Saturday, May 26, 2007

Economics 101

Rising gas prices invariably lead people to the conclusion that gas prices are high simply because oil companies have conspired to raise prices. Sometimes I worry this belief will become widespread enough to induce politicians into legislating a price fixing scheme or some system of rationing. Even if oil companies are colluding in any particular case, there's a more serious underlying problem of demand increasing faster than supply.

Although I'm not a real fan of the oil companies, I think there are some important basic pricing facts about which consciousness needs to be raised. Prices are largely being determined by supply and demand. As gas prices rise, will oil companies reap outrageous profits? Probably, but it's for the same reason a individual with basement full gold has the power to become dollar rich. (And if you force the individual to sell the gold below market prices, you can be sure it will disappear quickly.)

If it is true that demand is outstripping supply, high prices are a critical factor in maintaining the balance between demand and supply; without them shortages will ensue and long lines at the pump; in addition, high prices provide an impetus to entrepreneurs and other agents pursuing sources of alternative energy. Without the signal of rising energy prices, what will impel them to act and pursue alternatives?

Finally, if we as a society find ourselves outraged by the profits reaped by the oil companies, it's not a matter that can be solved by mandating low prices, which, again, will in all likelihood lead to shortages. It's a problem that needs to be solved by taxing oil companies or some similar measure.


"MEQUON, Wisconsin (AP) -- Motorists pulled in to Harvey Pollack's gas station, honked and gave him a thumbs-up -- because he wasn't selling any fuel.

The owner of Towne Market Mobil in this suburb north of Milwaukee shut down his pumps for 24 hours, hoping to start a movement aimed at convincing oil companies to lower their prices."


"While gas prices seem to have spiked recently, the issues leading to this increase have been decades in the making Our nation’s refining capacity has been stagnant for thirty years, we have limited our options to increase domestic supply, and we depend more and more on foreign sources of oil that are becoming increasingly scarce because of rising demand in other countries like China and India. "

Economics in One Lesson:

"Now we cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are both tempted to buy, and can afford to buy, more of it. The second consequence is to reduce the supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants."


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