MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

YOU DECIDE: Can economics explain gas prices?

By Dr. Mike Walden
North Carolina Cooperative Extension Service

Here we go again! After a respite during the fall and winter, gas prices are again climbing. It looks like they'll easily average above $3 a gallon this summer. And once again, there are questions about why, how and what to do about it.

So, as a professional economist, let me throw my two cents (or should I say $3) into the discussion about gas prices by addressing 10 questions that are on people's minds today. Here goes.

1. Why have gas prices risen all of a sudden this spring? There are really three answers here: warm weather, new environmental regulations and a tight oil market. When warm weather arrives, motorists drive more, and this always tends to push up prices. Adding a further wrinkle is that new environmental regulations are in place for gasoline, and at least for a while, this is causing some cost increases.

Yet more fundamental is the fact that world economic growth, especially from China, India and other Asia countries, is stretching oil supplies thin. Despite pumping record amounts of oil, usage is outstripping supply. This is a perfect recipe for higher oil prices, and when oil prices rise, so do gas prices.

2. Do oil companies manipulate oil and gas prices? Numerous studies have looked at this question, and the consistent answer is no. Instead, a better explanation for higher prices is supply and demand. When demand, or usage, increases faster than supply, the price of the product — here oil — rises.

3. Are consumers being gouged by gas prices? There's no economic definition of “gouging.” The price we pay at the pump reflects the fundamentals of the world oil and gas markets. Fortunately, relative to what people earn and spend, the cost of filling our tanks is not at an all-time high. Gas prices would have to rise to above $5 a gallon to equal the pain to our budgets caused by gas prices in the early 1980s.

4. Could a consumer boycott of any one oil company bring gas prices down? No, if consumers stop buying from one company and simply switch their purchases to an alternative retailer, total usage of gasoline will not have changed, so there will be no impact on gas prices.

5. Why is “old” gas that's already in the storage tanks priced the same as more expensive “new” gas? Because gas is gas. In other words, old gas is a perfect substitute for new gas. It doesn't matter when the gas was refined. If it's sold today, its price will reflect current conditions. It's the same reason that the price of a house today is largely independent of when it was built and what it cost to build.

6. Would price controls on gas help? While price controls could legally reduce gas prices, there would be a downside. Whenever price controls have been used, they result in less supply of the affected product. A shortage therefore results, which the government would have to eliminate with some kind of gas-rationing plan.

7. Aren't oil companies making obscene profits? In dollar amount, oil companies and their shareholders have seen profits rise. However, financial experts say the profit of any company should be measured in the context of how much money the company has invested in its operations. Measured in this way, oil company profits are still in a normal range.

8. Would increasing the tax on oil company profits help reduce gas prices? Probably not, and it might even do the reverse. Rising profits from selling any product motivate companies to make more of that product. Oil companies have dramatically increased their spending on oil exploration and development. Reducing their profits could curtail this activity and result in lower supplies and higher prices later.

9. Would gas prices fall if gas taxes were reduced? Yes, although likely not as much as the reduction in taxes if the lower price prompts motorists to drive more.

10. Why don't we just use gas alternatives? Price is the answer. To date, many gas alternatives couldn't be produced and marketed at a price competitive to gasoline. This is changing as higher oil and gas prices make more alternatives commercially feasible. One problem for developers of these fuels is whether oil prices will remain at their lofty levels. There are some forecasts they won't, and such uncertainly makes investors in the fuels nervous.

What do you think? Are these answers reasonable? You decide.

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Dr. Mike Walden is a William Neal Reynolds Professor and extension
economist in the Department of Agricultural and Resource Economics of North
Carolina State University's College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic outlook and public policy.
His You Decide column is provided every two weeks by the Department of
Communication Services. Earlier You Decide columns are available on the Web
at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm
Related audio files are at
http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html