Volatile gas prices have taken center stage in the media as the national average for a gallon of gasoline has swung from nearly $4 a gallon nationwide, to just under $1 in the wake of the COVID-19 pandemic.

Before the pandemic, geo-political tensions, hurricane seasons, flooding in the Mississippi, and increased travel demand during the summer driving season were forces pushing prices higher. At the individual level, higher gas prices mean that each of us pay more at the pump, leaving less to spend on other goods and services. But higher gas prices affect more than just the cost to fill up at the gas station; higher gas prices have an effect on the broader economy. Meanwhile, when gas prices fall, it is cheaper to fill up the tank for both households and businesses, and really eases costs on transportation-focused industries like airlines and trucking - but it also puts a damper on the domestic oil industry.

In general, higher oil prices are a drag on the economy, and so here we will focus on some the direct and indirect negative effects of high gas prices.

Key Takeaways

  • When gas prices rise, it can be a drag on the economy - affecting everything from consumer spending to the price of airline tickets to hiring practices.
  • Gas is an important input for transportation, which directly impacts households as they drive, but also businesses who rely on logistics and transportation chains around the globe.
  • If discretionary spending is hampered by higher gasoline costs, it can have knock-on effects throughout the broader economy.
1:20

How Gas Prices Affect The Economy

Recent Periods of High Gas Prices

Image
Image by Sabrina Jiang © Investopedia 2020

Retailers

A side effect of high gas prices is that discretionary spending of consumers goes down as they spend relatively more of their income on gasoline. Higher prices also mean that shoppers will tend to drive less - including to places like to mall or shopping center. Indeed, academic and industry studies provide support for this, showing that driving miles are directly tied to gas prices. While shoppers may not drive, they do switch to online shopping more when gas prices rise. According Marin Software, searches for online shopping do increase dramatically along with an increase in gas prices.

However, all retailers are further squeezed as they are forced to pass on the higher expenses that they themselves experience, which are associated with increased shipping costs to consumers. Anything that has to be shipped or transported - from apples to electronics - could cost more as gas prices rise. This is especially true for products, or components for products, that are manufactured overseas. Likewise, many products that contain plastics or synthetic materials are based in part on petroleum and refining. Higher oil prices means higher prices for these materials too.

Public Transportation

Higher gas prices can result in noticeable increases in some public transportation ridership. Shared and public transportation may become more appealing if gas prices continue to rise as it provides a more cost-effective alternative to sitting in traffic with expensive fuel in the tank. As a historical example, according to the American Public Transportation Association, the Raleigh-Durham-Chapel Hill region of North Carolina saw an 18% increase in riders for the express bus that connects the three cities during April, 2011, compared to the same month in 2010 - a period that saw gas prices rise sharply. Likewise, during the same period, riders on New Mexico's Rail Runner, a commuter train that provides service between Santa Fe and Albuquerque, increased by 14%.

Not all commuters have the flexibility to make this decision, but for some it has provided a welcome opportunity to save on weekly commuting expenses.

Auto Industry

The automobile industry has historically responded to rising gasoline prices by using these periods as opportunities to manufacture smaller, more fuel-efficient cars, such as hybrids and, most recently, all electric cars that can travel up to 250 miles between charges. Consumers have largely supported this move; sales of hybrids and all-electric vehicles in the United States has been on a strong upward trajectory since 2010, while sales of gas guzzlers like large trucks and SUVs have lagged behind.

Airlines

The largest operating cost for airlines, on average, are the companies' fuel expenses and those expenses related to the procurement of oil. Fuel costs are such a large part of an airline's overhead percentage-wise that the fluctuating price of oil greatly affects the airline's bottom line. When gas prices rise, airlines are forced to increase the price offered to travelers for flights, which may discourage non-essential air travel and put a further burden on consumers' wallets.

To protect themselves from volatile oil costs, and sometimes to even take advantage of rising gas prices, airlines commonly engage in the practice of fuel hedging. They do this by buying or selling the expected future price of oil through a range of investment products, protecting the airline companies against rising prices.

Jobs

Job growth is carefully watched as an indicator of the recovering economy. And some economists warn that rising gas prices could negatively impact an economic recovery in terms of hiring practices. Rising gas prices may force some businesses to re-evaluate their hiring plans, holding off because they are uncertain about the economy's health. Less discretionary spending results in decreased sales, both of which can influence a company's ability to hire.

New Jobs and Freelancers

Many job candidates have to weigh prospective positions against the costs associated with the commute. Some workers who have been offered new jobs have been forced to turn down the position simply because the costs to get to and from work would eat up such a large percentage of the salary. Freelancers can also be affected by higher gas prices, limiting the geographical region in which they will do business because commuting costs make it impossible for some gigs to be profitable.

The Bottom Line

Though economists and analysts may argue about the extent to which gas prices have an effect on the economy, there is, at the least, a correlation between consumer confidence, spending habits and gas prices. A recent Gallup poll in the United States, for example, showed that individuals' views of the economy appear to be inversely correlated to the price of gasoline. As gas prices increase, a decreasing percentage of Gallup poll respondents felt that the economy is "getting better."