Profits and Energy (Caveman Economics 101)


[E]nergy is not life, but a prerequisite for it, and life is insatiable for it.

– Bernd Heinrich, American zoologist, professor, and author

Civilization and profit go hand in hand.

– Calvin Coolidge, American President

In his book Economics on Trial, American economist Mark Skousen defined Economics as, “the study of how individuals transform natural resources into final products and services that people can use.”

Skousen’s definition is problematic for the purposes of this book [Caveman Economics, in process], which proposes to illustrate economic principles by imagining a prehistoric world at the dawn of our species.  For in such a world, natural resources do not yet exist.  Natural materials exist, but they do not become natural resources until they are combined with knowledge.  Such knowledge came only after thousands of years of trial and error—trial and error in a world in which error often resulted in death.

Cavemen were no less intelligent than we are but, unlike us, they did not “stand on the shoulders of giants.”  From our vantage point atop their shoulders, we see them surrounded by natural resources.  But those resources were denied to cavemen because they did not yet know their uses.  We see the sand they walked on as potential glass, but they had no concept of glass and probably no word for sand.  We see wood, dried animal dung, coal from surface seams, and petroleum from natural oil seeps as fuel, but they did not know what fire was, how to kindle it, or what to do with it if they could.

Better for us is the definition of economics proposed by British economist, Lionel Robbins: “The study of the use of scarce resources which have alternative uses.”

A caveman’s chief resources are time and energy.  He also has at his disposal one brain, two hands, two feet, and five senses.  His mind can plan actions, his hands and feet carry them out, and his senses observe the results.  Based on his observations, he can alter his plans and implement changes.  Thus, the caveman, as do all people, lives in an endless cycle of thought, action, evaluation, and adjustment.

Opportunity Costs

Armed with these limited resources alone, our caveman – let’s call him Rok – must provide himself with water, food, clothing, and shelter from predators and the elements.  His time and energy have, in Robbins’ phrase, alternative uses, and he cannot spend too much of them on any one activity.  Were he to concentrate exclusively on gathering food, for example, he might leave himself without shelter, exposed to the elements and to attack by wild animals.

Time and energy spent on one task cannot be spent on another.  Rok “purchases” food, then, not only with his labor, but also with the loss of anything else that might have been obtained with that same labor.  Economists call this loss an “opportunity cost.”  The concept of opportunity cost may seem to be too obvious to be worth stating, much less labeling, yet many fallacies stem from ignoring it.

Economics provides us with tools that, like the concept of opportunity costs, help us analyze the world around us and predict the likely consequences of our actions and those of others.  Many of the tools seem obvious, but economics provides a framework for applying these tools that provides a powerful way of understanding complex behaviors and institutions.

Profits

After a source of water, Rok’s most critical need is food.  All life is dependent on energy, and Rok must consume enough in the form of food to fuel all his thoughts and actions.  Not only does he need enough energy to gather, prepare, eat, and digest his food, he also needs enough to power all his other activities.  In short, he must make a net energy “profit” to survive.

This being so, a critical question is:  How does Rok know when he has made a profit or is running low?  He needs something short of his death to warn him when he should eat more.  Having no knowledge of thermodynamics or even simple arithmetic, he has no hope of performing a net energy balance between Calories expended and Calories consumed. 

Conceivably, he has several indirect means available.  For example, he could use a vine to monitor the growth or shrinkage of his waistline, or he could hang from the vine and note how much it stretches from day to day.  Perhaps he could immerse himself in a pool of water and observe how much the water rises in the pool.

At best, however, such measurements serve only as feeble proxies (or “stand-ins”) for the balance between Calories eaten and Calories burned.  A decrease in waist-size might indicate the need for food, but it could also result from illness.  Worse, by the time Rok noticed a difference by using these crude methods, he would likely be so weak from lack of nourishment that he would be unable to hunt or forage for food.  Dependent upon such indirect means of regulating his consumption, Rok would surely die and Homo sapiens would have disappeared along with him.

Fortunately, Rok has a built-in early-warning system known as “hunger.”  We think of hunger as a curse and ask how a loving God could so inflict us.  But any mechanism designed to warn us of an energy deficit must be unpleasant, otherwise we would do nothing about it.  It must also be urgent enough to get us to act and act quickly.  If we’re to survive, existential threats must go immediately to the top of our mental “in-boxes.”

And Today

Like the people of Rok’s time, our world runs on energy, and those who produce our primary energy sources – oil, natural gas, coal, nuclear power, hydroelectricity, wind power, solar power, and biofuels – must make a net energy profit if our societies are to survive.  In other words, they must produce more energy than it takes to locate, extract, transport, and refine hydrocarbon fuels and uranium; to build power plants, dams, wind turbines, and solar panels; and to construct power transmission lines.

And each of these producers need some means, short of bankruptcy, to tell them when they are not making an energy profit.  Unlike Rok, though, a company is not a single organism with a built-in warning system like hunger to keep it in the black.

In theory, an oil company (for example) could perform an energy balance on every productive well it discovers to determine whether its oil is worth pumping out of the ground.  The BTUs contained in the oil it expects to recover could be compared against the energy needed to fabricate, transport, and install all the piping, valves, and fittings needed to bring the oil to the surface and move it to a refinery.

Then the energy needed to refine the oil and transport the finished products to the various points of sale would be added along with the energy costs of the dry wells the company drilled on the way to finding productive wells.

Suppose that the company performs the myriad calculations needed and determines that producing the well will result in a net energy gain.  What then?  Will producing the oil leave it better off or just leave it with a storage problem?  Energy balance calculations tell us nothing about consumer demand.  Maybe people value other things that could be obtained with the resources the oil company is planning to use more than they value the oil.

But even if consumer demand for oil is high enough to warrant completing the well, the calculations don’t indicate where the oil is needed most or in what form – motor oil, gasoline, kerosene, jet fuel, diesel fuel, home heating oil, plastics, or any of dozens of other products.

Moreover, the only reason we could even consider performing a net energy balance is that energy happens to appear on both sides of the equation: energy expended versus energy produced.  I am willing, for example, to expend 10 BTUs of energy to produce 100 BTUs worth of crude oil, but how much energy should I use to produce a pound of copper, a bushel of wheat, or a pair of shoes?

These are all critical questions that must be answered countless times every day in any economy – free market, socialist, or otherwise.  How do we gather the information we need to answer these and other such questions without expending enormous amounts of time, labor, and scarce resources?

These are questions for another chapter.

—————

Richard Fulmer has a degree in Mechanical Engineering and has worked for more than 36 years as both as an engineer and a systems analyst. A long time student of economics, he has had over 30 articles published in free-market journals.  His article, Cavemen and Middlemen, was published in The Freeman and received the third annual Beth A. Hoffman Memorial Prize for Economic Writing.

With Robert L. Bradley Jr, founder and CEO of the Institute for Energy Research, Richard co-authored the book, Energy: The Master Resource, which has been used in college courses at the University of Texas, Texas Tech, and the University of Toronto.  The book won praise from Milton Friedman, the late, Nobel Prize-wining, economist.

Richard is a member of the FEE (Foundation for Economic Education) Faculty Network.

The post Profits and Energy (Caveman Economics 101) appeared first on Master Resource.

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January 31, 2019 at 01:32AM

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