Sunday, September 14, 2008

ECON 101: You Can't Have It Both Ways

Do a Google news search for "gas stations" and "running out of gas" and you'll find more than 400 news reports like this one:

NASHVILLE, Tenn.- Hurricane Ike's presence near refineries in the Gulf of Mexico, drove many drivers in the midstate rushing out to get gas and leaving many gas stations tapped out.

Along Stewart's Ferry Pike gas seekers saw one of three things at gas stations: long lines, gas pumps covered, or no gas at the station at all. Some of those gas stations with no gas have been placed on a waiting list by distributors because of the high demand.

Do a Google news search for "price gouging" and you'll find more than 2,000 stories like this one, also from Tennessee:

The
state of Tennessee has seen a significant spike in the number of calls reporting price gouging over the past 24 hours. Tennessee state law prohibits businesses from unreasonably raising prices on essential goods, commodities, or services in direct response to a natural disaster, whether the natural disaster happened in Tennessee or not.

Observation #1: Demand for gasoline has gone up due to panic buying by consumers "rushing out to get gas" at the same time as gasoline supplies are falling, or expected to fall. It's simple economics that when demand for a product rises at the same time that the supply of that product falls, prices naturally rise to reflect the change in market conditions. Market prices always transmit accurate information about "relative scarcity," and act as a truthful "scarcity-meter." Since gasoline has become relatively more scarce in the last few days, the price naturally rises.

Observation #2: There's the joke about the son who says to his father, "Dad, I want to grow up, and be a musician." The father says "Well son, you're going to have to make a choice, you can't have it both ways."

In the case of gasoline, you can't have it both ways: If you don't want gasoline shortages, and you don't want gas stations running out of gas, you have to let the price rise to ration the scarce supply. If you don't allow prices to rise and prohibit "price gouging," you'll have guaranteed shortages and stations running out of gas. But you can NOT have low gas prices and high gas supplies (inventories at stations) at the same time, in the face of rising demand and falling supply.

Observation #3: Buyers complain about high gas prices and many report "gas gougers," but it is largely their fault that gas prices rise, due to panic buying and "rushing out to get gas." Without panic buying, the prices wouldn't have risen as much.

Observation #4: Remember also that gas stations make most of their profits not on gas, but on the other items they sell inside (milk, cigarettes, groceries, etc.). When a station sells out of gas and has to close until the next delivery, it loses out on sales of items with the highest profits, so it would be natural to raise prices so that it can ration their current supply of gas until the next delivery, which might be days away.

18 Comments:

At 9/14/2008 12:29 PM, Anonymous SpinMan said...

I heard a news report yesterday about price gouging at a Holiday Inn. The report said the price doubled or tripled. In the next breath the reporter went on to say it was the last room available.

 
At 9/14/2008 1:54 PM, Anonymous thomas blair said...

Great observations. I'm down here in Huntsville, AL, right in the middle of it all.

It's unimaginably stupid to see accusations of price gouging while in the same breath acknowledging that supplies are severely restricted and will remain so for the next few weeks.

One cannot fathom the cognitive dissonance present in the minds of such people.

 
At 9/14/2008 3:35 PM, Anonymous Benji said...

Thanks for writing this excellent piece. Last night at work I had a converstion with co-workers where I inelegantly tried to make the same arguement. Unfortunately I was dealing with Democrats. Economics is eeeevil. lol.

 
At 9/14/2008 4:06 PM, Blogger Walt G. said...

I think another observation is the price you pay at the pump reflects the gas station owner’s forecast of how much he or she will have to pay for the next tanker load of gasoline. Many people fail to realize that the gasoline is paid for upon delivery; they think the current price should be based on the past wholesale price instead of the future wholesale price. I think this is the major reason they believe that they are being ripped off.

Customers buy ahead based on price anticipation when they believe the price will rise, so why shouldn’t gas station owners be able to do the same?

As an aside: I was hoping for diesel fuel and gasoline to be the same price. It is, but it went the wrong way: gas went up instead of diesel fuel going down. They are both currently $4.19 per gallon at my local gas station.

 
At 9/14/2008 6:13 PM, Anonymous Mike Slater said...

Brilliant post, Professor Perry. As always!

 
At 9/14/2008 6:18 PM, Blogger juandos said...

"Many people fail to realize that the gasoline is paid for upon delivery; they think the current price should be based on the past wholesale price instead of the future wholesale price"...

Good point walt g...

Shannon Love over at Chicago Boyz posted the following: "I’ll say it one more time for those who can’t be bothered to actually ask someone who owns a gas station. Gas stations set prices for the gas they sell today based on the wholesale price of the gas they will have to buy to replace it. Get it? The price you pay for a gallon today is the cost of the gallon the station will have buy to replace the one you just bought."...

Rich @ Shot Across the Bow also has a great explanation of how it works in his area of Knoxville: Gas Prices: The Real Story

 
At 9/14/2008 8:07 PM, Anonymous Anonymous said...

I'm having real problems following your argument.

You are claiming that gas stations are running out of gas because laws prevent them from raising prices.

But at the same time I seeing with my own eyes that gas stations across the board are raising prices.

Moreover, I'm seeing wide spread press reports of higher gas prices.

Now who am I to believe, your claims that anti-gouging laws are keeping prices from going up or my lying eyes that sees higher prices everywhere I look?

At least you are not as bad as they are at Cafe Hayek that cite two stations rasing prices from $3.50 to $5.00 and $7.00 as evidence that gas stations can not raise prices.

 
At 9/14/2008 8:14 PM, Anonymous Anonymous said...

Even the story above by juandos about Knoxville says gas prices in Knoxville are spiking.

So which is it? Your claims that the laws are keeping prices from going up, or the wealth of evidence, even by your supporters, that prices are risng?

 
At 9/14/2008 8:17 PM, Anonymous Anonymous said...

Your theory is that prices should rise to the point where the gas stations never run out of gas.

OK, why are we better off in a period of shortage with gasoline being left in underground tanks at gas stations rather than being transferred to people's gas tanks?

 
At 9/14/2008 8:54 PM, Blogger David Damore said...

Mark,
Under Observation #2
"In the case of gasoline, you can't have it both ways: If you don't want gasoline shortages, and you don't want gas stations running out of gas, you have to let the price rise to ration the scare supply."

The word "scare" was not picked up by spell check. Should be "scarce"

 
At 9/14/2008 8:59 PM, Blogger juandos said...

@ 8:07 PM says: "You are claiming that gas stations are running out of gas because laws prevent them from raising prices"...

anon @ 8:14 PM says: "So which is it? Your claims that the laws are keeping prices from going up"...

Hmmm, first of all who said anything at all about some supposed law regarding the raising of prices besides yourselves?

Are you two talking about the law of supply & demand?

Neither link had anything even remotely related to some law you two must know about but the rest of us don't...

Are you both vegetarians by chance?

 
At 9/15/2008 10:15 AM, Anonymous Anonymous said...

You are claiming that gas stations are running out of gas because laws prevent them from raising prices.

He did? I thought the entire point of the post was that prices are going up due to INCREASED DEMAND and NOT PRICE GOUGING.

 
At 9/15/2008 2:46 PM, Blogger Voice of Reason said...

The point of the observation is that people can't cry about gouging when they create the spike in prices. Mark is not saying anything about laws or regulations, he's merely highlighting the basic premise of economics law and demand. He is not claiming that prices aren't going up, we all obviously know this as fact. Gas stations have not raised prices high enough in some instances because it did not scare the masses into forgoing the gas stations. It is a very simple observation that a few of you have somehow turned into an opinion.

 
At 9/15/2008 2:47 PM, Blogger Voice of Reason said...

The point of the observation is that people can't cry about gouging when they create the spike in prices. Mark is not saying anything about laws or regulations, he's merely highlighting the basic premise of economics law and demand. He is not claiming that prices aren't going up, we all obviously know this as fact. Gas stations have not raised prices high enough in some instances because it did not scare the masses into forgoing the gas stations. It is a very simple observation that a few of you have somehow turned into an opinion.

 
At 9/15/2008 10:19 PM, Anonymous Anonymous said...

I drove from Houston to Austin north on 290 today (9/15) and there is no gas (or very difficult) to be found in Houston beltway area, which is a very large part of the metro. When I finally did find a station north of College Station, it was a 45 min wait to the pump, and that pump ran out while in line. Things got exponentially better towards Austin as I need to get back to trading (Internet+power) but to say that people aren't gouging (I say $5 gas at several places, even though supposedly we were well prepared for this storm and gas supplies were pre-positioned).

Finally, I'll make one last comment that some businesses have made a tremendous effort to get their pumps running if only on generators, like Valero, and other business, like Shell, have none nothing. Same with HEB groceries and their abilities to deliver ice, demonstrating their supply chain seems superior to FEMA.

Also, the hotel tax in TX is suspended by the Gov. for storm movers.

Yeah yeah, supply and demand, or screw your neighbor; call it whatever you want. What's a fair price for clean water? Because what you get out of the tap in Houston isn't ready to drink. Should I charge $40 for a case of water just because the line for FEMA water is 1000 people long?

The good thing is, most people have ignored the market dynamics and worked on a shared 'neighbor' basis. Instead much goodwill has been exchanged, call that what you will.

 
At 9/15/2008 11:57 PM, Blogger OBloodyHell said...

> One cannot fathom the cognitive dissonance present in the minds of such people.

I'm put in mind of a line from Heathers:

"Thank you [for those comments], Miss Fleming. You call me when the Shuttle lands."

In order to breach this unfathomable gap, you should undertake a study of victims of CRIS (Cranio-Rectal Insertion Syndrome). The most readily accessible population to study would probably be managers, unless a gaggle of liberals does not happen to be available.

 
At 9/16/2008 12:04 AM, Blogger OBloodyHell said...

> other business, like Shell, have none nothing.

...And perhaps that's because they don't want to bother with trying to sell gas at a price which business rules may require but would run the risk of being accused of gouging if they did.

BTW, if you know anything about the gas business, many stations are run by a local operator (often owning more than one station of a specific brand in that area) -- not all are corporate-owned -- who may be making that choice, hence your impression that "Shell" is doing this.

More likely, it's the owner-operator of the local Shell stations (probably the same one) who does not want to deal with the gouging accusation. Easier to shut down and write off the lost income.

 
At 9/24/2008 9:35 PM, Blogger Brenda said...

Gas prices should not be based on past or future prices, but rather on the price they paid for the gas they have. They should not go up until they get new shipments at a higher price. It is just taking advantage of people. I live in Charlotte, NC and when gas goes from $3.69 to $4.99 in on day something is very wrong. The one station that did not raise their prices because of what might happen, is the one I will buy gas at for life.

 

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