Elasticity Of Price For Gas example essay topic

Gas Price Elasticity The Energy Information Administration of the Department of Energy began tracking weekly gasoline prices in 1990 by means of a survey of 800 service stations around the country. The average retail price for unleaded gasoline posted its fourth record high during the week of June 12, 2000, increasing 5 cents a gallon to an average of $1.681. The price at the pump is higher than the same period last year by 56 cents and has risen 16.2 cents over the past month (Anonymous, 2000). How far will it rise? What will consumers do about the dramatic increases that are occurring with the arrival of each shipment? Price elasticity of demand would indicate that demand will fall as prices continue to rise, which in turn should result in a reduction of prices and a subsequent increase in demand.

Such may prove to be the case, but the scenario is an unlikely one. Prices have increased all over the country, but price increases in the Midwest have been even more dramatic than in other areas. Across the region, prices are averaging $1.874 for a gallon of unleaded, but that same product is well over $2 a gallon in many of the cities of the Midwest. Higher grades average $2.003 across the region, marking the first time that average prices have been so high in a specific region of the country (Anonymous, 2000). There is so much concern over the rising prices that apparently are continuing to rise without abatement that the Federal Trade Commission (FTC) has 'opened a formal investigation into soaring gasoline prices in some areas of the Midwest and will begin issuing subpoenas to oil companies by the end of the week' (Hebert, 2000; p. aol). Sen. Richard Durbin, D-Ill. believes that the oil companies will reduce prices right away once the subpoenas begin to appear, and the country's vice president has mentioned that collusion may be behind the oil companies' huge profits this year (Hebert, 2000).

The summer driving season always brings higher prices in response to heightened demand, but never to the extent seen this year. Of course the final cost of gasoline at the pump is affected by the price of a barrel of crude, but to a lesser extent than oil producers would have consumers believe. The price of crude accounts for only 30 percent of the final cost to the consumer (Brodrick, 2000 a). In 1981, the cost of crude accounted for 62 percent of the final cost at the pump. The difference today is that producers of crude have much less power over the final cost of gasoline than they did in prior years. The oil producing nations in the Mideast currently are meeting to discuss increasing production so that crude prices will decline from its current price of more than $30 a barrel to the region of $25 (Georgy, 2000).

The American Petroleum Institute reports that 32.6 percent of the final cost to the consumer is the refiner's share that covers the cost of refining and provides the oil companies with their profit (Brodrick, 2000 a). The government's share is greater, however. 'Taxes account for 37.4 percent of gasoline costs and averaged 41.5 cents per gallon in 1999, according to the institute. The federal government's share is 18.4 cents, and the state takes about 23 cents. Occasionally, local municipalities tack on an extra tax' (Brodrick, 2000 a; p. 000215 b). The price is further affected by locale.

The Midwest typically is one of the highest-priced regions in the nation because it is the most difficult section for transportation. Distance from refineries is prohibitive, and refineries are saying that the current high prices in the region have resulted from problems with using a pipeline that eases transportation costs. The retailer's price increase to the final consumer is between 4 and 8 cents a gallon, meaning that there is little option for the consumer to shop on price. Further, consolidation has been active in oil as in other industries.

A different brand name does not signify that the gasoline is being sold by different companies. BP owns Amoco; Shell has an alliance with Texaco. Exxon and Mobil have been merged for years. The end result is that there is little price competition at retail (Brodrick, 2000 a). Price increases are normal in the summer months as families pile into cars for the family vacation.

This year, there was additional price pressures as the industry recovered from the hard winter in the Northeast and Asia continues to recover from it currency crisis-induced recession. As people in affected regions have more discretionary income, they spend greater portions of it on gasoline for their own cars (Brodrick, 2000). William Berman is editor of Pump Price Report in Fairfax, Va., and retired energy director for the, and says that consumers get 'nervous' as gas prices rise. Conventional wisdom is that families indulge in 'fewer weekend getaways and long driving vacations with the family' (Brodrick, 2000; p. 000215d), but there is evidence that such is not the case.

Rather, Americans generally will not change travel plans unless gas is over $1.50 a gallon, which of course it is now (Brodrick, 2000). Even then, relatively few cancel travel plans. Unless there is a gas shortage so that availability is uncertain, Americans generally continue with their plans regardless of price. Gasoline generally is seen as a necessity.

Going to a family reunion once a year may be an option, but going to work each day is not. There is also no option for landscaping businesses and farmers to defer purchase in response to price. Higher prices encourage conservation, but they do little to change anyone's way of living or working. Were gasoline a greatly elastic product, then supply and demand would operate much more freely than they do. Here, it is clear that price does affect demand, but only after price reaches a high level and then does not affect individuals' plans all that much. Gasoline is a product with a low elasticity of demand (Anonymous, 2000; p.

Gas Price). There are several factors that could change the elasticity of price for gas, such as the availability of substitutes; the proportion of income that gas usage requires; and whether it is considered a luxury item or a necessity. There are few substitutes currently available, though there are alternatives available and expected to become more numerous in future years. California already requires that new cars being sold there incorporate some form of alternative fuel source. As more substitutes become available, the price of gas should become more elastic. Even though gasoline prices are their highest ever, gasoline still requires only a small percentage of a family's income.

This is another factor keeping gas prices less elastic, as is the view of gas being a necessity. Oil companies assured consumers that prices would revert to normal levels following the world oil shortage in the 1970's, but of course that never happened. Because the government controls more than 37 percent of the final cost, only 63 percent of the cost is open to being affected by market forces. Gas is a low elasticity product for the reasons discussed above; the wonder is that it does not cost even more at the pump.

Bibliography

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The Strategic Petroleum Reserve. US Department of Energy, Fossil Energy at web Cynthia E. (2000, February 15).
How do gas costs affect consumers? At web Cynthia E. (2000 a, February 15).
The cost of a gallon of gas. At web Michael (2000, June 20).
OPEC Prepares To Raise Oil Exports Again. Reuters at web H. Josef (2000, June 20).