Speculation Tends to Smooth Prices over Time and Increase Welfare The top panel shows the price of oil, oil consumption, and oil production in an economy without speculation. In the panel on the left, Today, the equilibrium is at point a, the price is low, and oil consumption and production are high. In the panel on the right, Future, the price of oil is high because the disruption has reduced the production of oil. Since no oil was stored from the previous period, the consumption of oil is also reduced.
The bottom panel shows what happens with speculation. In the left panel, oil speculators buy oil and put it into storage, pushing up the price of oil and reducing consumption today—thus, the equilibrium shifts from point a to point c. In the future when the price of oil is high (at point b), speculators sell their oil from storage. The oil flowing out of storage pushes the price down and allows people to consume more oil even though production is low.
The value of oil to consumers (in blue) falls today when oil is put into storage, but rises by an even larger amount in the future when oil is in short supply and speculators move their stocks out of storage.
The bottom panel shows what happens with speculation. In the left panel, oil speculators buy oil and put it into storage, pushing up the price of oil and reducing consumption today—thus, the equilibrium shifts from point a to point c. In the future when the price of oil is high (at point b), speculators sell their oil from storage. The oil flowing out of storage pushes the price down and allows people to consume more oil even though production is low.
The value of oil to consumers (in blue) falls today when oil is put into storage, but rises by an even larger amount in the future when oil is in short supply and speculators move their stocks out of storage.