The ‘potato cycle’ is a staple (sic) of the economics menu. The first thing, in fact, I was taught on the first day I began as an undergraduate, so, so many years ago. This simple rule uses the demand and supply curves for potatoes to illustrate how negative shocks to short-term supply, for whatever reason, trigger production responses. In the vast majority of cases, this returns the inflated price to what the fundamentals of the good’s production functions determine it should be.
What the potato model shows is that, for the most part, an upwards shock to the price of a fungible/commoditised good – of which the potato is a mere generic example – triggers a supply response. This positive supply response reverts the price back to its fundamentally determined level. And, to be clear, the model predicts that in almost all cases where supply is responsive, this price reversion is to the marginal cost of production. Straightforward stuff indeed. And yet, as simple as this model is, we have failed to employ it where it is perfectly sensible to do so, in a market which has recently seen a short-term negative supply shock, the energy sector. Indeed, any economist who denies the global energy market is competitive is far from competent.
The reality is that the near-term energy price shock we have suffered in the aftermath of events in Ukraine has set off a train of supply events, which will inevitably and quickly send the price of oil and gas – in dollar’s – back to its marginal cost of supply (and so too most other commodities).