Oil…It’s Not Like Peanut Butter
I know it’s a bit late to start talking about oil and gas prices, but I have heard some pretty nutty ideas about why prices are so high (even though they are much lower now). This piece is designed to guide the reader as to how the oil prices are set and why people who think there is some sort of Big Oil conspiracy are total idiots.
There is a basic law when it comes to free markets and how they operate. It’s called the law of supply and demand. Everything, including oil, obeys this law. Some people claim that oil is the exception to this law, but I assure it does. Oil is priced on the open market and is bought and sold in barrels in US dollars. This price fluctuates constantly and since gasoline is made from oil, the price for a barrel of oil directly affects the price of a gallon of gasoline. So far so good right?
What happens when there is a hurricane, or embargo, or a country like China starts demanding more oil? With a hurricane or embargo, there is a shock. This means that the supply of oil goes down. However the demand for oil stays the same. According to the laws of supply and demand, when this happens, the price will increase. Note that there was no person involved in the increase of the price. It was the fact the supply was decreased and the demand that remained the same. Also when China demands more oil, the supply remains the same as well so the price will increase. This is not a shock, but the same principle will still apply.
I’ve heard this next phrase a few times lately: “If peanut butter prices go up, I can live without it, but I can’t live without gasoline. I have to drive to work which is over 20 miles away” or “Big Oil is responsible for the price increases.” Ok, this just shows complete lack of understanding of basic economics. The consumer is just as responsible for the prices more than Big Oil and you can give up gas too. Remember that you are paying the $3.00 per gallon for gas. You don’t have to do that. You could not buy the gas at that price. If no one bought gas at $3.00 a gallon then the oil companies wouldn’t charge $3.00 a gallon. Also, why do you have to live 20 miles away? You could live closer to work. It was a choice you made when you took that job and chose to live where you do. When you made that decision, you said to yourself that I’m willing to live 20 miles away and drive to work. You have to live with that fact, because if gas prices go up, then you’ll pay. If you don’t consider the consequences when you made your decision, it’s your fault, not Big Oil.
I know this seems like a lecture to most people, but it’s one of my biggest pet peeves that people can’t grasp the simplest ideas of economics.
**This update has been brought to you by Karl Rove, Deputy Chief of Staff to the President and Oil Czar of the United States**
Comments
I'm not sure I agree with this. You make it sound like supply and demand dictates prices. But my understanding is that supply and demand allows for price changes to be made by those who set the prices. Just because supply goes down doesn't mean that prices automatically go up. Those setting the prices can choose to a) Leave the prices the same, b) raise the prices and c) lower the prices. Supply and demand only dictates what prices the market will bare not what it's set at.
Note from Vince: I agree with what you are saying Chuck, and I never meant to imply that Supply and Demand dictate what the price is set at, but have the biggest influence to what the price gets set at. Appologies for the confusion. (I'm trying to essentially say that people aren't randomly making up price, but rather taking into account market forces when making their pricing decisions)
Posted by: Chuck | December 28, 2005 01:15 PM