Wednesday, April 30, 2008

Microeconomics 101 for weenie Senators!!!

"Half a tank of gas, that’s his big solution."

- Senator Obama in response to the McCain/Clinton gas tax holiday scheme which analysts say will save the average consumer $30.

I am a bit disappointed to hear Senator Clinton repeatedly pandering to lower income Americans by calling for a suspension of the federal gas tax (a holiday, will there be balloons?) between Memorial Day and Labor Day. I expect that kind of mindless pandering from Senator McCain since it is abundantly obvious that the fundamentals of Microeconomics are so far over his head. But I expected better from the self-anointed master of the issues. Senator Clinton’s entire rationale for running is that she has a better command of the fundamentals of sound public policy than either Senator Obama or Senator McCain, but she is looking pretty average right now.

The best way to explain the impact of a gas tax holiday in Microeconomic terms is: in a market where there is a fixed supply of oil with which to refine petroleum (gas) and a fixed capacity to refine oil (regardless of what lame duck says), the price that consumers pay at the pump will adjust until the demand at that price matches that fixed supply. That is what is referred to as Equilibrium. I filled up my car two days ago and the price was $3.77 per gallon of high grade gasoline.

P = Price, Q = Quantity, S = Supply, D = Demand, P0 = Equilibrium Price, Q0 = Equilibrium Quantity

Many economists are predicting gas prices in the range of $4.00 per gallon by the summer of 2008. That price could (and probably will) include the 18.4¢ per gallon federal gas tax. Whether Congress votes for the gas tax holiday or not is of no significance. Either way, the price will not change. Oh, the price of gasoline will go down by 18.4¢ per gallon but that price will correspond with an increase in demand to bring the market back into Equilibrium. In essence, what Senator McCain and Senator Clinton are pushing for is a shift of that 18.4¢ per gallon from the federal coffers directly into the oil companies' profit statements. Make not mistake, McCain and Clinton are supporting reducing the federal budget and the governments ability to pay for the maintenance of our transportation infrastructure.

This predictable Demand shift can only be prevented by a corresponding increase in short-term Supply. I say short-term supply because oil is a natural resource with a fixed supply. Suppliers and producers can increase output, but only in the short-term. When it's gone, folks, it's gone. It just so happens that the world petroleum market is an oligopoly, that is to say, a market that is served by a finite number of suppliers. They have formed a cartel called the Organization of Petroleum Exporting Countries (OPEC). OPEC has thus far been unwilling to adjust their output levels at the whim of American politicians. Their interest is in maintaining supply levels at their current level because there is no interest to them to do otherwise. There are other market forces and uncertainties that are driving the price of gasoline up. Why would they increase supply and reduce the price of oil? That ain’t capitalist folks, and our entire foreign policy has been predicated on the goal of convincing the world of the genius of the American system, which is at its heart a “free market” system.

The only way to control gas prices and ensure lower prices is to cap the wholesale price of gasoline. I’ll bet a month’s salary that neither McCain nor Clinton have the stomach for that.

If we reduce the taxation level of gasoline the price will drop temporarily (very temporarily) until demand increases to bring the price back to the equilibrium level. Barring a drastic change in the market trends the price of gas (even with a tax holiday) will be higher at Labor Day than it is at Memorial Day. Congress has the power to suspend the gas tax, but not suspend the laws of supply and demand.

It turns out that the candidate with the best grip on reality in this case is Senator Barack Obama. Who woulda thunk it?

Let’s not forget that environmental advocates see a reduction in the gas tax as totally inconsistent with either Senator McCain or Senator Clinton's campaign rhetoric about reducing carbon emissions. The increase in demand that results from the gas tax holiday will increase carbon tailpipe emissions. No way to sugar coat that fact.

Let us also not forget that the federal gas tax is not indexed to the Consumer Price Index and has not been increased since 1995. I will let the following graph depicting the purchasing power of the federal gas tax.

Pretty weak stand Mrs. Clinton. I would have expected better from you than just naked pandering. Do you really think the American people are that dumb? Doesn’t that make you an elitest?

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