Government Interventions and their Impacts on the Gas Pump Prices
Describe the Economic Issue
Gasoline prices often rise at the pumps sparking controversy about the industry (Peltzman, 2000). This rise creates conflict between drivers, retail stations, station owners and policy makers. Besides, the rise of gasoline creates much concern because the prices of most consumer products become affected by changes in gasoline prices (Castanias & Johnson, 1993). A different reason why customers may react so robustly to changes in gasoline prices is because they are aware that their demands do not affect price, since they are inelastic. Compared with most consumer products the amount of gasoline bought does not change significantly when the price shifts. This creates the need for government intervention. A government might opt to intervene in the price mechanism, mostly, on the basis of wanting to adjust the distribution of resources and attain what they interpret to be an enhancement in social and economic wellbeing. The chief rationales behind policy intervention include; need to correct market failure, to attain an equitable allocation of wealth and income and enhance economic performance.
Which Principles of Economics Apply?
Equilibrium arises whenever markets are liberated to decide on quantity and price. . Prices act as an instrument that guides both suppliers and demanders to the equilibrium point. Whenever decision makers, in the government, perceive the equilibrium price to be extremely low or high, then the regime may employ price controls, in an effort to intervene in the market. Such controls become ratified, so as, to stop prices from declining into intolerable ranges (Johnson, 2002). Factors that may cause worries, such as equality are, obviously, subjective and signify something that regimes must portray. In other words, regimes must come to decisions on the possible maximum and minimum prices. Control on price is essential since it can regulate a market’s actions. Prices acts, as an enticement, to purchase and vend. In case, a regime considers a price to be extremely high, it may limit the value from growing above a definite point by introducing an utmost price (price ceiling) on market commodities. Correspondingly, in case the value is extremely low, the regime might inflict a minimum price, also called floor price.
Hence, a space will surface between the capacity demanded and capacity supplied, whenever prices cannot attain the equilibrium. Consecutively, other trends happen whenever there is no correspondence between the capacity demanded and that supplied. Despite the fact that these slight effects are not directly linked to control on prices, such effects can be of an adequate degree and, thus, justifiable of interest.
Let us take a case where an utmost price is applied on a certain market. This market will be the marketplace for ordinary gas. This market may be portrayed by the following supply and demand model.
For this situation, we assume that 9.5 Liters of ordinary gas (represented by Q*) go for $1.45 (represented by P*). Let us assume that consumers ask the regime to mediate, in this economy. Consumers argue that the lofty price of ordinary gas affects persons in middle and low income groups more than persons in high income groups, since rich citizens have vehicles that need more octane than what becomes offered in ordinary gas. Let us take that the regime considers the pleas of these people, by putting a $1 price limit on ordinary gas, with no upper limit on the other premium brands. In this situation, suppliers and demanders may still consent to trade at whatever price they desire, although, this price must be less than the ceiling amount. The following graph demonstrates this ceiling.
Since it is not possible for the price to increase above $1, lawfully, suppliers and demanders have to work with this novel price. By examining the quantity supplied (Qs) at the $1 price, we can establish the number of suppliers who would supply according to the new price. Let us presume that the resultant amount provided is 0. 525 Million Tins of ordinary gas. Likewise, if we think about the demanded amount at $1, we will have a million Tins on demand. Apparently, demanders can not obtain all these Tins, since barely 0. 525million Tins get supplied. Hence, there will be a deficiency of 0.475 million Tins, due to price limits. Limitations on utmost price causes alterations in quantity demanded and that supplied, thus triggering deficiency of commodities.
In this case, we recognize that the figure of gallons being traded in the economy is low. In other words, limitations on utmost price causes a 0.475 million Tins deficiency to take place, and, also, creates a shortage of about 0.425 million Tins of ordinary gas. Such a situation implies that most drivers who were customers of ordinary gas must search for a different fuel, because regulations on utmost price make this gas too expensive for them.
Numerous outcomes are feasible, but let us first reflect on the immediate effects. We shall describe immediate effects as constraints that alter behaviors of both providers and demanders. Apparently, suppliers can not to disappear from the market immediately, since they may desire to linger as they observe any market changes. Probably, the regime can alter its mind about the price ceiling. As a result, we assume that the existing market is something that a company will do after a long time, but not in a short span.
The price ceiling might also have some not direct effects on this market. Whereas the value ceiling may lead to scarcity, directly, the scarcity may consecutively have a consequence on the activities of demanders and suppliers. A number of the feasible short run changes may include alterations in the selling designs of suppliers or purchasing designs of demanders.
How do the Forces of Supply Impact the Issue?
Suppliers may fine-tune by changing toward providing additional, higher gasoline, eventually. By developing their capacity to store higher, octane gas, Suppliers may extend their capacity to deliver the gas. Also, it is likely that some distributors will not offer gasoline any longer. Some might depart the market and opt to provide mechanic services. Generally, a decline will be experienced in the amount of suppliers of ordinary gas. The supply curve moves left, when the quantity of suppliers reduce, thus, increasing scarcity.
How do the Forces of Demand Impact the Issue?
Demanders require gas due to scarcity, so possibly they will result to purchasing higher gasoline, which are more expensive. In case, demanders fail to afford these top priced brands, they might also go further to purchase ordinary gas in economies that do not have scarcity. Besides, suppliers may opt to impose some charge on the trade of ordinary gas.
How does elasticity apply to the issue?
Much transportation in America relies on petroleum based products (Bulow, Fischer, Creswell & Taylor, 2003). The population depends on trucks and automobiles for transport. This becomes mirrored in gasoline‘s price elasticity, which is predicted to be about 0.2, in the short run (Copen, 2001). Basically, this low figure demonstrates that gasoline is such an indispensable part of people’s lifestyle that a shift in price has virtually no impact on the quantity of consumption.
The theory of consumer choice applies in this case. Gasoline is a necessity for most consumers. The rise in gasoline price leaves consumers deciding on whether to buy gas at the high price, or to change their lifestyles. Since most consumers are not ready to change their lifestyles, they are forced to obtain the gas, although, they go away complaining.
The situation of high gas pump prices demonstrates the economic function of government in marketing and production, when the price and free market fails. So a, to improve this situation, the government has to treat gasoline as a utility, similar to natural gas and telephone services. This is because purchasing gasoline seems to be compulsory, although, the prices of gasoline do not reflect a supply and demand situation.
Bulow , J., Fischer, J., Creswell, J. & Taylor , C. (2003). U.S. Midwest Gasoline Pricing and the Spring 2000 Price Spike. The Energy Journal, 24 (3), 121-150.
Castanias , R. & Johnson , H. (1993). Gas Wars: Retail Gasoline Fluctuations.
Review of Economics and Statistics, 75, 171–174.
Copen, M. (2001). Gasoline prices – the need for a different type of government intervention. Retrieved from http://www.copencom.com/tandi/uncommon_sense/218/.
Johnson, R. (2002). Search costs, lags, and prices at the pump. Review of Industrial Organization, 20, 33-50.
Peltzman, S. (2000). Prices rise faster than they fall. Journal of Political Economy, 108, 466-502.