Wednesday, June 11, 2008

More on Gas Prices- What not to do

Occasionally, someone will forward me one of those "Here's how to lower gas prices!" emails or invite me to join a Facebook group for the same cause. The latest one I got advocates boycotting Exxon and Mobile gas stations. The "logic" is that if you boycott a couple of the big stations, the prices will come down and then every other gas station will lower their prices as well.

Here's why this won't work. This is Principles of Micro and I'd expect every student in an intro to economics class to be able to illustrate this.

Let's suppose in Town X that there are 4 gas stations. An Exxon station, a Mobile, a BP, and a SuperAmerica. Due to perfect competition, all of their prices are equal: $4/gallon. The supply/demand curve looks like this: Now, let's assume all of the residents of Town X receive the same email and band together to boycott the Exxon and Mobile stations. They're basically changing their preferences. The demand curve for Exxon/Mobile gasoline shifts to the left. People are demanding less at any given price: This would drive the equilibrium price to $3, let's say. But, the opposite effect happens at the BP and SuperAmerica stations. The demand curve shifts to the right as people line up for their gasoline instead of Exxon/Mobile:I didn't put a price in the illustration, but $5 would be a logical assumption given the above effect and assuming elasticities (slopes of the lines) are the same.

So, now all the residents of Town X are paying $5 for BP and SuperAmerica gasoline. The Exxon/Mobile stations down the street have lowered their price to $3.* What does everyone start to do?
Well, as people start to shift to the Exxon/Mobile stations, the demand curve for Exxon/Mobile again shifts to the right-- back to $4. As customers leave the BP/SuperAmerica stations, the demand curve shifts to the left, back to $4. And, in the end, we're back to our original equilibrium. The net effect of boycott is 0:

It's always funny, these emails have been forwarded millions of times over the years and they say something like "This idea comes from an engineer at Halliburton," or "a former gas station owner who wants you to know the truth!" etc.

* It's more likely that the Exxon/Mobile stations wouldn't lower their price to $3, they'd just go out of business. I wrote a post last year on gasoline "price gouging". It's pretty funny because people were calling $2.85 gas expensive back then.

Gas stations don't make much on gasoline, just a few cents on the dollar. They make more off of refreshments and in-store sales. The price for July delivery of a gallon of unleaded gasoline today is $3.41. Taxes get added to that, and you have to factor in marketing costs and other expenses the gas station has to pay to operate, so there has to be a markup on the gasoline for there to be a profit. If the station is a big one, it can buy in bulk and get a lower price, but mom&pop stations are being squeezed out of business.
I used a rule of thumb of 76% to calculate what gasoline prices would be on average, and it's worked pretty well.
So, in July I'd expect the national average price of gasoline to be $3.41 / .76 = $4.49.


DropClip LLC said...

Good post. I thought you might enjoy the angle I take on the subject on Pardon the Information

justin said...

I heard on NPr that in Europe taxes on gas are around 50 - 60%...while here in the US it is like 12%...

So why did we not raise the tax then and so we could cut it now and save some people some money. I am not in favor of higher taxes, but does that make sense?

JTapp said...

Dropclip, thanks for the link.

Justin, as my previous post pointed out, putting higher taxes on gasoline is something that is long overdue. 9/10 economists are in agreement on that.

But, I wouldn't advocate cutting them now as that would just be a short-term fix. The increased quantity sold would simply allow more money to go Iran, Russia, etc.

And once you cut a tax one place, people want it cut somewhere else, it's politically impossible to raise again, etc.

Higher prices are tough and painful medicine, especially with our entire lifestyle built around an (artificially) low price of fuel, but people need to adjust and adapt. We've been sheltered for way too long.

HW said...

Good post, but I find it hard to except the premise that increasing taxes is the solution for anything. Sounds like a Democrat's plot to me.

Taxing us to death is a lot of the reason why the US is in the shape it is now. If the US were not so over extended on social programs, there would be plenty of money to invest in research for alternate energy programs. If the government leaves it alone and encourages the private sector to solve the problem, it will be done much more efficiently.

We have had a good run on cheap oil and gas, just like we did with cheap hay and the horse and buggy, now it is time to move on to something bigger and better. If we are lucky, someone will make a profit in the process.

JTapp said...

As I mentioned yesterday, higher gasoline prices have been anticipated for quite some time. The government would have been wise to begin phasing in a gasoline tax over a period of 10 years, as most economists have tended to support in the past year as the gov't has looked for ways to deal with climate change.
Would have reduced consumption (money going to Iran and terrorists via the Saudis) pollution, congestion, and created greater demand for more fuel-efficient vehicles sooner.

As you say, people will respond to incentives and begin inventing ways to increase fuel mileage and use alternatives. The water-to-gas hydrogen system is becoming a popular example.

SBVOR said...

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