We assume that when prices go up, people demand (i.e. want to buy) less of a thing.
We assume that when prices go up, firms supply (i.e. want to sell) more of a thing.
These assumptions lead to demand and supply relationships that are negative and positive, respectively. We put these together on a graph, and whammo, they’re going to intersect somewhere, and that intersection reveals the quantity sold/bought and the price.
Consider gasoline. Let’s go back in time, when you could buy a gallon of gas for $2.50. That was the equilibrium price. People found gasoline relatively cheap, and Detroit rolled out all sorts of gas-guzzling SUVs and such.At the same time, environmental conditions were worsening because we were polluting the air. This is what we call a negative externality. The true costs associated with the sale and consumption of gasoline are not reflected in market prices.
The Supply function is supposed to reflect the costs of production and sales. If pollution costs were included the Supply curve would actually be higher, and the price of gasoline would go up, say to $3.50.But pollution costs are not reflected in supply functions, for the most part. One reason for this is that no one owns the air; no one has the property rights to force others to keep the air clean.
Some countries use taxes to adjust supply functions for these pollution costs. England is a perfect example of this; approximately 75% of the price of petrol is tax. But we don’t have taxes nearly that high in the U.S.
There are two main opposing Economic camps on this issue:
Camp One: The government should use taxes to reflect pollution costs and limit the consumption of gasoline.
Camp Two: If gasoline/oil is such a scarce resource, market forces will adjust so that prices rise and consumption will fall as a result.
Camp Two is the most powerful camp in the U.S. So, let’s reconsider our current situation.
Two main factors must be considered. One is global instability, particularly in the Middle East that has impacted the supply. I’m not sure about the exact extent of this supply change, but many economists argue that the Iraq War and other things have effectively limited the supply coming to us (or at least raised the price sellers ask of us, thus shifting supply left).
The other factor is our consumption of gasoline. We all know that vehicles with lower gas mileage yield higher gas consumption. But there’s a lot more going on. The outward expansion of most cities (“urban sprawl”) yields longer commutes. Larger vehicles slow down average travel times because 1) they take up more space on the road, and 2) they’re harder to see around so other drivers need to leave more following distance. Both imply longer commutes. Most cities have horribly bad public transit, and no good incentives for carpooling. Again, we get longer commutes. Longer commutes mean average gas consumption goes up and up and up, i.e., demand increases.
But we also need to consider the rest of the world. The demand for gasoline in India and China is skyrocketing. Global demand is super high and it’s only increasing. The days of $2 a gallon gas are behind us. Forever.So with lower supply and higher demand, we end up with prices where they are now.
And then, the yammering about how to deal with this. McCain has this brilliant idea of a Tax Holiday to lower (effective) per gallon prices by 18 lousy cents.
And people are excited about this? There is no reasonable Economic justification, or cause to be jubilant about this proposal. Either 1) gas demand is too inelastic, or 2) we should let market forces do what they do.
1) Gas demand is too inelastic (unresponsive to price changes). Um, this is obvious. Particularly in the short run, people don’t drive significantly more or less as a result of changes in gas prices. I truly have difficulty believing that enough people would add enough summer trips across the country to make any difference to our overall economic health. We respond far more slowly to gas prices. A friend of mine suffered through high commuting costs for years before deciding to move closer to her job to cut down on her gas consumption. That’s just how it goes.
2) Market forces have led gas prices to rise. Anyone who Believes In The Market (read: conservatives et al.) should let the market do what it does. We have known about high gas prices for a really damn long time. This is not a surprise anymore. The market is telling us to adapt. A Tax Holiday from gas prices is just Big Brother Government trying to stave off the inevitable. And that this BS is coming from Republicans is just horribly ironic.
