27 October, 2005

You just experienced a basic lesson in economics

Isn't it funny that no one is complaining about the price of gasoline all of a sudden? Even North Carolina's attorney general has stopped rumbling about price-fixing, despite the fact that the gas stations have unanimously lowered their prices. Based on the loud protestations in those days after Katrina, you'd think that some shadowy cabal must have decided to lower the price of gasoline, which ought to be illegal.

Yet no one is complaining.

Anyone who's studied even the basics of economics understands why the price of gasoline has increased over the last few years; it's a simple matter of supply and demand. When the supply tumbles or the demand jumps, the price skyrockets. Over the last few years, China's economic growth has been consuming more and more of the world's oil, so that demand has increased, while supply has not been able to increase similarly. On the other hand, the hurricanes that recently slammed into the Gulf coast cut off all the supply. Besides the insatiable Chinese thirst for oil, we Americans are infamously reluctant to forego our SUVs; the lower supply and increased demand was a Situation Waiting to Happen.

It's true that the prices rose because of greed, yes, but this has a singularly beneficial effect of cutting down the demand. Higher prices force people to consume less; this cuts down on waste and encourages people to choose alternate products. It didn't surprise me to see a few more people riding their bicycles during those weeks that the price of gasoline remained above $3/gallon. This preserves the supply of the commodity.

Now that the price is back below $3/gallon, these bike-riders have mostly disappeared. Pity.

In general, rising costs are due not usually to price fixing, but to the fluctuation of supply and demand. This is especially true in markets that are subject to perfect competition, where the product is the same, regardless of the supplier, and there are many, many suppliers, or monopolistic competition, where different suppliers have slightly different products, and there aren't so many suppliers as in perfect competition. As far as I can tell, gas stations are a mix of the two: there is some difference between Chevron's gasoline and Exxon's, but most drivers don't care whether they buy their gas from Chevron, Exxon, BP, Crown, or the neighborhood shop. Mostly, they care about two things: price and the location.

Admittedly, there were some instances of price fixing during the recent price surge, and such things should be prosecuted ruthlessly. However, even our loud attorney general managed to uncover only one bona fide instance of price fixing. Considering the number of gas stations in the state of North Carolina, I'm not impressed. (I arrive at this figure of one prosecution based on what I have heard on the radio and read in the newspaper. It's possible he's uncovered more, but there has certainly been no indication of wide-spread price-fixing.)

Economics is one of the most important subjects our students should learn if they want to understand the modern world; in my not-so-humble opinion, it's more important than statistics, psychology, and a great deal of other courses that colleges list in their requirements for a degree. Paradoxically, it's one of the courses that even college-educated students can disregard and still obtain a degree; this includes students at my college. Worse, college students have an aversion to this one singularly important class. It's no wonder that people are so susceptible to conspiracy theories and political demagoguery.

These days, people are complaining about the windfall profits that the oil companies made. I am sympathetic to this complaint: capitalism works well when companies invest their profits into research and development, discovering technologies that improve the production and distribution of their product. If the oil companies don't re-invest their profits, they are hurting themselves more than anyone else.

After all, the recent price surge showed how the cost of biodiesel is not that unthinkable after all. If the technology ever gets there, biodiesel and methanol and the like will become viable alternatives, and corn, unlike petroleum, is a renewable resource. Thanks to the laws of supply and demand, we don't need petroleum, and time will prove it.

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