speculation is often perceived as something wrong or immoral such problems are beyond the limits
of economics it is not a task of economics to morally evaluate a particular behavior the role of
economics is to examine economic consequences of a given action every human action is a speculation
and broad meaning of this word because every action is directed towards the future
which is uncertain people take action to satisfy their needs but they can make a mistake in their
assessment and take a subjective loss today however we will take a look at speculation in
a more strict sense of the word let's start with the definition in finance speculation is the act
of buying something hoping that its value will increase and then selling at this higher price
in order to make a profit if you watched our previous video about the role of an entrepreneur
you can see some similarities we've said that an entrepreneur notices the difference between
prices of factors of production in the anticipated price of the final product and try to use it to
make a profit actions of an entrepreneur is also a speculation in a broader sense but the
difference is he does something he transforms factors of production into a new product
thus creating a new value philip carey who was a speculator himself defines speculation in this way
pure speculation involves buying and selling in the same market without rendering any service in
the way of distribution storage and transportation the man who bought 60 eggs and sells them a dozen
per customer at a higher price is not a speculator in this meeting because he must store the eggs
and distribute them his profits are the payments for his services which customers want to pay for
at the same time part of his profits may be speculative if the egg market price were to go up
we can thus notice that entrepreneur even though he speculates in his business out of necessity
produces goods or services whereas a speculator on financial commodity or currency markets
does not at least at the first glance he only buys stocks commodity or currency he holds them
and then sells them if the price goes up does this action have no other function is it harmful
or maybe the opposite is true it's both necessary and useful contrary to the first impressions
speculation is useful in the market the first rule of speculation is to accommodate the market to
constantly changing conditions let's assume that speculators anticipate that there will be a big
problem with the availability of crude oil soon and its price will go up they will start to buy
oil at a present lower price only to sell it at a higher price later as a result price of oil goes
up because they are buying it the price surge is an impulse for the rest of the market participants
it tells consumers to reduce consumption of oil and it tells the producers to increase production
the economist malt tobias keller writes that each speculator possesses a piece of dispersed
subjective and often times tacit knowledge and reveals this information through his buying
actions which ultimately determine prices in doing so multitudes of market participants
revealed data that otherwise could not be gathered and many adds that the market's
efficiency derives precisely from its ability to gather and make available dispersed knowledge
speculators are one of the driving forces behind this process so when the problems anticipated by
speculators with crude oil availability come the market will be better prepared for it the prices
will change less steeply than they would without speculators without them there would be sudden
unexpected shortages we can notice however where the resentment for speculators is coming from
it may seem in this situation that they are the ones who raise the prices but we must first
remember that it's not their actions which are responsible for the price increase at least if
their anticipations are correct speculators are not responsible for oil supply problems
they just anticipate it and act accordingly the prices would go up anyway only later and more
violently and the availability problems would be more severe kaler puts it like this the capital
market's concern and the action of speculators can be compared to a medical thermometer that helps to
evaluate the patient's state of health would any patient really blame the thermometer for his fever
because of speculators actions prices are less volatile and reach a market equilibrium quicker
than they would otherwise well everything is great as long as speculators are right
but what if they are wrong it can and does happen that speculators don't correctly anticipate future
conditions what happens then they lose money the market clears itself of ineffective speculators
by taking their capital away and rewarding the effective ones who got it right it's very hard
to be infallible with the anticipation of future events so it's natural to make mistakes sometimes
the speculator doesn't always get everything right he will be fine as long as he is right
more often than he is wrong there are many speculators so absolute infallibility of
every single speculator is not required for the market to work as described previously
even if the majority of speculators would make the same mistake and the price will reach different
level than the market equilibrium it would only be temporary there would be a shortage or a surplus
which will soon be adjusted by subsequent actions of buyers and sellers
so the negative effects wouldn't last long the second rule of speculation
is to take over the risks let's assume that a company needs copper in their production process
present copper price is beneficial so the company wants to avoid the risk of copper price changes
there is a chance that the copper price will fall which would benefit the company even more
but the price may also rise and the company doesn't want to speculate it wants to focus on the
production using the right financial instruments the company can protect itself against price
changes and ensure that it will buy copper at the present price for some period of time but someone
has to take the risk of price changes the copper producers don't want to take the risk either
the one that can take the risk is a speculator who thinks that the copper price will increase
in this period the transaction is mutually beneficial the speculator hopes he will make a
profit because of the price difference the company does not like the risk and wants a constant price
it's worth noting that the speculator does not create the risk he simply takes over the risk
that existed anyways without the speculator the company would have to take the risk
the third role of the speculators is to provide liquidity as we know for any transaction to take
place the mutual will from both the seller and the buyer is needed the buyer must want to buy
and the seller must want to sell when there are no problems with finding a buyer or a seller
we say that we have a liquid market illiquid or thin market is when there is a problem with
selling or buying because the other side of transaction is reluctant to either buy or sell
as speculators are not buying to use but only to hold and sell later it's easier to find a buyer or
seller on the market where there are speculators thus this kind of market is more liquid than it
would be otherwise to sum up speculators even though they are perceived as harmful idlers
in fact provide some services whether they know it or not they contribute to better
and faster resource allocation in the economy they decrease business risks for companies they provide
liquidity and they help decrease price volatility speculation in itself is not a cause of business
cycle as long as there are no additional factors that distort resource allocation
you can learn more about these additional factors in our video about business cycles
we will leave the moral judgment of speculation to you our dear viewers please visit econclips.com
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