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Dear Editor:

Please allow me to respond to the myriad complaints I read and hear about gas prices and market pricing in general. The most recent letter to the editor on this matter contains three errors in economic thinking that are extraordinarily common and if paid heed to could result in the implementation of pernicious public policy.

Like many Americans, I love to drive and I use my car rather extensively to travel to work, to visit family, to go shopping or to enjoy my free time. As such, I would be made better off if the price of gas were less than $1.00 per gallon. That my last fill-up cost be $2.30 per gallon nonetheless has not caused me to lose my mind – low gas prices are not a birthright.

The first error is made when the writer asserts that, “the value of gas in their underground tanks … only changes when they get a new delivery with a new wholesale cost.” While there is a granule of truth to this, prices are also determined by what consumers are willing to pay for that product. The simplest analogy to help you understand this is to remember what I paid for a pack of Topps baseball cards when I was an 11 year old kid in 1985 – about 50 cents. In one of those packs (which contained about 10 cards – so each card cost 5 cents) I was lucky enough to land a Kirby Puckett rookie card! I have kept that card in a folder in my garage for nearly twenty years. While I might have been able to resell that card for 5 cents back in 1985, today I can fetch at least $12.99 for it . Nothing about that card has changed and I certainly did not receive a new card at a higher cost – so what is different about that card today than twenty years ago? Kirby Puckett became a Hall of Fame outfielder and many people now wish to collect that card – the demand for that card has increased. Should I be interested in selling that card, would one contend that I must sell it for what I bought if for? That would amount to a $12.94 charitable contribution from me to the purchaser of that card. Similarly, if a gas station can fetch $2.30 for a gallon of gasoline that was priced last week at $2.10 per gallon, then $2.30 is the market price of gasoline. If you compel it to sell that gasoline at a price no higher than $1.50 you’re forcing station owners to make a charitable contribution of 80 cents per gallon to each person lucky enough to get a gallon of gas before supplies run out. Why compel the owner of the BP station to extend such charity? Why not be angry at other citizens of Danville who can easily afford that 80 cent difference for not giving you the money to purchase your gasoline? It is the gas station owner’s important role as a merchant to adjust her prices so that her quantities demanded equal her quantities supplied. By doing this, and not intending to do anything else, she serves the long-run interest of the largest number of people by allowing the price of gasoline to convey the true value to consumers and producers throughout the market. She is, of course, free to extend charity to you, but the best way to do that is to give you cash, not to lower the price of gasoline.

Second, the writer asserts that since most gas stations in Danville charge similar amounts for a gallon of gasoline that this is price fixing. While the charge would be hard to substantiate, what a casual observer will note is that there are a multitude of gas stations in and around Danville , and it is very easy for drivers to move from one station to the next – they pass many in their daily commutes and casually take note of the prices. If the stations were indeed price fixing, then the incentives for any one gas station to lower its price would be enormous – I would certainly fill up there (I gas up at Kroger because I save 10 cents per gallon if I spend enough on food for a month) as would many others in Danville. Soon, all customers would fill up there, which may cause all other gas stations to lower their price – but at this lower price, gas stations will find that they can sell all the gas that they want, and still have customers wanting more – enabling them to increase their prices. If the other stations chose not to respond, they would lose all sales – but seeing that it sells all of its gasoline faster than it can keep it in stock, the initial low price seller can now raise her price and still satisfy the wants of her customers.

Third, the writer claims that the high pricing of gasoline, particularly in anticipation of, during, or after a natural disaster is price gouging. I’d first like to ask what the definition of price gouging is. I just read that a new Porsche Boxster S costs $53,000 – well beyond my means to afford it. Is Porsche gouging customers like me in its pricing of this car? The writer might object, “you don’t NEED a Porsche, drivers NEED gasoline.” When gas stations raise prices in anticipation of natural disasters, they are responding to the increase in demand for their product. These increases are useful in that they direct gasoline to its most highly valued uses. At a price of $3.00 per gallon, a person may choose to drive alone to seek refuge from a hurricane, but at a price of $6.00 she might decide that she can submit to carpooling – thereby making the gasoline that she was going to use available for people more desperate to use it – for example for a butcher to rent a refrigerated truck so he can prevent tens of thousands of dollars worth of meat from spoiling or being destroyed. As prices rise in response to this demand increase, this will stimulate producers to provide more of the product that is needed.

These three common errors are all rooted in a misunderstanding of how prices are determined. Prices do not simply represent what it costs to produce a product – if that were the case, my Kirby Puckett card would only sell for 5 cents. Nor are prices solely representative of how much people value a product – if that were the case a cup of coffee would cost a heck of a lot more than the $0.89 I spent at Speedway last week. Rather, prices reflect both marginal values to consumers and marginal costs to producers and discussing one without the other is pretty much like cutting material with a one-bladed scissor.

Those that complain about high goods and services prices need to ask themselves the question, “high prices are bad compared to what?” The fundamental economic dilemma that we all face is that our wants cannot all be completely satisfied. This scarcity problem is not solved by eliminating or manipulating the price system, which happens to convey information most efficiently to both producers and consumers, since some other method of allocation will surely arise in its place. Market prices are the great equalizer. Without market pricing, queuing might take place, goods might be distributed by lottery, by force, by political favor, or by some other means – all of which are at least as arbitrary as the underlying distribution of income. A poor family is no more likely to be politically connected or to secure a lucky lottery number than they would have the means of securing additional income. Rationing goods with market prices reduces to a minimum the role of arbitrariness of who gets a good or service – anyone who is willing to pay the market price for a good or service is as likely as anyone else to get that good or service, regardless of whom they are.

Writers like Mr. Jones are demanding that someone force businesses to sell goods below their would-be market prices. Among the countless problems that would arise from this coercion are (1) forcing false and misleading information upon the market; (2) stripping away incentives for suppliers to provide more of the goods in question; (3) encouraging black markets to arise; (4) forcing shop owners to substitute some arbitrary means of allocating their very scarce supplies among the very large number of people who can use these supplies (recall what happened during the gas lines in the 1970s – as an example, in my hometown gas stations sold memberships to customers because they were not allowed to raise the price of gas; (5) forcing shop owners to extend charity to customers.

Aside from the economic realities discussed above, there are practical considerations that might help place these price increases in perspective. The real price of gasoline has fallen by 6% since 1980 and has risen by only 40% since 1976 ( Energy Information Association) . Consumers today have many more choices about which car to buy and mode of transportation today than 25 years ago. Even if a car were to get only 20 miles per gallon and one were to drive 15,000 miles per year, even a 50 cent increase in the cost of a gallon of gas would result in a $375 higher gasoline bill per year, or about $7.21 per week (yes, the cost of other consumer goods might marginally rise as well, but space does not permit me to address all of the effects here).

Furthermore, an increased price of gas might be celebrated by supporters of a cleaner environment as it will encourage users to economize on their use of this resource. While higher gas prices certainly will induce oil companies to expand their exploratory efforts, they will also contribute to a more rapid pace of technological development in equipment that depends on petroleum products and the relative affordability of alternative energy sources.

Finally, writers like Mr. Jones ask WHO is going to do something about this. This question ignores the essence of a commercial society, no one person can do anything about this – gas prices are the results of millions of transactions between buyers and sellers of gasoline – each having their wants satisfied to the best of their abilities. There is no great conspiracy. There is little one person in a white house can do about this, aside from pressuring legislators to remove taxes from gasoline altogether, but I suspect that this action would be perceived as an attempt to further enrich his oil baron self. Would the President have similar vitriol directed at him if oil companies were lowering prices in order to line their pockets?

Michael J. Rizzo

Much credit is due Don Boudreaux for this commentary. You can read more about him at http://www.gmu.edu/departments/economics/boudreaux/.

Alfred Marshall should be credited with the analogy.

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