Gasoline, Regulation, and Economies of Scale

by Don Boudreaux on September 20, 2006

in Energy, Prices, Regulation

I mention again the gasoline-market paper (first mentioned here) — the one by the University of Illinois’ Andy Morriss and te Mercatus Center’s Nathaniel Stewart — in this column appearing in today’s Pittsburgh Tribune-Review.

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{ 6 comments }

John Booke September 21, 2006 at 8:39 pm

The government should put a cap on the price of gasoline. There is no fundamental reason why the price should double in one year. Its simply legalized larceny. Hyak would be rolling over in his grave if he thought his name was being used to condone this.

triticale September 21, 2006 at 9:36 pm

On a couple of occasions I have attempted to point out to people complaining about "Big Oil" that they would have to pay even more if they had to deal with "Small Oil" instead. The concept of economies of scale is outside their ken.

Don Boudreaux September 22, 2006 at 9:12 am

Mr. Brooke,

Whether or not Hayek was correct about this matter or not, he certainly would never have supported the use of price controls. My reading of Hayek differs entirely from your reading which tells you that he "would be rolling over in his grave" if he knew that the bloggers at Cafe Hayek opposed capping the price of gasoline.

Nosivad September 22, 2006 at 10:38 am

From having studied natural gas prices closely over the past thirty years, I am struck how people who advocate price controls on commodities, such as gasoline or natural gas, can overlook the dynamics involved. It has been demonstrated repeatedly that rising prices produce incentives for the exploration and development of new sources. When these new sources come on line, which can happen over a very short time period, the pressures on supply are reduced, and prices decline from the peak they reached during the prior situation in which increasing demand was driving the prices in light of the then current limited supply. Under these circumstances, price controls simply lead to lower supply, which leads to rationing and exacerbated shortages.

William Baumol pointed this out in his book "Super Fairness," where he observed that the effects of the Irish potato famine in the 1830's was exacerbated by the imposition of price controls on potatoes during the onset of the crisis. Had the prices of potatoes not been controlled early on, signals would have been sent that there was a need to curtail consumption of potatoes or import or produce more potatos early on, and more potatos would have been available in the latter stages of the crisis and fewer people would have starved.

In response to Mr. Brooke's assertion that "[t]here is no fundamental reason why the price should double in one year," commodity market experience demonstrates that a slight disparity between supply and demand can produce very large swings in prices, up to the order of two to three times. There is no inherent "fair" price for a gallon of gasoline or an mmBtu of natural gas. The prevailing price is a combination of many factors, but a major force is that in the short run, demand is fairly inelastic, leading to the potential for substantial volatility in prices. This is why the arguments against opening certain areas for exploration, such as the claim that the areas in the Gulf Coast currently closed to exploration or the ANWR will only provide increases supply equal to a few percent of national consumption, are misguided. It only takes a slight realignment of supply and demand in these markets to have a major effect on prices. A few percentage point increase in supply can have a substantial effect on reducing prices and stabilizing the market.

Dr Anjan Chatterjee September 22, 2006 at 10:50 am

Agreed price controls in any regime by any Govt is bad in letter and spirit, but what does the consumer do when the prices hit the ceiling and even fracture it with a bid to reach above it and then more and more—-.After all why should a cartel comprising oil producers and exporters and the speculators hold the whole world to ransom? Are their no checks? The world leaders need to devise mechanisms to apply brakes and arrest the whimsical highs of the gasoline prices.The economy of many nations go haywire meeting huge oil import bills. Must we as people and responsible citizens not also try to minimise the wastage of gasoline in our daily consumption and usage?

JohnDewey September 24, 2006 at 11:37 pm

Dr. Chatterjee: "After all why should a cartel comprising oil producers and exporters and the speculators hold the whole world to ransom?"

If this cartel had the ability to "hold the world at ransom", why did they allow oil prices to remain under $25 a barrel
for two decades after Reagan eliminated price controls?

Dr.Chatterjee: "The world leaders need to devise mechanisms to apply brakes and arrest the whimsical highs of the gasoline prices."

That was already tried. Price controls just lead to gasoline shortages and angry consumers. Were you around in the 70's?

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