Tuesday, November 22, 2005

Never had one lesson!

Interesting how the dramatic drop in gasoline prices has gone practically unnoticed, considering how big of a deal it was not one week ago that Big Oil was raking in the profits at the expense of women, poor people and minorities? Ok, I exaggerated that last part. It chaps my hide how the press is bandying about claims of price gouging on the part of oil companies. Oh, businessfolk are not necessarily paragons of virtue, but I'd trust them farther than I could throw Teddy Kennedy.

Well, since this comes up every year, I'm going to do a quick explanation about why gas prices fluctuate the way they do. Then I can refer back to it without repeating myself. Oil companies, despite what you hear in the news, do not control the price of gasoline. It is the nature of the marketplace that they need to sell their goods at the market price. If they sell at too high a price, no one will buy their product and they will lose money. If they sell at too low a price, they also lose money because they are not covering their costs. The profit margin in a capital and asset-intensive industry like Oil and Gas is slim, even though it does amount to billions of dollars

I've drawn a basic supply-demand curve here. The point where the supply (blue) and demand (red) lines cross is called equilibrium (dotted line); where the price (P) of the good is set. Either line can slide back and forth horizontally as quantity supplied increases or decreases, or as quantity demanded increases or decreases. As demand increases, producers attempt to match it by increasing supply. If they can achieve this, the price stays the same. If demand outpaces supply, the price increases.

This essentially is what the curve for oil looks like. The supply line is more vertical because refineries currently produce at near 100% capacity to meet existing demand. This makes the oil market especially vulnerable to current events: weather, war, OPEC embargoes, that kind of thing. Say that the price before a hurricane in the Gulf of Mexico was at P1 and the supply was at S1. Once the hurricane hit and interrupted operations of oil companies in the region, the supply would decrease to S2 due to a reduction in quantity and the price would increase to P2. Notice that demand stays exactly the same.

This is not to say that demand for oil never changes, because of course it does, but gradually. Demand for oil is quite inelastic (meaning that it changes very little regardless of the price). The demand curve I drew in the second figure could be represented as much more vertical than it is, but I left it the way it is for instructional purposes.

I've had one economics class ever, in which this was explained to me by an ultraliberal economics professor. It was nice how he was able to effectively convey the subject matter without interjecting personal politics into it. If I can understand this, it shouldn't be too difficult for even the looniest of moonbats. The price of gasoline depends very little on the companies that sell it, and only slightly more on the government, and then only when the government manipulates the regulations and taxes on the companies that sell gasoline. More regulation and taxes mean higher prices for consumers. Is this clear?

4 Comments:

Blogger Rebekah bloody well said...

I'm inclined to agree with that. Bill O'Reilly almost had me convinced they were gouging, until he had Ben Stein and another financial expert on and wouldn't let them get a word in edgewise. Bill came across looking like an ignorant boor while their points made sense.

Also, I don't understand why nobody's going after OPEC.

22 November, 2005 21:25  
Blogger Robosquirrel bloody well said...

O'Reilly does have a tendency to come as an ignorant boor. I tend to avoid watching TV, because most of those talking heads annoy the crap out of me.

I'm curious what you mean by "going after." OPEC is full of thugs, sure, but U.S. anti-trust laws don't apply outside our borders; how would you suggest going after them? OPEC has 11 members--Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela; some of them we are on better terms with than others. I think maintaining good diplomatic relations with them is likely the key to dealing with them.

It's also my understanding that OPEC has been keeping their prices reasonable, though I can't back that up. They have a lot of control, even if they only control 7%(I'm unsure if this is still accurate) of the world oil supply, but those countries have changed a lot since 1973.

Curious what you think OPEC is doing right now and how we should go after them?

23 November, 2005 10:51  
Blogger Rebekah bloody well said...

Sure. I mean attacking and pressing and criticizing OPEC, like people are doing the gas companies. I don't have any concrete proof, but I wouldn't trust those Saudi Arabians any farther than I can throw them. Same for most of the other countries over there.

23 November, 2005 19:16  
Blogger Robosquirrel bloody well said...

Well, not that I think OPEC are a great bunch of guys, but do you think the unfounded criticism of oil companies is fair? How is unfounded criticism of OPEC any more fair? If OPEC is not nefariously tweaking supply to get prices up (which was why they were originally fomed, actually), then that seems a little harsh.

They certainly do set limits on production, which is necessary for market equillibrium. If they flood the marketplace, the price goes down and they don't make as much money. But in the past, when the limits were set artificially low, member countries broke with OPEC and took advantage of the increased scarcity to sell more oil. More often than not, the marketplace takes care of itself.

As far as trust goes, I don't care much for the current Saudi government, either, but most of the people who live in the Middle East are decent folk, believe it or not.

24 November, 2005 08:05  

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