Tag: gas prices

The economics of gas prices

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Gas prices at my local gas station have recently dropped to $2.20/gallon. It seems as though back in August I was paying about $3.15/gallon. In that time, gas prices have dropped nearly a dollar a gallon and I am at a loss for understanding it.

Economics was never my strong suit, but I understand the basics of supply and demand, or at least I thought I did. As supply dwindles, and demand increases, price has to increase as well. As inventories loom large and demand falls off, price has to drop. Maybe I’m oversimplifying a bit.

Oil is a primary ingredient of gasoline and in summer months, the demand for oil, in the form of gasoline increases as poeple plan summer vacation. Some people drive and others fly but we are told that the demand for gasoline skyrockets during summer months. If gasoline were more scarce, I could see prices rising rather dramatically, but it seems to me that the demand for gasoline in the summer months is usually met without any kind of supply crisis. So what I don’t understand is if increased supply meets increased demand, price should remain the same, shouldn’t it?

Now that summer is over, demand for gasoline is dropping and supplies can be cut back. Prices therefore can drop with the diminishing demand until they stablize at a lower level. This seems to be what is happening now, but it still doesn’t make sense why the prices increased in the first place. People often point to the oil companies as being the ones who arbitrarily raise prices because people will pay no matter what. I was skeptical of this, but lacking a better explanation, I am beginning to wonder if there isn’t some truth to this. Other products whose price is tied to supply and demand don’t seem to fluctuate nearly as much as the price of gasoline. Take milk for example, or the price of a pound of bananas.

I’m anxious to get to the gas station to pay just abotu $2/gallon to buy gasoline. But I drive so infrequently that I can go a month or more between fillups. With the way gas prices fluctuate, gasoline could be back up over $3/gallon before I need to fill up again.

The high price of gas

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Once again, gas prices are climbing and approaching all-time highs and that is good.

It is not good for the commuter, of course, especially those of lower incomes who, having to choose between medication for their children or gas to get them to their job, can ill afford to give up either. But it is good, nonetheless, for oil company executive and those of us who can peer into the future with the bigger picture in mind. And in fact, in the long run, it is better for us far-seers than it is for the short-sighted oil company executives.

This is, perhaps, a peculiar outlook for a lifelong Democrat, but it makes perfect sense as I shall explain.

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“Relatively” cheap gas?

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I don’t put gas in my car much any more. In fact, I average 41 days between refuels, which suits me and my wallet just fine. However, I drive past my local gas station on the way to the train station each morning, and I take mental note of the price of gas. I believe I have noted a strange phenomenon–one that presents a chink in the armor of gas pricing.

Ordinarily, the price of the three types of gasoline sold at the station near my house differ by about 10 cents each. Thus, if 87 octane is $2.50, 89 octane is $2.60 and 92 octane is $2.70. Now let’s set aside for the moment why anyone who doesn’t drive a Ferrari would buy anything other than 87 octane gasoline and instead focus on price differentials. These differences are for the most part, consistent from station-to-station across the board. The differences would imply higher manufacturing costs and/or lower demands for the higher octane gasoline, which is priced higher because of its better “anti-knock” quality.

This morning, however, when I passed my local station, I noted the prices were as follows:

87 octane: $3.11
89 octane: $3.25
92 octane: $3.29

This is suspicious to me. Why, I asked myself, has 89 octane suddenly become “cheaper” relative to 92 octane? Where before, there was always a consistent 10 cents difference, this morning there was only a 4 cents difference between the two flavors. One might argue that it is because the price of gas is high to begin with and this is a way of making the higher octane gasoline more palatable to the ignorant consumer who would buy it in the first place.

But I ask, if one octane level can be priced only 4 cents cheaper than another, doesn’t that imply that there really isn’t much of a difference in the manufacturing and production costs in the first place? Does that seem to indicate that the pricing of gasoline is much more arbitrary than what the oil companies would have us believe?

I don’t know. Maybe I am missing something. Afterall, economics was never a strong suit of mine. But it sure seems suspicious and I wonder why more people don’t pick this up. (Of course, you have to be able to subtract two numbers in your head in order to recognize this, so that might explain why.)