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More on gas prices

Given the concerns about rising gas prices, Hillary Clinton chose to jump on board with John McCain’s proposal to waive the Federal gas tax over the summer.  As I mentioned previously, there’s no reason to assume that oil companies will pass these savings along to consumers, especially if, as Clinton proposes, the shortfall in revenue be made up through higher taxes on the oil companies.

Over at TalkingPointsMemo, David Kurtz discusses the issue.  In response to his post, one of his readers comments on the inelasticity of the supply of oil.  In a “normal” market, driven by supply and demand, competition tends to push prices down.  The lower your prices, the more you can sell.  The thing that sets the floor on your prices is your cost of production.  As you lower your prices, you increase sales because (a) people buy from you instead of your competitors (who are charging higher prices) and (b) people buy more of the product because it’s cheaper.  (Of course reality is far more complex than this.)

In some cases, demand is inelastic.  Lowering the price of toilet paper a couple cents is unlikely to make people consume more of it.  Raising the price doesn’t make people use a lot less.  Competition is likely to keep prices low.

In other cases, supply is inelastic.  And that’s the case with oil.  Right now, oil companies can sell all the gas they can produce.  Lowering the price of gas isn’t going to change the amount of oil they sell – it’s only going to reduce their profit margin.  There’s an upper limit that the market will bear, of course – the higher the price, the more people will switch to more fuel efficient vehicles, the more people will walk or take the bus, and the more people will skip non-essential travel.  Gas prices always spike in the summer because Americans travel more.  Higher oil prices are likely to cut back on travel and make people vacation closer to home.  Thus, higher prices are likely to damn demand, which is likely to reduce price spikes.

I’m just guessing here, but I suspect that cutting the gas tax will probably make people less likely to cut back on their summer plans.  And, of course, once they have taken the trip, they still need to get back.  So cutting the gas tax might actually increase prices.

The only real solution is to cut demand.  If demand falls, not only are we likely to reduce the amount of greenhouse gases that we are pumping into the atmosphere, it’s also the one thing that can actually push real prices down.  What’s interesting to think is that if the price of gas is determined by what the market will bear, then not only is reducing the gas tax likely to have no effect on the prices consumers pay for gas, increasing the gas tax should also have little effect.  Increase the gas tax and put the money into public transport and fast commuter trains.  Cut demand for real.  And then maybe gas prices would actually decline… (Yeah, I know, it’s not going to happen.)

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