Why you can’t affect the price of gasoline

Every time the price of natural gas rises, we hear many people around us attacking large oil companies. They are greedy monsters, they must be responsible for the high price of gasoline, and they are raping consumers for unfair and excessive profits.

Below you will see a recent chain of emails that blamed high oil prices on large oil companies. However, if we consider the principles of free market economics, it is clear that the author of this email has a serious lack of understanding when it comes to basic economics. If you have finished reading Economics 101, it’s time to wake up and understand the factors that really drive gas station prices.

Gas prices and oil companies

Excerpts from chained emails:
We can reduce gasoline to $1 per gallon!
Now that oil companies and OPEC countries have made us think that any drop in the cost of a gallon of natural gas is a transaction, we need to take proactive action to tell them that buyers control the market, not sellers.
We can do this without hurting ourselves. how? Because we all rely on our cars, we can’t just stop buying gasoline, but if we act together to force a price war, we can have an impact on gasoline prices.
This is an idea: For the rest of the year, don’t buy any gasoline from the two largest companies. If they do not sell any natural gas, they will tend to lower the price. If they lower their prices, other companies will have to follow suit. But to have an impact, we need to reach millions of natural gas buyers. It’s really easy to do.
Join the resistance movement!

Why does this email fail Econ 101

The author of this email text asserts and implies several things; in the next section, we will analyze each of them in an economic context. First, let us determine the assumptions of email:

  1. The buyer controls the market, not the seller (in other words, the buyer can control the price of the goods alone, or at least the buyer has more control over the price than the seller).
  2. Consumers can boycott an oil company without increasing the demand of other oil companies.
  3. There is no wholesale-level pricing and distribution in the gasoline market.
  4. Integrated oil companies are allied with OPEC (Organization of Petroleum Exporting Countries).
  5. The “price war” is not something that constantly occurs between competitors in a free market economy.
  6. It is unfair for oil companies to make so much money.
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Back to the basics of economics

Now let us analyze each of the author’s propositions based on economics.

1. Buyers have more control over prices than sellers: Incorrect.

The price of gasoline is not and cannot be determined by the buyer alone. The price of gasoline (just like any commodity) is a function of supply and demand.

This basic economic principle deserves a quick review. Figure 1 shows how the supply and demand sides determine the equilibrium price of a commodity. Please note the following:

  1. The axis of the chart is price and quantity. The slope of the supply and demand line (curve) shows the supply and demand of goods at a specific price. The intersection of the two lines establishes the market clearing equilibrium price (equilibrium 1 in the figure).
  2. If the demand for a good increases (the demand curve shifts to the right, D1 to D2), while the supply remains the same, the price of that good will rise (P1).
  3. When the price of a commodity rises, the supplier has the incentive to produce more of this commodity, and the supply curve shifts to the right (S1 to S2). The increase in supply establishes a new equilibrium price, that is, the overall sales volume is higher (Q1 to Q2)

In the context of gasoline price emails, buyers do not control gasoline prices like sellers. The market will always find an equilibrium price established by the level of supply and demand.

Supply and demand balance.

2. Consumers can boycott an oil company without increasing the demand (and prices) of other oil companies. Incorrect.

What this e-mail addresses is simply to transfer demand from one oil company to another. In the short term, this is likely to lower the prices of large companies, but as demand for its products increases, it will also raise prices for other oil companies. The economic laws of supply and demand and equilibrium pricing apply to individual companies and gas stations as well as the entire market. Therefore, regardless of whether the price of the big gas station across the street is reduced due to reduced demand, the X station will not reduce the price as assumed in the email, because the product demand of the X station has just increased.

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3. There is no wholesale pricing and distribution in the gasoline market. Incorrect.

The proposal in the e-mail does not change the overall level of demand in the market, it just shifts the demand from one company to another. In the long run, larger companies will sell their excess supply in the wholesale crude oil and crude oil product markets (due to the decline in demand for their products). Companies experiencing increased demand will buy the supply and compete with each other to establish an equilibrium price.

The crude oil and petroleum products (including gasoline) markets are very mature and liquid. Crude oil and refined products are continuously traded on the global physical and futures markets. The proposal in the email failed to recognize that total demand and total supply have not changed, and in the long run, gasoline prices will eventually approach their starting level. In the short term, consumers who boycott large companies will only hurt themselves by raising prices at competing gas stations.

4. Integrated oil companies are allied with the Organization of Petroleum Exporting Countries (OPEC). Incorrect.

Many people believe that oil companies have an influence on OPEC’s decision-making process. OPEC is trying to control the supply of oil, thereby controlling prices, in order to maximize the profits of its members.

Within OPEC, each member country is assigned a production quota. International oil companies operate independently of OPEC, but because OPEC controls a large proportion of world crude oil exports (supply is not consumed by producing countries), OPEC’s policies affect global oil prices. As shown in the figure above, if the demand for a commodity increases while the supply remains the same, the price of that commodity will rise (equilibrium 1 to P1). Although oil companies may benefit from OPEC’s supply restrictions, they do not participate in OPEC’s decision-making process. If OPEC (assuming its member states are capable) decides to try to increase oil supply, they are also vulnerable to OPEC’s policies to harm the world.

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5. In a free market economy, there is no continuous “price war” between competitors. Incorrect.

The email suggested that buyers should start a price war between competitors. In a free market economy, price wars continue to occur between competitors as companies try to maximize profits and drive competitors out of the market. Competitive pricing and the pursuit of efficiency are the grease that lubricates a free market economy. If a company believes that it can maximize total profits by lowering prices—which in turn will increase sales and thus total profits—the strong motivation for profits prompts it to do so.

Assuming that the company does not always try to outperform its competitors, it is against the laws of human nature and economics.

6. It is unfair for oil companies to make so much money. Incorrect.

The motivation to make profits is the reason for the operation of a free market economy. If you take away this incentive, you will take away market innovation and efficiency. Without a profit motive, capital will not face risks. Therefore, imposing a “windfall tax” on oil companies may result in a reduction in the amount of gasoline supplied by the company, which means that consumers may experience shortages.

If you deprive an oil company of the motivation to make huge profits, you also lose its motivation to make risky investments, such as exploring new crude oil fields and building new refineries. In addition, these large oil companies are listed companies, and their operations are for the benefit of shareholders. Anyone can freely buy the stocks of these listed companies-these investors hope to get a return on their investment.

Bottom line

In a free market, the relationship between supply and demand determines the price of goods. There are actually only two options for lowering gasoline prices: increase total supply or decrease total demand. If you decide to boycott a large gas company, in the short term you will only hurt yourself by paying higher prices on competitors’ pumps. In the long run, prices will find a balance through supply and demand adjustments at the wholesale level.

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