below market." Of course, an artificially low price stimulates additional demand for what is being subsidized, so those countries, ESPECIALLY China, end up consuming notably more gasoline, which drives oil prices higher still.
Obviously, industries for which oil or its byproducts, including gasoline, are major inputs suffer disruptions in their cost structures. In the U.S., nowhere is that more evident than the U.S. airline industry. Jet fuel is a major input, yet airlines in this country have been mostly too poor to hedge even a part of their fuel costs in futures markets. Higher gasoline prices have a ripple effect that echoes throughout our economy--in agriculture, in all types of transportation, and in the price of groceries (because they have to be trucked from where they are grown to food-processing facilities and then to food warehouses around the country).
As the price of oil has increased, so has the cost of oil exploration. Drilling companies can "do the math" - that is, they can figure out how much oil output a new well is likely to produce over its lifetime and then price accordingly. It doesn't help that, in the last downturn in the oil industry in the U.S., a number of oil companies went out of business, while others just merged with bigger industry players.
The prices of oil-company stocks are a function, first, of supply and demand for a company's stock and, second, of analysts' expectations of the present value of future dividends to be paid on shares of stock outstanding and of the expected future movement (and magnitude thereof) in the price of the underlying (stock). Reasonable people can and will disagree about both of these issues. That's why markets are so useful.
Oil-producing countries which are "net exporters"--that is, they don't consume every barrel of oil they produce--have more money than they know what to do with. That is why there are construction booms in major OPEC members, including Saudi Arabia, Dubai, and Kuwait. These countries' investors are also buying the stocks of U.S. companies in the open market.
Higher oil prices generally increase the gross, operating, and net income margins of oil companies. However, to fully understand those margins, be sure to read the footnotes to the annual audited financial statements of those companies. Margins, remember, are a function of accounting principles and can change easily.
That's my long-winded response, Parimal. I hope you found it helpful. Please fill out the 'rate the expert' email you'll be receiving shortly after this one. Please be candid in your ratings of me - that will help me do a better job of helping folks like you.
