2011-4-21-3Qs--Paradox-at-the-pump

Paradox at the Pump

3Qs with Assistant Professor of Economics Zhongmin Wang
April 21st, 2011

Gas prices nation­wide con­tinue to surge. The Energy Infor­ma­tion Admin­is­tra­tion reported that at an average of $3.79 per gallon for regular gasoline, prices in the United States were nearly a dollar higher last week than they were the same week in 2010. Zhongmin Wang, an assis­tant pro­fessor of economics at North­eastern Uni­ver­sity, is an expert in strategic pricing behavior in var­ious gaso­line mar­kets. Here, he dis­cusses the ebb and flow of gas prices throughout the year, why they are at record highs, and their economic impact.

What fac­tors play a role in deter­mining how gas is priced? Why are gas prices approaching record highs?

The retail gaso­line price that con­sumers pay at the pump reflects the costs and profits of refiners, dis­trib­u­tors, and retailers, as well as fed­eral, state and local taxes. Envi­ron­mental reg­u­la­tions also affect gaso­line prices some­what by inducing or forcing the use of ethanol and “bou­tique” gaso­line blends. Here, the cost of crude oil is by far the largest and most vari­able com­po­nent of gas price. Gas prices are approaching record highs because the crude oil price is approaching record highs.

What periods throughout the year do gas prices tend to peak and why?

Gas prices tend to be highest during the summer and lowest during the winter. This sea­son­ality in gaso­line price is due to simple demand and supply. First, people drive more during the summer, which increases the demand for gaso­line. Second, it is more expen­sive for refineries to pro­duce summer gaso­line blends than winter gaso­line blends. Summer gaso­line blends, due to a lower vapor-​​pressure allowance, can only have a small pro­por­tion of butane, a rel­a­tively cheap and abun­dant blending com­po­nent that has a high vapor pres­sure. Increased demand and cost both cause gaso­line prices to peak in the summer.

How will increased gas prices affect the economy in the short– and long– term?

Higher fuel prices hurt the economy in the short run. Having to spend more money on fuel, people have less money to spend on other things, and fuel-​​dependent businesses—such as airlines—may earn less profit. How­ever, high gaso­line prices are not all bad for the economy in the long run. This is because con­sumers and firms make adjust­ments to higher fuel prices, which may ben­efit the economy over time.

As gas prices go up, con­sumers have greater incen­tives to drive less and buy more fuel-​​efficient vehi­cles. We as a society would be better off if we drove less than we do now.

Most of us do not take into account the fact that our dri­ving leads to pol­lu­tion, con­ges­tion, and noise, as well as energy con­sump­tion. This is one of the ratio­nales used to jus­tify very high taxes on gaso­line in some Euro­pean coun­tries. In the U.K., for example, gaso­line prices are over $9 per gallon because of high gas taxes. Eco­nomic research sug­gests that it would be better for the nation if the U.S. gov­ern­ment were to increase gaso­line taxes, albeit not to the U.K. level. High fuel costs also offer busi­nesses stronger incen­tives to pro­duce fuel-​​efficient vehi­cles, adopt fuel-​​efficiency tech­nolo­gies and to invest in alter­na­tive energy sources.

by Kara Shemin


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