Question

What's Right With Gas Prices

The Wall Street Journal - February 25, 2012

It is always pitiful to see a president of the United States in the grip of energy panic, uttering desperate nonsense about gasoline prices.

President Bush did it, with his temporary insanity over switchgrass. President Obama is doing it, though his condition might be better described as temporary sanity. He who once would stop the oceans from rising by getting America off oil now wants credit for boosting America's production of oil. In the 2008 campaign, Mr. Obama may have denounced President Bush for offshore drilling. Now his munchkins can't fill our inbox fast enough with spam crediting Mr. Obama for offshore drilling.

Let's look at today's price. At $3.65 a gallon, gasoline has reached a price, in real, inflation-adjusted terms, it has reached only a few times in history. It reached a similar price in the last year of World War I, during the global trade breakdown of the '30s, after the Iranian Revolution in 1979, and amid the extended instabilities that began with the Arab Spring, continued with the U.S. withdrawal from Iraq, and are reaching a pitch with today's war talk over Iran's nukes.

The price of gasoline has always fluctuated in tune with global events. That was true even during the longish period in the last century when the U.S. was the world's dominant oil producer, and indeed could satisfy its needs domestically. If that does not put the faulty ideal of "energy independence" in a curative perspective, nothing will.

Today price volatility is assumed to be an aberrant product of the world's reliance on Mideast oil, but it may not be so aberrant. When the U.S. was dominant, its politicized behavior also created chaotic pricing at times. Reserves of fossil energy are distributed widely around the world; the Mideast today plays its central role (as we once did) only because its production costs are the lowest and thus, in a rough sense, determine what everyone else's oil is worth.

QUESTION:

1. Suppose there is a disruption on a substantial amount of supply in the gasoline market. If the gasoline market is perfectly competitive, will a gasoline shortage result? Explain your answer.

2. Is the price mechanism of a perfectly competitive market a good mechanism to allocate gasoline? Is it good during periods of very high gasoline prices? Alternatively, during periods of very high market gasoline prices, should the federal government place a price ceiling on gasoline? Explain your answer.

Answer 1

a. There will not be a gas shortage. Once there's a pause on a substantial quantity of supply within the gas market, the provision curve will shift to the left.

The demand curve won't change. The recent equilibrium will not exist. A replacement equilibrium are created at a lower amount and higher value.

b. Yes, because price mechanism under perfect competitive market will make the sellers and buyers to allocate gasoline in a optimum and efficient way.

As all the firms are price takers in perfect competitive market, this mechanism will help during periods of very high gasoline prices. As it will keep an equilibrium price in the market.

Under perfect competitive market, there is no need for government to fix a price ceiling because here price is fixed by the forces of demand and supply.