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Thursday, April 26, 2012

Gas Prices and Greed

So what else is new?

When gas prices go up, people complain about the economy. Most of us buy enough gas week to week that a price increase of any notable size really hits us in the wallet. Not surprisingly, rising gas prices are an easy target for those who are frustrated with, or do not understand, market economies. Many people look for villains. Who’s responsible for rising prices and why?

The most common version of this complaint is that greedy station owners and oil companies are raising prices to profit at the expense of the public. Putting aside the fact that most station owners make just a penny or two per gallon (and some even lose money, making profit off their car washes and convenience stores), is greed really the cause? And if greed is the cause, how do we explain falling gas prices, such as the slight decline we’re seeing this week?

If greed explains rising prices, perhaps then falling prices are due to a sudden attack of altruism on the part of station owners and oil companies. Could it be that they have all had a change of heart and suddenly turned magnanimous and philanthropic? Perhaps they all saw a psychologist or a preacher and suddenly realized the error of their ways.

Greedy Buyers?

Or perhaps it’s the buyers who now are greedy! After all, one reason prices fall is that people buy less of a product, opting instead for substitutes or simply reducing their consumption. In the case of gasoline, people might be taking public transportation, carpooling, or buying more fuel-efficient cars. Why is their desire to get the most out of their resources any less greedy than the same aim of the sellers of gasoline? Why do those who blame greedy sellers for rising gas prices not also “blame” greedy buyers for falling prices?

We might ask all the same questions about speculation. The Obama administration calls for new regulation of oil speculators, arguing that such speculation has been driving up prices. Unfortunately for the President, the last 60 days have seen the price of December 2016 oil contracts in a steady decline. The very same speculators he blamed for driving prices up are now driving prices down. Have they too suddenly undergone a massive switch from greed to altruism?

Economists have long noted that one big advantage of speculation is that it reduces variation in prices by giving those who think a price will change in one direction or another the chance to profit from their expectations. And it is often forgotten that for every speculator who buys a futures contract with the expectation that prices will rise, there is someone selling that contract who thinks prices will fall. Blaming speculators for profiting from rising prices ignores the other half of those speculators who lose wealth when prices rise. It takes two to tango . . . and speculate. The same greed that drives prices up, drives them down.

The upshot is that explaining price changes and the effects of speculation by reference to “greed” is not likely to explain much at all. The reality of markets is that self-interest is omnipresent and thus part of the explanation of pretty much everything. Therefore invoking greed for a particular price hike adds little or nothing. Changes in gas prices can no more be credited to or blamed on greed than airplane crashes can be blamed on gravity.

Underlying Factors

Instead, we should be looking at the underlying factors affecting supply and demand. Longer run trends such as global economic growth and political instability will affect prices, as will shorter run factors such as the weather, the time of year, regulation, and changes in consumer behavior and inventories.

If it really is all about greed, what good are economists? Economic phenomena can rarely be explained by reference to intentions only. Market outcomes are the results of human action, yes, but not human design.

If we want to be serious about understanding movements in gas prices, or any other price, we need to get beyond the psychology of the actors and grasp how their intentions interact in ways that produce the patterns of outcomes we observe in the market. It is that task for which economists are uniquely suited.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.