Why rising income isn’t helping the economy

Rising income may make you temporarily feel better, but that’s about it.

When President Obama took office, the greatest economic problem was soft demand for consumer goods and services. This was due to diminished consumer purchasing power, which existed because prices were moving up faster than incomes. Though mortgage debacles, failing automobile companies and unethical financial houses grabbed the headlines, many folk were savvy enough to recognize the real constraint on economic vitality: Lack of purchasing power.

Weak purchasing power has continued under Obama until recently, when a significant uptick

was noted in the personal income statistic. Wages, salaries and investment income have

shown a somewhat unexpected, upward mobility. This, in and of itself, is great news because

it means a potential purchasing power increase and subsequent advance in consumption.

Increased money in the pocketbook translates into increased demand for goods and services — a right-shifting demand, or “D,” function if you are looking at demand and supply curve graphs.

Much of this increase in demand is for more oil and oil derivatives; therefore, you have a right-

shifting oil demand curve. This lateral transposition coupled with the fact that the oil D-function

is inelastic, or steep (meaning that the quantity of oil demanded is relatively insensitive to

moderate price change due to the fact that there are no real substitutes for oil and oil is a

necessity) creates a problem the economy cannot readily resolve.

Here is the crux of the issue: This inelastic D-function is accelerating east, encountering a

stationary, very inelastic oil supply, or “S” function. The collision means exploding oil prices.

The oil industry can’t ramp up supply quickly in response to advancing demand for oil because of the length of time required to find more oil, finite pumping capacity in the fields, limitations on oil transport volumes and nonflexible refining capacity. The industry can only respond with a slow, minuscule supply increase along the present supply curve, and can only do that at extreme cost. So price is what gives. Our higher incomes are siphoned away by inflation.

Instead of a demand-responsive, right-shifting S-function resulting in more jobs, greater output

and an expanding economy, we get higher prices. This is the problem with oil. It is so central

to our economy but its supply cannot be adjusted rapidly enough to accommodate changes in

demand.

Thus, not only is the sticky-steep oil supply function responsible for inflation, it is simultaneously responsible for retarding economic growth. The administration in Washington shows little appreciation for this as evidenced by its failure to incorporate a priority plan for dealing with the matter in its political platform.

The administration has chosen to blame Bush instead of developing constructive strategy for addressing the real problem. Bush had relatively little to do with our present economic ills other than failing to recognize and address this problem himself.

Unfortunately, the rigid, high-incline, positively sloped oil supply function is going to be around

for a while, having a major negative effect on world economic health. Any present efforts at

substituting other forms of energy are woefully inadequate. Because of the nature of the

industry, competition is not likely to enter the market to keep prices down. We are going to

need more oil, or oil substitutes … and soon.

Obama is operating under at least three major wrong assumptions which will prevent him

from correcting this problem just as his predecessor was not able to (although his predecessor

wasn’t able to for different reasons).

First, Obama has been distracted by the thought of deflation, which many economists were warning about a bit ago, so inflated oil or anything else inflated does not register with him. Indeed, his administration falsely denied inflation existed for two years.

Second, Obama seems to think gas can rise to $5 per gallon (while other prices similarly rise) before it really puts the brakes on the economy. He should know that limited oil supply is putting the brakes on now. And, third, Obama thinks we can have significant economic expansion without oil. He has not internalized the centrality of oil to the world economic state.

We need to elect somebody who understands and gives priority to the oil supply problem if we

want rising income to count and standards of living to rise.

Phil Grant is professor emeritus at Husson University. He is the author of the pioneering book “The Mathematics of Human Motivation” and founder of the Law of Escalating Marginal Sacrifice.