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Monday, October 03, 2005

The gas market

Recently Fox News's Bill O'Reilly's made comments about gas prices, and wanting to find the individual who sets such prices. I found such a notion to be laughable and bit unnerving. Gas prices are not dictated by an individual or small group (clandestine or otherwise)--it is part of a market exchange. First, let me explain how prices at individual gas stations are set in a practical way that non-economists (including O'Reilly) can understand: gas stations receive the price of gas that they will pay their distributors. They then set their prices accordingly to make a profit from the gas. No "Gas Czar or some warped version of the Federal Reserve's Board of Governors. The station/distributor exchange is part of the market--supply and demand. Right now, in light of the natural disasters along the Gulf Coast, supply has been decreased, meaning the quantity demanded has increased, and price has increased.

Even before the Gulf Coast hurricanes, demand for gas has increased dramatically, especially in demand from China. Taken with American demand, there will be a price increase, along with an increase in quantity supplied. In short, gas prices are part of the market. People want prices to decrease, but the only we are going to see a significant decrease is if driving habits or the cars people drive change.

I was also uncomfortable with O'Reilly's implication that gas companies are raking in cash at the expense of "victimized" Americans. First, there are no victims in a market, as they are voluntary. Second, as was pointed out in "Anonymous's" post, $3+/gallon does not necessarily equate to $95/barrel. O'Reilly did not take into account the fact that many refineries are off-line and possibly damaged and in need of repair. Second, O'Reilly seems to think that there is some sort of market failure because gas companies are (supposedly) making astronomical profits from price gouging. Perhaps I am reading too much into O'Reilly's comment, but I there are those who do not understand basic economics and believe that we need price controls--ceilings imposed by the government. However, that will do nothing in the long-run to bring down gas prices; all it will do is end up creating shortages reminiscent of the 1970s-1980s. I do not think that high profits necessarily equal price gouging and think that government investigation and intervention (especially in the form of price ceilings) is pointless from an efficiency standpoint. Markets are self-correcting. Should prices get too high, consumers will change their driving habits and/or drive more fuel efficient-cars, bringing prices down. As the Gulf Coast starts its recovery from the hurricanes and the factors of production once again bring about greater supply, the prices will fall (as we are seeing today). In short, gas prices, though high, are just from the supply and demand interaction of the market.

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