Friday, July 5, 1996

FISCAL FITNESS: Gas price greed?

ALTHOUGH THE RAPID RISE IN THE PRICE OF gasoline this summer is certainly a pain in the pocketbook, it may have been better than the alternative: Remember the gas lines of 1974?

The root causes of sudden gas price increases are often many and varied, but this recent price hike is similar to the one we experienced in 1990 when the troubles in the Middle East restricted the world's available oil supply. What dismayed many people at the time was that prices at the gas pump increased almost immediately as soon as there was a threat of a problem. Even before the refiners faced restricted supply or higher raw materials prices, they raised the prices of their products.

A lot of people at the time, especially politicians, called this unconscionable. Weren't the producers just exploiting an unfortunate situation? Not necessarily.

Consider what would have happened if the dealers had waited to raise their prices. Consumers watch the news. They could see that oil supplies were about to be curtailed. They could predict that prices would soon be higher, so they would stock up on gasoline as much as they could. That, of course, would aggravate the shortage.

For the good of the economy, it's best when prices rise as soon as there's a probability of a reduced supply.

A reduced supply necessitates a reduced demand. Far and away the fairest and most efficient way to reduce demand is through higher prices. Higher prices spread the cutback much more effectively than rationing, waiting in lines or first-come, first-served.

The greatest contribution of the price system is balancing supply and demand, and thereby eliminating shortages and surpluses. Either shortages or surpluses are extremely costly to the economy. Raw materials shortages, for example, can bring producers to a virtual standstill.

What economists refer to as the "price system" plays an extremely important role in the economy. The price system is basically the matrix of the relative prices of all goods and services in an economy. What's most essential in the price system is the relationship of one price to another.

When the price of a good is relatively high, that's an indication that the good is relatively scarce or costly to produce. The high price provides us with both the message and the incentive to respond appropriately to the message.

As is typically the case, some people blamed the latest gasoline price increase on greed. It's undeniably true that greed is a widespread part of the human condition, but greed isn't very useful in explaining a change in something. Using greed to explain rising prices would mean that for some reason greed has suddenly appeared. You can certainly argue, if you like, that oil company executives are greedy. But what basis is there for arguing that they are greedier today than they were six months ago?

In general, it's reasonable to work on the assumption that sellers set their prices as high as they can. Keep in mind, however, that they do not set their prices as high as they would like. Sellers compete for consumers' dollars, and consumers have a wide array of choices.

Even a casual look at gasoline price behavior will reveal that there is not a simple or direct relationship between wholesale and retail price movements. For example, when the 4.3 cent gasoline tax first took effect, there was very little movement in retail prices. That's an indication that supply and demand conditions were such that dealers simply did not have the ability to pass along the tax to consumers. Obviously, they would have preferred to do so.

I cannot tell you all the reasons why gasoline prices have risen so much recently. I can tell you, however, that the economic forces leading to the increase were real. You could almost say that we are fortunate that prices went up! Given the available alternatives, we are better off than if they had remained the same in the face of new realities.

The good news is that most of the factors resulting in the higher prices appear to be temporary. One such factor is that oil companies guessed wrong about crude oil prices and got caught with depleted inventories. That situation will correct itself before long. By this fall we will probably see gasoline prices significantly below their peak levels. If you postpone your vacation plans until then, you will help reduce the current demand for gasoline prices and hasten the price decline!

A former professor of economics, Ron Ross is a financial planner with Premier Financial Group, Eureka.


FISCAL FITNESS: Gas price greed? - North Coast Journal June 1996

Ron Ross Ph.D. is a former economics professor and author of The Unbeatable Market. Ron resides in Arcata, California and is a founder of Premier Financial Group, a wealth management firm located in Eureka, California. He is a native of Tulsa, Oklahoma and can be reached at

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