Gas Prices and Some Econ 101

The supply of gas fell recently. Now, that phrase has a very specific meaning in economics: It means that sellers of gasoline now want more money for each gallon of gas they sell. I am not going to bother arguing about conspiracy theories. Instead, I am going to examine some ideas whose proponents claim will help reduce the price of gas.

The figure below shows our the starting point of my discussion:

[ Fall in supply causes price of gas to increase ]

Proposal: Eliminate the tax on gasoline

It is hard to see how this would help reduce the price of gasoline. A tax on gasoline purchases reduces the willingness of consumers to pay for each gallon of gas they purchase. Hence, getting rid of the tax would increase how much they are willing to pay per gallon. Or, in Econ 101, getting rid of the tax would cause the demand curve to shift up. As a result, both consumption and prices would increase:

[ No gas tax leads to higher prices, higher consumption ]

Proposal: Tax the windfall profits of oil companies

In the short term, this would only serve to reduce the profits of oil companies, and nothing else.

However, the oil business is a cyclical one: Remember the not so distant past when oil was ten bucks a barrel? Cutting the maximum profit oil companies can make in times of high oil prices without compansating them for the losses they incur on their costly investments would not encourage anyone to take the risk of sinking a whole bunch of money into new oil wells and refineries.

In the long run, such a policy would likely push the supply curve even further to the upper left corner of our supply-demand diagram, and thus cause prices to rise even more.

Proposal: Require all new cars to get at least 35 mpg

How much gas one consumes is determined by a simple formula:

 Gas Consumption = (Miles Driven) divided by (Miles per Gallon) 

Note that people choose how many miles they drive based on the cost to them of every mile. This cost has many components: Oil changes, tire wear and tear, but by far the most important component is the price of gas.

Replace your truck which gets 15 mpg with a car that gets 35 mpg, and the cost of driving each miles goes down, and you drive more miles.

Thus, whether getting a more fuel efficient vehicle means your overall fuel consumption will go down is far from obvious.

Second, consider the fact that the overall gas consumption by everyone is depends on the share of high versus low mpg vehicles on the roads. Suppose you are someone who absolutely wants to drive a Dodge Ram. If there are no more new Dodge Ram's, you won't just toss your current truck in the junkyard, and buy a Civic. More than likely, you are going to try to keep your truck going as long as possible.

Total gas consumption by all vehicles will be:

Gas Consumption using Low MPG Vehicles
    + Gas Consumption using High MPG Vehicles

where

Gas Consumption using Low MPG Vehicles =
    (Miles Driven in Low MPG Vehicles) / (Average MPG for Low MPG Vehicles)

and

Gas Consumption using High MPG Vehicles =
    (Miles Driven in High MPG Vehicles) / (Average MPG for High MPG Vehicles)

Note that requiring every new car to be a high MPG vehicle will increase both the number of miles driven in high MPG vehicles and the number of miles driven in low MPG vehicles. The net effect on total gas consumption depends on how long people hold on to their low MPG vehicles, and by how much they increase their driving when the cost per mile goes down due to higher MPG.

Conclusion

Every genius wants a quick solution to high gas prices. I am sure I will have no difficulty finding other wonderful ideas to add to this list.