09 February 2008

The words of a parrot

I believe it was Alfred Marshall who said, "a parrot can be taught to be a competent economist." The point is, one need only teach the parrot two words: "supply" and "demand."

I submit that in order to make ourselves at least as smart as Marshall's parrot, we have to leave behind some of the regnant myths as to gasoline prices.

What makes gasoline prices go up? The parrot will tell you. Or, to fill out the avian wisdom a bit, imagine that on Tuesday, Exxon is charging me $3.00 per gallon. On Wednesday, Congress enacts a new law increasing their taxes. So by Thursday, in order to pass this along to me they'll have to charge me, we'll say, $3.50 per gallon.

Why weren't they charging me $3.50 already on Tuesday, though? Because they were being nice to me? Or because the market wouldn't bear that extra cost -- it might force me to start car pooling or move closer to where I work or something?

If there's any good reason why Exxon wasn't charging me the whole $3.50 on Tuesday, that reason still exists on Thursday, doesn't it?

From a manufacturer's point of view, an increase in the price of the raw material and an increase in taxes work out the same. They are each an increase in the cost of doing business. Neither translates into higher market demand. Does an increase in crude oil prices cause the companies to pass along that increase to consumers, thereby pushing up the price? No. Unless it can be explained through one or the other of the two factors enumerated by the parrot, this is simply irrelevant.

But haven't we seen the increase in crude oil prices causing an increase in petroleum prices, through direct pass-alongs, thereby refuting the parrot. I submit that we have not.

We've seen gasoline prices as denominated in dollars rise as a result of the loss of value of those dollars. Suppose I'm making more money this year than I was last year --- because inflation works on the wage/salary side of the economy as well as on the prices of the goods those wages are used to purchase. If I'm making more money, then I have more to spend, and I will presumably be willing to spend some of that "more" on the higher gas prices, especially if they two sides of the inflationary coin are keeping pace with one another.

The gasoline price increases that have held up after discounting for inflation are modest and have either demand or supply-oriented causes. For an example on the supply side, refinery fires and other problems putting them out of commission have limited the supply of gasoline, (not of crude oil) which of course has driven up the market price.

A toast, then, to the wisdom of Mr. Marshall's parrot.


Henry said...

Christopher, I am confused. I gather that you're saying that an increase in crude oil prices does not cause the gasoline companies to charge more for gasoline because an increase in crude oil prices constitutes neither supply nor demand, and supply and demand are the only factors that affect prices. But how can the cost to the seller not be a factor in setting prices, if the seller seeks to make a profit? And, if an increase in crude oil prices does not cause the gasoline companies to charge more for gasoline, then why does an increase in taxes cause them to charge more for gasoline?

Christopher said...

Neither the crude oil price increase nor the tax increase will in itself lead to an increase in the price of gasoline, unless it works through the amount of supply coming to the market.

If the costs (both of those sorts of cost and whatever others we might wish to list) exceed the price that the market will bear, then companies will stop bring petroleum to the marketplace. Some will go out of buisness,others will shift their activities elsewhere. This won't happen all at once, but gradually, because some firms will enter this crunch with deeper pockets and will wait it out and for other reasons.

At any rate, at some point the withdrawal of supply from the market will generate a new equilibrium.

My point was just that a lot of people think in automatic "pass-along" terms in connection with both OPEC announcements and taxes. "Oh, that will show up at the pumps." It might. In time through the indirect processes I've mentioned. Or it might already HAVE shown up at the pumps through the anticipatory effect of such processes.

But there is no "pass-along" exception to the law of supply and demand. The parrot is right.

Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.