Is Market-Driven Demand Destruction an Example of a Market Failure?
The tendency of a free market to cut the most elastic demand first seems to be an example of market failure–that is, where the market action produces a long-term result that runs counter to the goals of the market mechanism. One of the classic causes of market failure is where the market acts to optimize short-term benefit, but in the process creates significant long-term problems that aren’t adequately accounted for due to inability to incorporate these long term costs in the analysis of present decisions. We saw exactly this in the rush to extend credit to increasingly low income home buyers resulting in today’s “credit crunch,” and I predict that we are currently seeing a similar market failure in the market’s destruction of the most elastic demand first. The result will be an increasing vulnerability to future supply disruptions–unfortunately, this will come exactly as the likelihood of more severe supply disruptions increases, as I discussed in my recent article on Geopolitical
