Case Studies
California’s Thirst for Water
 In 1974, water was cheap. But, 1975 marked the beginning of one of the worst droughts in California’s history. It’s a semi-arid state with the gigantic agriculture industry dependent on water from its northern snow-pack and winter rains. But in the fall and winter of 1975, the relief of seasonal winter rains and snow did not come. Accustomed to "dry-spells", Californians showed little concern. But that winter wore on with no rain or snow, and soon what was great weather for some began to cause problems for others.
The summer of ’76 exploded into flames as over 1,400 fires swept the state.
Marin County was particularly hard hit by the drought. It was one of the first areas forced to begin rationing water and people were penalized if they used more than their allotted amount. Rising to the challenge, Marin residents reduced their water consumption by 66%. As the drought continued, Marin County saw more and more evidence of just how valuable water was. Besides being motivated to conserve, Marin residents were also willing to spend a lot more money…and make a long term commitment so they wouldn’t be as vulnerable again. There were costly bond issues proving that people were willing to pay a high price for water, so they wouldn’t have to deal with drought again.
Torrential rains in the final days of 1977 marked the end of this drought. But six years later, with memories fading and plenty of water at hand, consumption slowly climbed back to where it had been.
| Comment & Analysis by Richard Gill One thing the Marin County experience clearly brought out was that when you have a shortage of a commodity like water, you get very careful about how you use it. When you have very little of a commodity, an additional unit of it will bring you more added satisfaction…more marginal utility, than if you had an abundant supply. The principle expressed here is called the "Law of Diminishing Marginal Utility". It explains why we’re willing to pay more for a commodity when it’s in short supply and why we’ll pay only a low price for it when it is abundant. |
Producing American Oil
 In response to the 1973 Arab-Israeli War, OPEC put the squeeze on America by quadrupling its prices for oil. So Americans looked to domestic producersto increase the supply. The price of oil which is the critical factor in the incentive to drill had been very stable o through 1971. So as inflation began to accelerate beginning in 1965, it meant that in terms of purchasing power, the real price of oil was declining… therefore there was less incentive for producers to drill, and drilling activity declined to a low point in 1971.
With world prices rising, President Nixon offered the American oil industry an incentive. The price of old oil was fixed, but new oil, found after 1972, was free to follow the higher "world price". By allowing this source of oil to follow the "world price,’ the government encouraged additional oil research and technology.
The new high price for oil, coupled with government decontrol, were the financial carrots needed to lure suppliers back into domestic production. Many of these producers were independents who accounted for 90% of domestic drilling.
With the lure of rising oil prices and profits, oil production almost doubled in America as well as the OPEC countries. As profits soared, more producers decided to pump even more oil. Soon there was a glut. By 1985 the price of oil had plummeted.
| Comment & Analysis by Richard Gill With higher oil prices, American consumers found ways to use less oil. They economized on the more expensive oil, just as in the California drought, they economized on the temporarily expensive water. But the oil episode also tells us a good deal about producer reactions to higher prices. The higher price of oil served as an incentive to search for and produce larger quantities of domestic oil. This search was expensive and risky. It required the promise of higher prices and a higher profit. |
The Blue Jean Revolution
 A fascinating part of our culture is our preoccupation with "fads." …whether it’s "Cabbage-Patch" dolls or "hula-hoop." The blue jeaning of America took place in several stages…and peaked when this almost basic commodity became "high fashion"…designer jeans. Though they were double the price of regular jeans, America bought them in droves.
It was Jordache, through creative advertising that created the demand for designer jeans. Brands were built up with a lot of TV hype and consumers were willing to pay a premium for those reasons.
Jordache’s success caused other designers to jump on the bandwagon…Any designer who had a name was putting his name on the back pocket of a jean. To keep up the momentum, even more money was poured into advertising.
Back in 1965, jeans were bought on the order of less than one pair per capita. Now it had increased to almost three per capita. Soon the market was over saturated. At that point designer jeans lost its status or cachet, and the consumer was no longer willing to pay a premium price for it.
| Comment & Analysis by Richard Gill A great Greek philosopher once summed up the world in the phrase, "All is flux." He could have been talking about the jeans craze, or, for that matter, about the American economy generally. One year, the demand curve for jeans shoots way up.A few years later, people tire of jeans or find substitutes in athletic sportswear and the demand falls back down again. People’s tastes change, their incomes change, the availability of other products changes…All such factors can shift the demand curve for any product and down and back up again. |
|
