Amid all of today's economic turmoil, we economists have been handed what is essentially a laboratory experiment. Specifically, we've been given a rare chance to observe how consumers and businesses respond to rapidly rising energy prices.

Experts of all stripes generally perceived American businesses and consumers as some monolithic beast that would never change its energy consumption regardless of how high prices climbed. Of course, unless you've been hiding under a rock, the current era of $130+/barrel crude oil and $4+/gallon gas has shown that to be wrong. Indeed, the price signal is a very powerful mechanism. Even when you're dealing with energy or other goods where supply and demand tend to be price inelastic, a point will be reached where something has to give and behavior changes or technology shifts to the point that newer or better ways of doing things are discovered. In essence, prices act to ration goods and services to where they have their greatest value.

Check the news and you will see plenty of examples. Outsourcing of manufacturing activity was thought to be an unstoppable force, but this article (subscription required) suggests soaring transportation costs are slowing this trend down a bit. American consumers are even showing signs of becoming more 'European' as mass transit ridership hit a 50-year high, gasoline demand is falling and purchases of fuel-efficient autos are on the rise (while SUV sales plummet). Automakers have taken their cue and many are ramping up production of fuel-efficient platforms (see here for an example). On the supply side, high prices have also opened the door for alternative ways of extracting oil that were once highly unprofitable.

Overall, watching the news or reading the newspaper might give you get the sense that the sky is falling. As this article points out, despite a weak dollar, high gas prices and tight credit markets, turning back the clock to an earlier time will not magically increase your standard of living-in fact, you will probably we worse off.


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