Here’s a letter to economics teacher Elaine Schwartz:
Hi Elaine:
Your daily EconLife series continues to educate and entertain. Thanks for doing it.
I write to endorse a different answer to the question that you pose in today’s episode, that question being “Why do gasoline prices rise faster than they fall?”
This price phenomenon is real, but I don’t believe that it’s explained by consumer ignorance, by lack of competition, or by the uniqueness of the elasticity of demand for gasoline. A more compelling explanation is offered by the late economists Armen Alchian and William Allen. In the 2018 edition of their famous textbook, they explain that “future goods can’t be brought backward to the present, while existing goods can be carried forward to the future by storing them.”*
In practice, when people today, witnessing a rise in crude-oil prices, come to expect that tomorrow’s price of gasoline will be higher than previously anticipated, much of today’s existing supply is immediately taken off of the market and stored for sale tomorrow. As a result, prices rise today – that is, quickly. But the situation differs when people today, witnessing a fall in crude-oil prices, come to expect that tomorrow’s price of gasoline will be lower than previously anticipated. Future supplies of gasoline have not yet been produced. Therefore, as Alchian and Allen say, future supplies “can’t be brought backward to the present” in order to put downward pressure on the price of gasoline today.
When tensions in petroleum-rich regions unexpectedly rise, everyone comes to expect that the price of gasoline in the future will be higher. So many existing supplies of crude oil are immediately withheld, pushing up prices at the pump immediately. But when these tensions unexpectedly ease, the anticipated future increase in gasoline supplies are today just that: anticipated. They don’t yet exist and so cannot be offered for sale today.
Prices at the pump thus take longer to fall than they take to rise.
In summary, the long-observed pattern of gasoline prices rising faster than they fall in response to changes in the price of petroleum has, I believe, an explanation as innocent as it is compelling – namely, the asymmetry in the ability to shift supplies of gasoline through time.
Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030* Armen A. Alchian and William R. Allen, Universal Economics, Jerry L. Jordan, ed. (Indianapolis, IN: Liberty Fund, 2018), page 265.
