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Every time that gas prices take a jump, water-cooler talk increases and chain-letter-type emails circulate an idea on how to "strike back" at oil companies, which supposedly are responsible for the high price of gasoline and are earning unfair and excessive profits at the expense of consumers.
In this article, we'll break down and analyze one of these emails (and the basis for the water-cooler mumbling) according to the principles of free market economics to show how the common call to action in these grumblings lacks a basic understanding of economics. If you slept through Economics 101, it's time to wake up; you might not want to forward that email and continue the economic fallacy. (To learn more, be sure to check out our Economics Basics tutorial.)
Gas Prices and Oil Companies
Chain-Email Excerpt:
WE CAN GET GAS BACK DOWN TO $1 PER GALLON!
Now that the oil companies and the OPEC nations have conditioned us to think that any drop in the cost of a gallon of gas is a DEAL, we need to take aggressive action to teach them that BUYERS control the marketplace, not sellers.
We can do that WITHOUT hurting ourselves. How? Because we all rely on our cars, we can't just stop buying gas, but we CAN have an impact on gas prices if we all act together to force a PRICE WAR.
Here's the idea: For the rest of this year, DON'T purchase ANY gasoline from the two biggest companies. If they are not selling any gas, they will be inclined to reduce their prices. If they reduce their prices, the other companies will have to follow suit. But to have an impact, we need to reach literally millions of gas buyers. It's really simple to do.
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Why This Email Fails Econ 101
The writer/sender of this original email text asserts and implies several things; we'll analyze each of them in an economic context in the next section. First, let's identify the email's assumptions:
- Buyers control a marketplace, not sellers (in other words, buyers alone can control the price of a good or at least buyers have more control over prices than sellers).
- Consumers can boycott one oil company without creating increased demand at other oil companies.
- There is no wholesale level pricing and distribution in gasoline markets.
- Integrated oil companies are all in league with OPEC (the Organization of Petroleum Exporting Countries).
- A "price war" is not something that does not continuously happen between competitors in a free-market economy.
- It's unfair that oil companies should make so much money.
(Feeling overwhelmed by rising oil prices? Save a bit of money by following the tips presented in Getting A Grip On The Cost Of Gas.)Back to School With Econ 101
Now let's analyze each of the email writer/sender's propositions as listed above in the light of economic principals. 1. Buyers have more control over prices than sellers: False.
The price of gasoline is not and cannot be determined by buyers alone. The price of gasoline (like any good) is a function of both supply and demand. (For more insight, read Economics Basics: Demand and Supply.)
This fundamental economic principal is worth a quick review. Figure 1 demonstrates how both supply and demand determine the equilibrium price for a good. Note the following
- The graph's axes are Price and Quantity. The slope of the supply and demand lines (curves) show the amount of a good that will be supplied and demanded at a certain price. The intersection of the lines establishes a market clearing equilibrium price (Equilibrium 1 on the graph).
- If the demand for a good increases (the demand curve shifts to the right, D1 to D2), and supply remains the same, the price of the good will rise (P1).
- When the price of a good increases, suppliers have incentive to produce more of that good, and the supply curve shifts to the right (S1 to S2). This increase in supply establishes a new equilibrium price at an overall higher quantity of goods sold (Q1 to Q2)
In the context of the gas price email, buyers do not control the price of gasoline any more than sellers do. The market will always find and equilibrium price established by the levels of both supply and demand.
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| Figure 1 |
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