Comparative Advantage: A Natural Gas Dilemma

Aug 17, 2013 • Behavioral Economics, Economic Debates, Economic Growth, Economic Thinkers, Health Care, Households, Innovation, Labor, Uncategorized • 495 Views    No Comments

When the price of natural gas plunged in 2008, manufacturers smiled.

As Dow Chemical’s CEO recently explained, cheaper natural gas means a $4 billion investment in 120 new manufacturing projects. Using cheap gas, Dow plans to build ethylene, propylene, chlorine and herbicide plants. They will be producing the chemicals that mattress, toy, plastic packaging and adhesives makers need.  But, as one Dow officer said, “You know, we can’t do this without affordable natural gas.”

Because affordable US natural gas is more expensive in world markets, producers want to export it. However, selling the gas abroad at a higher price could elevate its price at home. Consequently, Dow says the US government should limit and even prohibit natural gas exports. Disagreeing, a Chevron executive said, “We need enough demand to keep the supply coming. We believe markets work best when there are no artificial constraints or stimulants to supply and demand.”

Hearing the Dow position, 19th century economist David Ricardo would ask us to remember comparative advantage. He would say that because the US produces natural gas with the lower opportunity cost, it should export it to others who sacrifice more when they produce their own energy. Then, world productivity will increase and every nation will benefit. Dow would reply, “But what about the jobs that the US needs now?”

And therein lies the dilemma.

Crossing the supply curve at a higher quantity than the domestic price, the world price creates the incentive to produce more natural gas.

Crossing the supply curve at a higher quantity than the domestic price, the world price creates the incentive to produce more natural gas.

From:

From: EIA

Sources and resources: For more detail on the natural gas dilemma, I recommend this NY Times article. You also might want to look at a recent McKinsey report, an excellent econtalk podcast on Adam Smith, David Ricardo and comparative advantage, and more from econlife on natural gas.

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