Blogs Car Info Our Show Deals Mechanics Files Vehicle Donation

A Hypothetical Question about Free Markets and How Fuel Prices and Taxes Interact

@ Whitey: there was a lot of good, solid information in Mustangman’s post. At the very least, it was “on topic” W/R/T oil prices, and the extent which the oil production market is truly free, or an oligopoly. Why you chose to “shoot the messenger” is unfathomable.

Prices will always be where the demand curve and supply curve intersect. Suppose a $1/gallon tax is enacted. This would not effect the demand curve: at $3/gallon, consumers would still want the same amount of gasoline they always have…where the money goes AFTER they pay it is irrelevant to the consumer.

What would change is the supply curve. At any price, the amount of gasoline supplied to the market decreases (there’s less money to be made), which corresponds to a leftward shift in the supply curve.

The equilibrium price–the price at which supply and demand curves intersect–would move leftward and upward: less product sold, at a higher price. The extent to which the change is one of increased cost, versus reduced numbers sold, is termed ELASTICITY OF DEMAND. The more elastic demand is, the more change is one of less sold; the less elastic, the predominant effect is higher price, with little reduction in amount sold.

Long-run demand tends to be more elastic than short run: SR, you’re sorta stuck, but LR, you can do things like sell the gas hog for a Prius, move closer to work, etc.

IT SHOULD BE NOTED THAT CALIFORNIA IS ABOUT TO PUT DEMAND ELASTICITY TO THE TEST! Gov. Schwarzenegger signed into law a measure that would tax gasoline–the exact amount to be determined–until demand for it stabilizes at 1990 levels. That is, they’d tax gas, and keep increasing taxes, until demand drops to where they want it to be…

"Gov. Schwarzenegger signed into law a measure that would tax gasoline–the exact amount to be determined–until demand for it stabilizes at 2007 levels. That is, they’d tax gas, and keep increasing taxes, until demand drops to where they want it to be… "

YIKES! What a nightmare! Folks that wrote that law must think the economy is just a finely tuned machine, adjust a knob here (gas tax) get a desired output there (precise decrease in consumption). As we’ve seen over the last 10 years, economies are often UNSTABLE, with seemingly minor changes causing wild swings elsewhere…

Let’s say, hypothetically, we live in a completely unregulated free market, and the federal government decided not to tax fuel anymore. Would the invisible hand of the market react by automatically raising the price of fuel by the amount of the federal fuel tax (18.4 cents per gallon)?

I’m no expert and I’m not going to provide data to back it up so feel free not to take me seriously…

In a free market with stiff competition among providers, the price is set by a minimum amount of profitability for the business to remain viable. Barring the occasional price war to weed out competition, the price is fairly well evened out by the time it gets to the consumer.

Look at gas stations now, if one is 5 cents less than the one next to it, it is packed and the other one a virtual desert. There is way too much competition to allow one to raise prices over the next and remain in business for long.

If the tax were to magically disappear, the price would drop accordingly, because one station would be looking to get a leg up on their competition and they would all have to follow suit. Unless they were in collusion to fix prices, the price would always be kept as low as possible and still make a reasonable profit.

The price of a product is not where the supply curve and demand curve intersect, it is where they are furthest apart (if profitable) or closest together (minimizing loss as with gasoline). Where they intersect is a zero profit point. The supply curve can change quickly as there are only a few oil companies supplying gas anymore. A change in the tax will have an immediate short term affect, though not necessarily a linear affect. Over the long run though, it has much less affect.

The demand curve changes more slowly. If the price goes up too dramatically, we can see a small drop in consumption as people eliminate unnecessary trips, but we stall all need to go to work, get groceries and run errands in out vehicles, so the change is usually small. But when gas goes up, those in the market for a new vehicle will look more closely at the gas mileage figures and that has a slow but long term affect on the demand curve.

But the oil companies can’t cut production too much because the profits on a barrel of oil are in other products. If they cut back on gas production, they loose money on the other products, so in effect, the supply curve is affected more by the demand curve for the other products than the demand curve for gasoline. Gasoline is a hazardous waste byproduct they have to get rid of.

Raising gas prices too quickly is not in the oil companies or governments best interest. It may sound good to the tree huggers, but is not a good economic policy. Economics will win out over the environment almost every time.

Driving to Baltimore last week I observed the price of regular range from $3.09 to $3.65 in Maryland while Tennessee, Alabama and Virginia prices were more narrowly ranged from $3.09 to $3.35. Soon after filling the tank in central Virginia and paying $3.35 I passed a large Pilot market that advertised $3.09 and wondered how far I would drive to save $2.60 for 10 gallons.

3.09? now I m mad!

@meanjoe75fan, I went back and look to see which of Mustangman’s posts I flagged as off topic. I can’t find it. I did flag a couple other posts as off topic because they bear absolutely no relation to the question I asked.

Look, I go off topic sometimes too, so I don’t claim to be perfect. However, I deliberately made this a hypothetical question about a 100% free market so we could discuss economics without engaging in political bickering. I went out of my way to make this a non-political conversation, and yet some people insist on injecting politics and other off topic conversation anyway. Like I’ve said before, if we were in person having a conversation about economic theory, and someone injected himself into the conversation with an off topic subject, we would consider that behavior rude, because it is rude.

whitey, you are the rudest person on the board, IMHO. with the possible exception of me.

Well, that was constructive… not.

If you want to call me out for something I do that is rude, I wonder why you wait until I’m conversing with someone else to do it. I also wonder why you only engage in name calling without attempting to discuss the issue in a civil manner.

that’s funny. you ve gone back back four weeks and just started flagging me. lol

I ll add childish and hypocritical too.

flag away

I wish I knew what you’re talking about.

I’ve been giving you a wide berth until now in the hope of making peace. I read something that I thought was off topic, and I flagged it as such. If you think that is childish, so be it.

@wesw and @Whitey, If you’ve got differences you would like to sort out, feel free to do it privately. If part of the disagreement here is about being off-topic, going down that road will derail it altogether, and I’ll have to close it. But for what it’s worth, Whitey, your response to Caddyman came across quite harshly. He might not have answered the question you asked, but that doesn’t mean it was due to a comprehension problem. Also, Wes, that didn’t make it any more OK to name-call.

Close it anyway. Before wesw started name-calling, the conversation was already off topic.