Gasoline Price Changes - Federal Trade Commission

GASOLINE PRICE CHANGES:
supply. Producers will reduce their production to meet the new, lower level of consumer
demand for gasoline, and will not be inclined to consider any new capacity increases.
C. Together, Consumer and Producer Responses to Changes in Market
Conditions Will Produce the New Market Equilibrium Price.
Prices need to change if current prices no longer will equate the quantity demanded to the
quantity supplied. See Box 1-4: What Happens If Gasoline Prices Are Not Allowed To Change.
For example, a gasoline supply disruption such as the pipeline break in Phoenix will cause prices
to increase to give consumers an incentive to decrease consumption and producers an incentive
to increase production. In such circumstances, short-run gasoline prices will need to swing
sharply higher to provide those incentives. Consumers do not have very many good substitutes,
and producers usually cannot instantly increase output or transport distant inventories to increase
the quantity supplied to a market. Thus, higher prices are necessary to give consumers and
producers sufficient incentives to change their behavior in the short run.
Over much longer time frames, however, both consumers and producers have more
options to react to the higher prices, so that the long-run price increase will usually be much
smaller than the short-run price increase. For example, following gasoline price hikes in 1979-
1980, U.S. consumers decreased their consumption of gasoline by more than 800,000 bpd – from
7,412,000 bpd in 1978 to 6,539,000 bpd in 1982. See Figure 3-6 infra. Substantially reduced
U.S. gasoline consumption, along with other factors, then drove gas prices down to levels
significantly below the extremely high levels of 1979-80.
Box 1-4: What Happens If Gasoline Prices Are Not Allowed To Change:
Rationing Is a Costly Solution.
Gasoline markets provide a good example of what happens when supply shortfalls are handled through
rationing, rather than allowing prices to change to the new equilibrium price. During the oil crises of
1973-74 and 1979, some states rationed gasoline. For example, drivers with odd-numbered license
plates could buy gasoline only on Monday, Wednesday, and Friday, and drivers with even-numbered
license plates could buy gasoline only on the other days. This type of allocation caused long lines at
gas stations all over the country. The time that consumers spent waiting in line was certainly a cost to
society, as well as problematic for the individuals stuck in those lines. For a full discussion of the
welfare costs of rationing, see H.E. Frech III & William C. Lee, The Welfare Costs of Rationing by
Queuing Across Markets: Theory and Estimates from the U.S. Gasoline Crises, 102 Q.J. ECON. 97
(1987).
Moreover, price controls and rationing do not signal producers to bring more supply to the market to
meet increased demand or to offset, at least in part, an interruption in supply. If prices are not allowed
to increase in reaction to a supply reduction, producers have no incentive to provide additional supplies
to alleviate the supply reduction. Shortages are therefore likely to be prolonged. See, e.g., Robert T.
Deacon & Jon Sonstelie, The Welfare Costs of Rationing by Waiting, 27 ECON. INQUIRY 179 (1989).
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FEDERAL TRADE COMMISSION, JUNE 2005