annenberg media ♪ annenberg media ♪ in 1974, california water was cheap. by 1977, the state was in the midst of a great drought. what would californians pay now for water? after the 1973 arab-israeli war, the middle-eastern oil spigot was shut off. what did america do to get domestic oil producers to fill the gap? during the designer jean craze, why would so many pay so much for so little?

during the holiday season, shoppers descend on this store en masse, ready to buy if the price is fair. the producers of every item try to predict what the shoppers want and what they'll pay. supply and demand: what sets the price? economic analyst richard gill and i will examine that on this edition of economics usa. i'm david schoumacher.

rarely have americans had to worry about water. they take it for granted because it's plentiful, available, and cheap. but for what water does, there is no substitute. what would it take to show how much water is really worth? 1975 marked the beginning of one of california's worst droughts. it's a semiarid state with a gigantic agricultural industry, dependent on water from its snow pack and winter rains. but in the fall and winter of 1975, winter rains and snow did not come. accustomed to dry spells, californians showed little concern. but that winter wore on with no rain or snow,

and soon, what was great weather for some began causing problems for others. the summer of '76 exploded into flame as over 1,400 fires swept the state in a three-week period. marin resident sharon mooney recalls. when the rains didn't come and didn't come, people talked about preferring to have rain to sunshine. the next winter continued without rain. farmers were notified that water for irrigation would be drastically cut back. by march of 1977, the reservoir levels had fallen dramatically. don neudeck recalls. it was really amazing to fly over and look at how the reservoirs were down. you couldn't believe it. california was running out of water.

officials reallocated water and promoted conservation methods. the drought control center was flooded with suggestions. one woman asked for a moratorium on watering cemeteries. when the living's needs are in danger, let the dead rest a little drier. north of san francisco lie the well-to-do suburbs of marin county. it was forced to begin rationing water. early in the drought's second year, each resident was cut back to 46 gallons daily, 2/3 less than normal. why was marin hit so hard? we asked the former manager of the county water district. that goes back to the decision of the people in the early seventies, in which a number of issues were placed on the ballot for additional water, bond issues to develop additional water.

folks in marin county at that time did not want these issues to go forward. ts they defeated them. there were many in the bay area and in california, too, that felt it served marinites right to be suffering from the drought. they resented sending water over the richmond bridge or to send any water to us at all, because marin county had defeated several bond issues for water and had not really developed any water resources. to reinforce the 46-gallon- per-day allotment, new water rates were imposed. former marin water district board member pamela lloyd. by numbers of people per household, this is how much water you have in a given period of time. you choose how you use it.

over a certain period of time, you cannot go beyond that use, or you'll be penalized. this is where economics did come in. you'd be penalized very severely for it. cooking and drinking water were important and our vegetable garden. you didn't wash the car. you didn't hose down the patio or the deck, all these real wasteful uses. some put signs up directing people toward conservation methods. it was in to wear dirty clothes or drive a dirty car. when you were waiting for the hot water, you'd collect the cold water for something else. rising to the challenge, marin residents reduced their water consumption by 66%. there's an old saying, "you never miss the water till the wells run dry."

marin county saw more evidence of how valuable water was. look at what people would pay for something recently taken for granted. 1,000 gallons of water today for an individual through the municipal system is 60 cents to $1.00. so they were selling the same amount for somewhere in the neighborhood of $500. another expensive option was to dig your own well. many hard hit farmers and wealthy landowners did. the well drillers did a phenomenal business. they couldn't keep up. people now willingly invested time and energy needed to follow strict conservation methods. conservation is going to be part of one's water supply. what you save, you don't have to buy. besides being motivated to conserve, marin residents were willing to spend more money

so they wouldn't be as vulnerable again. the successful bond issues in '76 and '78 were extremely costly projects. adding both together, they were more than the ones that could have been passed in the early seventies. but people were willing to pay so they wouldn't have to go through that again. torrential rains in the final days of 1977 marked the drought's end. northern californians were humbled. for the next six years, people carefully held down their use of water. but with memories fading and plenty of water, consumption slowly climbed back to where it had been before the drought. richard gill explains what water shortages teach us about consumer demand. clearly, when you have a shortage of a commodity like water,

you get very careful about how you use it. watering cemeteries and washing the dog are out. drinking water is definitely in. baths and showers? after a few weeks, when you have very little high of a commodity, an additional unit brings more added satisfaction, more marginal utility, as economists describe it, than if you have an abundant supply. at the height of the drought, additional water would have been used for high priority purposes-- drinking, cooking food. the added utility, the marginal utility of water, was very high. as the drought eased up, more water became available. the car got washed. the lawn got watered. additional water brought less added satisfaction,

a lower marginal utility. the principle expressed here is usually called... graphically speaking, it would look like this. we measure the marginal utility of water on the vertical axis. along the horizontal axis, we measure the amount available. at the drought's height, we have little water, and its marginal utility is high. when the drought eases, more water is available, and the marginal utility becomes very low. in general, for most commodities, the marginal utility curve will look like this, diminishing going to the right. this principle is important. it explains why we willingly pay more for a commodity when it's in short supply, and why we'll pay only a low price when it is abundant.

droughts have taught us much of what lies behind the demand side of the famous law of supply and demand. as the smoke cleared from the 1973 arab-israeli war, o.p.e.c. put the squeeze on america by quadrupling its oil prices. where america was once a major petroleum exporter, by the 1970s, it had become overly dependent on imported oil. o.p.e.c. had it. america needed it. this first oil crisis shook the nation's economic structure. where were american oil producers? ike kerridge, an economist from the hughes tool company, explains. the price of oil-- a critical factor in the incentive to drill-- had been very stable through 1971. as inflation accelerated in this country about 1965,

this meant that in terms of purchasing power, the real price of oil was declining. there was less incentive to drill. drilling activity declined by about 70% from the '55-'56 period to the low point in 1971, when fewer than 1,000 rigs ran in the united states. from '51 or '52 to '73, the dollar number was $3.25 for west texas crude. your purchasing power, of course, decreased all that time, and the costs obviously escalated during that 22 years. the american oil industry had other problems. to curb inflation, price ceilings were set in 1971 by the nixon administration. james schlesinger, the nation's first secretary of energy. if we attempted to control the price of oil or natural gas based upon the assumption

that a 15% rate of return was the ceiling because there are so many failures, dry holes, we would discover that it would not have been the entrepreneurial activity in the industry that was necessary to maintain any activity. the control of price in a highly risky industry will destroy that industry. we were doing damage to the industry during the period of control. world oil prices kept rising. although prices for our known oil reserves were restricted by nixon's controls, the american oil industry had one incentive-- new oil. oil found after 1972 was free to follow the higher world price. american producers heard the knock of opportunity. one newcomer, sam lefrak, a new york city landlord, declared war on o.p.e.c. because they drove the price up so high,

it now became economically viable for us to go deeper and drill right here for oil and gas. in 1972, at least 40-60% of america's known reserves remained trapped in rock pores and fissures. expensive, enhanced oil-recovery techniques designed to extract more oil could greatly add to the nation's reserves. by allowing this source of oil to follow the world price, the government encouraged additional research and exploration. but this oil boom was soon stifled. in 1975, to protect consumers from dramatic oil price hikes, president gerald ford put ceilings on all domestic oil. this discouraged domestic production and left us more dependent on imports.

then in december 1978, iran, racked by political upheaval, curtailed production of crude oil. cut off from this major source, oil prices to the united states again more than doubled. frustrated consumers were reacquainted with the energy crisis as long gas lines reappeared. oil suppliers put pressure on the government to decontrol gas and oil. mr. schlesinger, what turned this around and made decontrol acceptable? first, there was the opportunity created by the fall of the shah. public concern was rising when production ended in iran. governmental concern was rising even more rapidly. alarm ultimately became more than alarm-- almost panic in the industry-- to acquire additional supplies. some action had to be taken by the government.

by june of 1979, president jimmy carter announced the gradual phaseout of controls on domestic oil. once controls were lifted, did the wildcatters jump out to start drilling again? yes, indeed. it had an immediate effect. the level of drilling activity began to rise as soon as decontrol was announced. we were drilling annually about 2,000 wells. we moved up until 1982 to about 4,500 wells, more than double the level of drilling activity. the new high oil price and government decontrol were the financial carrots needed to lure suppliers back into domestic production. many of these producers were independents who accounted for 90% of domestic drilling.

wildcatter william rutter, jr. left the oil industry in 1959 and re-entered when the promise of profits returned. when the price of oil went up enough, i started looking at deals that would pay out in a reasonably short period of time, and that the total estimated value of the reserve was an attractive multiple of the perceived risk. these commodity prices go up, but always come back down. the producers want to produce a lot. the consumers want to consume less. this is the law of supply and demand, and it works. many new suppliers won their gamble. with the lure of higher oil prices and profits, oil production almost doubled in america and the o.p.e.c. countries. as profits soared, producers began pumping even more oil,

and soon, there was a glut. by 1985, the price of oil had plummeted. we asked economic analyst richard gill what this story tells us about the law of supply and demand. it tells us how consumers and producers react to higher prices. with higher oil prices, american consumers found ways to use less oil. their demand curve for oil had this general shape. as the price went up, oil consumers found ways to economize. we would expect this from our earlier discussion of droughts and marginal utility. they economized on the expensive oil, as in the california drought they economized on expensive water. but the oil episode also tells us about producer reactions to higher prices. the higher oil price was an incentive

to search for and produce more oil. this search was risky. @ it required the promise of higher profits for the producers to undertake it. high prices give producers this signal. ÷ high prices promise higher profits. meaning businessmen can now expand production even though the costs of additional production may be high. in saying this, we are describing the supply curve of an industry. whether oil, potatoes, or videocassette recorders, it would generally look like this. the higher the price, the more goods producers bring to the market. as the consumer demand curve slopes downward to the southeast, the producers' supply curve slopes upward to the northeast. if it's a very well-behaved industry, the intersection of these two curves will determine the price of the product

and the quantity of the product. that, in a nutshell, is... not all industries are that well-behaved. o.p.e.c. gets into the act, or the government. consumers may get new ideas. that's another law of economics. nothing ever seems to stay put. a fascinating part of our culture is our preoccupation with fads. we're always being consumed by a mania for something that's in style, whether it's cabbage patch dolls or hula hoops. the jeaning of america took place in several stages, peaking when this basic commodity became high fashion-- designer jeans. when shopping for blue jeans, why not simply look for the lowest price? though double the price of regular jeans, america was buying them in droves.

why were people willing to pay a premium for these jeans? ♪ they're always in style ♪ tight blue jeans makes a cool cat wild ♪ we talked to joe nakash, president of jordache enterprises. in the beginning, right in the beginning, when we brought the concept of tight and sexy jeans, we went into the department stores, and they said, "we don't need another jeans company." we were very upset. we said, "i'm going to fix them." we're going directly to the consumer and tell them that we have those beautiful designer jeans. ♪ you've got the look, you've got the look ♪ ♪ you've got the look ♪ i want to know better ♪ you've got the look that's all together ♪ ♪ you've got the look

♪ jordache ♪ you've got the look ♪ jordache you've got the look ♪ we created such a demand that the consumer said to the department stores, "i want that jeans." we talked with advertising and marketing experts in the apparel industry. they fit much better on women than any jeans had before. they were a melding of the fashion, practical, and status worlds at a price people could afford. it became very acceptable to wear jeans almost anywhere. it became a universal product. your jeans were a product you could work in, play in, go out at night in. ♪ the jordache collection is you ♪ brands were built up with a lot of tv hype. it attracted the consumer. it would give them an image.

they were willing to pay a premium for it. how did other fashion producers react to the early success of the trendsetters in designer jeans? any designer with a name put it on the back pocket of a jean. to keep up the momentum, money was poured into advertising. department stores placed jeans in high-traffic areas. at its heyday, the designer jean industry was spending 10% of sales on advertising and promotion. it was really the first time that television had been used so powerfully and so much money spent on television in any kind of fashion category i know. from that viewpoint, it had to have a big impact on people's consciousness. were you spending more on advertising than other companies in your field?

at that time, i did. we spent 50% on advertising then. we created that demand. by putting millions of dollars into advertising very early on in the designer jean phenomenon, many entrepreneurial producers were taking a very great risk with their finances. they didn't know if the consumer would like it as much as they eventually did like it. if it hadn't been a success, that advertising money would have bankrupted many companies. in 1965, jeans were bought on the order of one pair, less than one pair per capita. that increased to almost three per capita. a blue denim gold mine-- how long could you work that vein? the market got overdone when you'd see a designer jean

on everybody's back pocket regardless of their station in life. the product started at the market's higher end, working its way down to the masses. it lost its status. the consumer wouldn't pay that premium price. whenever we look back on yesterday's hot fashions, we generally ask, "what did we ever see in that?" times change and tastes change. we asked our economic analyst richard gill what the changes in tastes, fashions, and products might tell us about the nature of supply and demand. a great greek philosopher once summed up the world in the phrase, "all is flux." he could have been talking about the jeans craze or the american economy. the law of supply and demand

sets prices, but these curves never stay put. one year the demand curve for jeans shoots way up here. later, people tire of jeans or find substitutes. bango! back down here again. people's tastes change. their incomes change. the availability of other products changes. these factors shift the demand curve. on the supply side, when oil prices zoomed up in the 1970s, for example, that affected the costs of all sorts of industries that used oil as an input. their supply curves shifted up. businesses find new, cheaper technological devices for producing their products. the supply curve shifts down. there's a lesson in all this. the law of supply and demand

is really more a way of analyzing the deep, underlying forces affecting the prices of commodities than of determining prices in any rigid way. all is flux in economics, a field that's sometimes frustrating, always fascinating. the price of clothes, fuel, even water are all influenced by the laws of supply and demand. "supply and demand" now sound like a cliche, but the forces remain vital. the interplay between supply and demand is still at the heart of our market system, a subject we'll consider again in economics usa. this is david schoumacher. captioning performed by the national captioning institute, inc. captions copyright 1989 educational film center