Speculation

Summary

This video script explores the role of speculation in markets, challenging the common view that it's morally dubious. It explains how speculators, by buying low and selling high across time rather than space, can stabilize prices and increase welfare. The script also discusses futures markets, where speculators can bet on future prices without physically handling goods, and how these markets embed valuable information about future events.

Takeaways

• 💡 Speculation is often seen as morally dubious due to its association with gambling, but it can be a useful part of the market process.
• 🔄 Speculators move resources through time, similar to how entrepreneurs move goods geographically to capitalize on price differences.
• 📈 Speculation can smooth prices over time and increase welfare by moving goods from periods of low value to periods of high value.
• 🛠️ The basic model of speculation involves buying low and selling high, which can stabilize prices and increase overall value in the market.
• 🌐 Speculators can affect the market without physical storage by using futures contracts, which are agreements to buy or sell an asset at a future date at a price set today.
• 💼 Futures markets allow anyone to speculate, providing a platform for those with knowledge about future market conditions to participate without needing physical resources.
• 💰 Successful speculators can make significant profits by accurately predicting future market conditions and adjusting prices in futures markets.
• 📊 Information about future events, such as weather forecasts, can be embedded in market prices, making them a valuable tool for prediction.
• 📉 Speculators can raise prices today but are also expected to lower future prices, which can lead to a more stable price over time.
• ⚖️ Speculators have a strong incentive to be correct in their market predictions because they risk their own capital, leading to a self-correcting market.
• 🔮 Speculation and futures markets incentivize people to think about and predict future events, which can be more accurate than non-market-based institutions.

Q & A

What is the common perception of speculation and speculators?

Speculation and speculators are often considered morally dubious, similar to gambling, and people question the social good or true value they produce.

How does the script redefine the role of speculation in the market?

The script suggests that speculation can be a useful part of the market process, as it helps to move resources through time from lower to higher valued uses, thus increasing welfare.

What is the basic principle behind speculation?

The basic principle behind speculation is to buy low and sell high, profiting from future price changes.

How do speculators move resources through time?

Speculators move resources through time by buying commodities when prices are low and storing them to sell when prices are expected to be high in the future.

What is the impact of speculation on prices over time?

Speculation tends to smooth prices over time by increasing prices in the present and decreasing them in the future, leading to more stable prices.

How does speculation increase welfare?

Speculation increases welfare by moving goods from a time of low value to a time of high value, similar to moving goods from a location of low value to one of high value.

What is the role of the futures market in speculation?

The futures market allows for speculation without the need for physical storage or delivery of goods. It involves contracts to buy or sell commodities at a future date at a price agreed upon today.

What happens when the price of a commodity in the futures market is higher than expected?

If the price is higher than expected, the speculator who predicted the increase can sell the contract at a profit, or the contract can be settled in cash for the difference in price.

Why is it beneficial for speculators to have their own money at risk?

Having their own money at risk gives speculators a strong incentive to make accurate predictions about the market, as incorrect predictions can lead to significant losses.

How can the information embedded in futures market prices be useful?

The information in futures market prices can be used to predict future events, such as weather conditions affecting crop yields, and can sometimes improve upon predictions from other institutions.

What is the ultimate goal of speculation according to the script?

The ultimate goal of speculation is to increase value for society as a whole by incentivizing individuals to think about and predict future events that will impact production and consumption.

Outlines

00:00

🔮 Speculation in the Market Process

This paragraph discusses the role of speculation in the market and how it is often misunderstood as morally dubious. It likens speculation to the example of moving oil from the west coast to the east coast to exploit price differences. Speculators, like entrepreneurs, move resources but through time rather than space. They buy low and sell high, profiting from anticipated future price changes. The paragraph argues that speculation can smooth prices over time and increase welfare by moving resources from periods of low value to periods of high value. The example of oil prices being influenced by a potential war in the Middle East is used to illustrate how speculators can stabilize prices and increase overall welfare.

05:03

📊 The Role of Futures Markets in Speculation

The second paragraph delves into the mechanism of futures markets as a tool for speculation without the need for physical storage or delivery of commodities. It explains how futures contracts work, with an example of Tyler and Alex agreeing on a future oil price. The paragraph highlights how the futures market allows individuals to speculate based on their predictions of future prices. It also touches on the idea that futures prices can contain valuable information about future events, as illustrated by the example of Richard Roll's research on orange juice futures and Florida weather forecasts. The paragraph concludes by emphasizing the importance of speculation in providing incentives for individuals to accurately predict future market conditions.

10:04

🧠 Incentivizing Thoughtful Future Predictions

The final paragraph emphasizes the importance of speculation and futures markets in incentivizing individuals to think about and predict future events and their impact on production and consumption. It argues that these markets are more effective at predicting the future than institutions that rely less on market incentives. The paragraph suggests that speculation markets筛选出能够更准确预测市场的人，因为他们用自己的资金承担风险，并且有强烈的动机做出正确的预测。 It concludes by noting the value of having people think about the future and the role of speculation in facilitating this process, hinting at further discussion in the next lecture.

Keywords

💡Speculation

Speculation is the act of investing in financial markets with the hope of making a profit from future price changes. In the video, speculation is likened to moving resources through time rather than space, aiming to profit from anticipated price changes. The concept is used to explain how speculators can help stabilize prices and increase welfare by moving resources from periods of low value to periods of high value.

💡Speculators

Speculators are individuals or entities that speculate on the price movements of assets. The video suggests that speculators play a crucial role in the market by anticipating future price changes and acting on those predictions to buy low and sell high. They are portrayed as contributing positively to the market process by smoothing out price fluctuations.

💡Gambling

Gambling is the act of staking something of value on an event with an uncertain outcome, often for entertainment or financial gain. The video script mentions that speculation is often associated with gambling, which is considered morally dubious. However, it goes on to argue that speculation can be a useful part of the market process, distinguishing it from the negative connotations of gambling.

💡Market Process

The market process refers to the way in which supply and demand interact to determine prices and allocate resources in a market economy. The video script uses the market process to frame the discussion of speculation, showing how speculators can contribute to this process by moving resources through time to match future demand with current supply.

💡Buy Low, Sell High

This phrase describes the basic strategy of speculation, where one aims to purchase an asset when its price is low and sell it when the price is high to make a profit. The video uses this concept to illustrate the speculative strategy of buying oil when prices are low and selling it in anticipation of higher future prices.

💡Price Smoothing

Price smoothing refers to the reduction of price volatility over time. The video argues that speculation can lead to price smoothing by taking supply out of the market when prices are low and releasing it when prices are high, thus stabilizing prices and benefiting society.

💡Welfare

In economics, welfare refers to the economic well-being and happiness of individuals in society. The video script explains that speculation can increase welfare by moving resources from times of low value to times of high value, thus increasing the overall value and utility of those resources.

💡Futures Market

A futures market is a financial market where participants can trade standardized contracts to buy or sell a commodity or financial instrument at a predetermined price at a specified time in the future. The video explains how futures markets allow for speculation without the need for physical storage or delivery of the underlying asset.

💡Futures Contract

A futures contract is a legal agreement to buy or sell a commodity or financial instrument at a predetermined price at a specified time in the future. The video uses the example of a futures contract for oil to illustrate how speculators can profit from their predictions about future prices without physically handling the commodity.

💡Spot Price

The spot price is the current market price of a commodity or financial instrument. In the video, the spot price of oil is mentioned in the context of a futures contract, where the contract price is compared to the market spot price at the time of delivery to determine the profit or loss.

💡Incentives

Incentives are factors that motivate individuals to take particular actions. The video discusses how the incentives in the market, such as the potential for profit, motivate speculators to make accurate predictions about future market conditions, which in turn helps to allocate resources more efficiently.

Highlights

Speculation is often considered morally dubious and similar to gambling.

Speculators move resources through time, not just geographically.

Speculation can smooth prices over time and increase welfare.

Speculators buy low and sell high to profit from future price changes.

Speculation increases value and welfare by moving resources from lower to higher valued uses.

Without speculation, oil prices would be low today and high in the future due to a hypothetical war.

With speculation, the price today goes up, and the price in the future goes down.

Speculators take supply off the market today, leading to higher prices.

In the future, speculators sell from storage, which increases supply and lowers prices.

Consumer surplus is impacted by speculation, with a loss in value today and a gain in the future.

Speculation stabilizes prices by increasing them today and decreasing them in the future.

Futures markets allow speculation without physical storage or delivery of goods.

Futures contracts are agreements to buy or sell at a future date at a predetermined price.

Speculators can profit from futures contracts by correctly predicting market prices.

The futures market often contains information about future events that can improve predictions.

Speculators have an incentive to predict the future correctly to avoid losses.

Bad speculators tend to go bankrupt, while good ones become a larger share of the market.

Speculation markets are better predictors of the future than institutions that rely less on incentives.

Transcripts

♪ [music] ♪

- [Tyler] Today, we're going to be looking at speculation.

Speculation and speculators are often considered

to be morally dubious.

Speculation is associated with gambling,

and gambling is morally dubious.

When a speculator gets rich people wonder,

"What has this person really done for the social good?

What have they really produced of true value?"

What we're going to show is that using a basic model

of speculation, speculation can be quite a useful part

of the market process.

So let's take a look.

Speculation is actually very similar to an example

we've already talked about.

Remember our example, when oil prices are low

on the west coast, and high on the east coast,

this gives entrepreneurs an incentive to buy low

and sell high to move oil from the west,

where it has low value, and bring it to the east,

where it has higher value.

Speculators do the same thing, but instead of moving resources

through space geographically, they are moving them through time.

For example, suppose you believe that oil prices will be higher

in a year due to, for example, a very destructive war.

You might think there will be such a war in the Middle East,

and that's going to push up oil prices in the next year.

You can make a profit by buying oil now

when the price is low, storing that oil,

and then selling it next year when the price is high.

Buy low, sell high.

That's speculation -- the attempt to profit

from future price changes.

Is this a bad thing?

What we're going to show is that speculation tends

to smooth prices over time and to increase welfare.

Why does it increase welfare?

Exactly for the same reasons that moving oil

from the west coast to the east coast

increases welfare.

You're taking oil from where it has low value

and moving it through time to where it has higher value.

You're increasing value and increasing welfare.

Let's take a look at that with our model.

Here's two markets: today's market and the future market for oil.

Let's look at what happens without speculation.

Here's our demand, here's our supply.

I've just drawn a vertical supply curve

for simplicity.

So production today is high, that means today's price is low.

If there's a destructive war in the Middle East,

then production in the future will be lower

and price in the future will be higher.

That's what happens without speculation.

Now let's consider what happens with speculation.

Remember, we begin with a situation where the price today is low

and speculators expect that the price tomorrow

because of this war will be high.

What do speculators want to do?

They want to buy low and sell high.

They want to buy today and sell in the future.

If speculators buy today, they're going to take

some of the current production, take that production

and put it into storage.

They'll take it off the market and store it.

The supply curve to the market is this supply curve.

This then gives us consumption, which is equal to production

minus what the suppliers put into storage.

Notice that with speculation, the price today goes up

because the speculators have taken some of that supply

off the market.

What happens in the future?

In the future when the price is high,

the speculator’s going to want to take what they have

out of storage and sell it in the market.

The supply curve in the future becomes equal to production

plus what is being pulled out of the inventory.

Production is low in the future because of disruption

due to, let's say again, this destructive war,

but consumption will be higher than production in the future

because suppliers are taking some of the inventory out

and selling it into the market.

Notice that in the future, the speculators

are pushing the price down.

What about welfare?

This is slightly tricky, but if we just follow our rules,

let's look at consumer surplus, which is what is going to matter

here with the vertical supply curve.

It's simpler that way.

Well, consumer surplus, what's going to happen?

There's a loss in value today when speculators take oil

off the market.

That oil is not consumed, those units are not consumed,

and because they're not consumed there is a resulting loss in value.

However, notice what the speculators are doing.

In the next period there's a gain in value.

The consumption would have been here

but because of the speculation, because the good comes out

of inventory, consumption is now higher.

The value of that consumption is equal to this green area.

Since the green area is bigger than the red area,

speculation increases welfare.

It also stabilizes the price over time.

The price today goes up, but the price in the future

goes down.

We get a more stable price.

Again what's the basic point here? What's the basic idea?

It's that what speculators do is they take resources

from where they have lower value and they move them

through time to where they have higher value.

That's a very useful thing to have happened.

That increases welfare, that makes the speculators money,

but because of the invisible hand, in the right circumstances

the incentives lead the speculators to do the right thing,

thereby increasing value for society as a whole.

Here is one more important point.

In order to speculate in a market like the market for oil,

you don't actually have to have a storage tank

where you're going to store your oil.

You can do it another way -- that's through the futures market.

Futures are contracts to buy or sell specified quantities

of a commodity or a financial instrument

at a specified time in the future, at a price

that is agreed upon today.

So how would this work?

Suppose that Tyler thinks the price of oil will be greater

than $50 per barrel in 12 months from now.

But Alex thinks the price of oil will be lower than $50

in 12 months.

Tyler agrees to buy from Alex 1,000 barrels of oil

12 months from now at a price of say, $50 per barrel.

It's a futures contract.

Let's see what happens after 12 months pass.

Suppose that 12 months from now, the price of oil

on the market is $82.

That we call the spot price.

That means Tyler was right, the price of oil went up,

and by a lot.

So what do they do then? Tyler has two options.

He can accept the oil from Alex, pay $50,000 to Alex,

and then turn around and sell the oil for $82,000,

netting Tyler $32,000.

But Alex doesn't have any oil.

Tyler also doesn't really want to take the delivery of the oil

and then turn around and have to sell all that oil.

That can be a big pain.

Instead, Tyler and Alex come to an agreement,

perhaps through a clearing house.

Alex gives $32,000 to Tyler

and they close the contract out in cash.

Notice that either way, Tyler nets $32,000

and Alex is out $32,000.

The second method is usually more convenient.

Neither Tyler nor Alex actually have to deal in the oil.

They only have to deal in the cash value

of the futures contract.

In fact, futures contracts are usually settled in cash,

rather than through physical delivery.

What this means is that through the futures market,

anybody can speculate in oil.

Now we're not suggesting you actually do this --

it's one way to lose a lot of money very quickly.

But the point is, you don't have to accept

or deliver oil to speculate in the oil market.

That's a good thing because there are many people

who may know lots of things about conditions

in the Middle East or about the oil market

who don’t themselves have the facilities

to store or deliver oil.

The better speculators can predict the future,

the more money they can make.

When they make their predictions, they change the prices

in futures markets.

Prices in futures markets often have information

built into them which tells you something

about the future.

Think, for example, about the Florida orange juice crop.

What determines whether the crop is really going to be

a bumper crop, in which case, the price of orange juice

will be low, or whether the crop is going to be a small crop,

in which case the price will be high.

Very often it's the weather that matters.

This led one economist, Richard Roll,

to look at the weather forecasts of the National Weather Service

and to see whether orange juice future prices could help to predict

Florida weather.

What he found, in fact, is that they can.

There was additional information in the orange juice futures prices

that allowed for improvements in the weather forecasts

from the National Weather Service.

Lots of information is embedded in market prices.

Let's end where we began with the image problem

speculators have.

One of the issues is that speculators

raise prices today, but lower prices in the future.

Everyone sees the price increase today,

but fewer people see that the future price will be lower

than it would have been without the speculation.

Why is society better off with speculation?

Remember, the speculators are moving resources

through time from lower to higher valued uses.

Of course, the speculators don't always guess correctly.

When they guess incorrectly, they'll be moving resources

from higher valued uses to lower valued uses.

We don't want that, but the speculators have got

their own money on the line.

They have a huge incentive to be right,

and when they're wrong, they have to take big losses.

Over time, bad speculators, speculators who aren't good

at forecasting the market, they tend to go bankrupt.

And the good or better speculators will become a larger share

of the market.

Let's also remember that we really want somebody

to be able to predict the future.

We really want people to be thinking about the future.

We really want to give people an incentive to think

about future events, both good and bad,

and how those events will impact production

and consumption decisions.

Speculation markets, futures markets,

they give people strong incentives to think carefully

about the future.

Indeed, these markets have been shown

to be much better predictors of the future,

much better ways of seeing into the future

than our alternative institutions which rely less on incentives

and rely less on markets.

We'll talk about all of that more in the next lecture.

Thanks.

- [Narrator] If you want to test yourself,

click “Practice Questions.”

Or, if you're ready to move on, just click “Next Video.”

♪ [music] ♪