The Efficient Market Hypothesis

One of the best real-world explanations for the efficient market hypothesis that I've heard came from a young man who took several courses in our department (and who is well on his way to being a big shot in the investment world):

OK. You are sitting at your computer, on Ameritrade, and you want to beat the market. Meanwhile, in New York, there are 30,000 people who have more experience than you in buying and selling investments. They also have access to information quicker than you do. What makes you think you are smarter than them?

So What is the Problem?

Skip Sauer, my co-blogger over at The Sports Economist has this take on the business of baseball. One of the biggest problems in baseball is the salaries of baseball, right? Wrong:

The story in the LA Times focuses on the steroid issue, which is understandable - thank your congressman for that. But the steroid issue is likely in the sport's rear view mirror. High salaries for workers and rising prices for the product (they are reportedly up 6.3 per cent) reflect a healthy business, with high and growing demand. They are problems any business would like to have.

The demand for any resource is said to be a "derived demand" - it is derived from the product/service made by the resource. When a product/service is in high demand, the demand for its resource will also be in high demand - leading to higher salaries. According to this article in the Chicago Tribune, this year's average baseball player will earn $2.63 million, an increase of almost 6%. That number is skewed because of a few very lucrative contracts (such as Alex Rodriguez's $25.7 million salary). The median salary (the figure with 50% of salaries above it and 50% of salaries below it) this year in baseball went from $800,000 in 2004 to $850,000, a little over 6% - in 2005.

Is this a sign of a worsening problem in baseball? No - it's just the opposite.

Research Subject

Are you a budding researcher who doesn't have access to excellent resources but who has some interesting ideas you'd like to test? What do you use as a research subject?

Yourself!

Will We Ever Run Out of Oil?

From time to time, I tell my students that as long as market forces are allowed to work, the world will likley never run out of oil. I think it's an intriguing question and it gets them thinking about how market forces work. There are four basic reasons, all based on market forces, for why we won't run out of oil. Each is based on the premise that when the supply of known oil reserves start dwindling, the price of oil will increase.

1. High oil prices provides an incentive to people to reduce their consumption of oil.

2. High oil prices give an incentive for oil companies to start extracting oil from places where oil is known to exist but where extracting it is very costly. As a case in point, some small oil companies are drilling in urban neighborhoods in Houston.

3. High oil prices give an incentive for oil companies to start exploring for new sites to drill for oil. From this morning's Wall Street Journal (paid subscription required):

Few U.S. motorists need give a thought to bomb-wielding terrorists in the Caucasus or the rifle-toting Urhobo tribe in the oil-rich delta of Nigeria.

But to national-security planners, diplomats, oil companies and energy planners, they are becoming critical components in the increasingly difficult and risky game of bringing new oil supplies to market. ...

... The oil supplies expected over the next two decades are coming from or moving through some of the least stable and most corrupt areas in the world.

As a result, long-neglected regions such as West Africa are rising in importance to U.S. policy makers. Emerging countries around the Caspian Sea are attracting new attention, too, as is the tense U.S. relationship with Venezuela's leftist government.

4. High oil prices give an incentive for enterpreneurs to develop alternative forms of energy.

The big kicker revolves around information and impediments to market forces (such as regulation). Do we really know exactly how much oil is in the ground? Maybe not, but incentives and technology are there for firms to know as much as they possibly can. Even if we know how much oil is in the ground, regulations may add so much cost to drilling that it makes no sense to drill for it?

Will we ever run out of oil? Likely, the answer is no. Will we ever stop using oil - quite possibly, yes. Of course, if market forces aren't allowed to work, then all bets are off.