Economics 101...

It seems the Texican Tattler is off on a rant about so-called price gouging by the oil companies. He thinks that oil companies make "huge" profits because they are price gouging, and that that is automatically a bad thing. Unfortunately, he's falling into the all-too-common trap laid by the media about economics in general. There's a good take on the question at Pubcrawler, but it's really a simple issue.

In a free market, prices are dictated by the supply of a particular product compared with the demand for that product. The demand for gasoline is high -- everyone needs it to get to work, heat their homes, produce electricity, ship their products to the market, and so on. Some of that demand can be adjusted in the short term (consumers can choose to cut down on non-essential driving, put up with the heat, etc); some can be adjusted in the long term (buying more fuel-efficient cars). The supply is also variable, sometimes significantly.

We should not be surprised to see rapid price spikes when there are supply problems. The individual gas stations need to make enough money on their current inventory (ie, the gasoline in their underground tanks) to be able to replace it when they run out; that means they need to be ahead of the price curve, selling today's oil at tomorrow's prices. If they don't do this, they will go out of business. This doesn't mean they are making huge profits.

The recent spike in prices at the pump in the US can be laid partially at the feet of Katrina, which impacted much of our refining capacity, combined with the fact that we were already running pretty much at the limit of our refining capacity to begin with. That combination means that we had to make up the shortfall somewhere -- by finding refined gasoline elsewhere and shipping it to the markets. Doing that costs more than the usual procedure (otherwise, the usual procedure would not be the usual procedure). So, when the cost of delivering a gallon of gasoline to the local gas station goes up, the supplier has to raise prices; the alternative is to go out of business.

We also should not be surprised to see large oil companies making big profits. Consider; there are about 300 million people in America alone, and each adult probably spends at least $100 on gasoline for their car per month -- sometimes less, sometimes more. That's completely ignoring business use and non-vehicle use, and it adds up to $360 billion per year for the US alone. That's a huge industry. Large absolute profits are meaningless; you have to compare that industry with other industries to see how the profit margins match up before you can even start to complain.

Let's not forget that gasoline taxes often make up a huge portion of the price of gasoline. That money is going to your local government, not your local oil company.

Here's a quote from the Tattler's post:

We are being led to believe that a 24 cent per gallon increase in 24 hours was a good thing. That somehow magically that prevented the country from running out of gas. Say what? Did the extra 24 cents per gallon prevent anyone from doing anything other than pay more at the pump?

Sure. It prevented gas stations and their suppliers from going out of business. There are sources of gasoline that they can get to the marketplace so long as people are willing to buy; but those sources cost more than the usual sources, so those additional costs have to be covered. The oil companies could have chosen to keep prices at the same level, and simply not supplied oil to the market at all while the price was higher than some arbitrary point. Would that have helped the situation at all?

This is not a Republican or Democrat thing. This is a consumer thing. As comsumers we need to get mad enough to care about what is going on. We need to start to hit back a little. We need to let the big oil companies we won't put up with this anymore. No one is saying don't make a profit. No one wants to say how much you can make. But not at the cost of gouging it's customers. That's why we have anti-price gouging laws. Try raising the price of plywood by 1000% during a hurricane and see what happens. Why is this being allowed with gas?

Because this is a free market. Sellers set their prices and buyers choose to buy -- or not. It's not something we want the government involved in "allowing". As for raising the price of plywood during a hurricane -- no problem! There's a limited supply of plywood. Suppose you raise the cost by a factor of 10; that means you can then pay your suppliers that same additional factor to get more plywood. If the roads are shut down or blocked by debris, it's going to cost more to deliver that plywood. Maybe even ten times more, especially if you intend to pay someone to drive into a hurricane.

But really, there's a simple truth here. If gasoline prices are too high for your taste, and you don't like the idea of oil companies making profits... you don't have to buy gas. Really. It's a voluntary transaction. That you are willing to exchange two or three dollars for a gallon of fuel is a sign that the price is reasonable under the circumstances. If you think it's unreasonable... don't pay it. That's the sign of a healthy market at work.

UPDATE: Featured in the Carnival of Liberty.

Posted on 2005-11-11 23:20:55.0 by matthew@triggerfinger.org

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