A few months I argued with a friend (guess who) about oil’s rapid rise to $147 a barrel. He said demand from India and China was causing the price increase, I said a speculative bubble. Now that the price has dropped to $61 a barrel, I’d say the bubble has popped and we are now approaching the actual value of petroleum. An investment banker friend of mine confirmed my suspicions during a discussion of the price elasticity of gasoline. When asked about the cause of the recent rise and fall in the price of gasoline he answered:  

Speculation. Prices became detached from supply and demand fundamentals. The “invisible hand” pushed prices back down to equal the new lower demand. The lowered demand though is indeed a function of lowered quantity demand (def some endogeneity), which was itself a function of higher prices, and the higher price was really a function of the commodity markets, which had become disconnected from s&d and was being pushed up by speculators and the persistent supply-side fears. So there was stable supply but demand was driven by higher prices than what the equilibrium would have predicted. Quant. Supply > quant. Demand caused prices to go down. It’s been awhile since we’ve seen demand-side pulls have an effect. Take away is that because consumers weren’t 0% inelastic, supply and demand reached a new equilibrium that resulted in lowered prices. If we were 0% elastic, than even if there was a disconnect from s&d equilibrium, we’d still demand the same amount. We didn’t witness that. People stopped driving.   

(Note: this is Zoe’s boyfriend, and he sounds like a textbook)

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