Gasoline Price Changes - Federal Trade Commission

THE DYNAMIC OF SUPPLY, DEMAND, AND COMPETITION
consumers’ purchases by 30 percent, the amount of lost supply. Extrapolating from above,
prices would have to increase by 150 percent. 3 Phoenix prices did increase substantially – by 40
percent – but remained far below a 150 percent price increase, because Phoenix gas stations had
succeeded in obtaining some additional gasoline supplies from the West Coast. This new supply
of gasoline dampened price increases to some extent.
On August 24, the pipeline owner restarted gasoline flow on the Tucson-Phoenix line,
although at a reduced capacity. Retail gasoline prices in Phoenix declined by about $0.31 per
gallon between the last week in August and the end of September. Phoenix gas stations,
however, still had to obtain significant quantities of gasoline from West Coast refineries by
pipeline or from other terminals by truck – both at higher cost.
Three basic lessons emerge from this example.
First, in general, the price of a commodity, such as gasoline, reflects producers’ costs and
consumers’ willingness to pay. Gasoline prices rise if it costs more to produce and supply
gasoline, or if people wish to buy more gasoline at the current price – that is, when demand is
greater than supply. Gasoline prices fall if it costs less to produce and supply gasoline, or if
people wish to buy less gasoline at the current price – that is, when supply is greater than
demand. Gasoline prices will stop rising or falling when they reach the price at which the
quantity consumers demand matches the quantity that producers will supply. In Phoenix, prices
rose primarily because there was not enough gasoline to supply the quantity demanded at the
prices that prevailed before the pipeline broke.
Second, how consumers respond to price changes will affect how high prices rise and
how low they fall. Limited substitutes for gasoline restrict the options available to consumers to
respond to price increases. That gasoline consumers typically do not reduce their purchases
substantially in response to price increases makes them vulnerable to substantial price increases,
such as the 40 percent price increase in Phoenix.
Third, how producers respond to price changes will affect how high prices rise and how
low they fall. In general, when there is not enough of a product to meet consumers’ demands at
current prices, higher prices will signal a potential profit opportunity and may bring additional
supply into the market. How high prices have to be to bring in additional supply will depend on
how costly it is for producers to expand output. Phoenix gas stations’ offers to pay prices to
West Coast refiners that were higher than they had been receiving from West Coast gas stations
were sufficient to bring additional supplies into Phoenix.
II. WORLDWIDE SUPPLY, DEMAND, AND COMPETITION FOR CRUDE OIL
ARE THE MOST IMPORTANT FACTORS IN THE NATIONAL AVERAGE
PRICE OF GASOLINE IN THE U.S.
To understand U.S. gasoline prices over the past three decades, including why gasoline
prices rose so high and so sharply in 2004 and 2005, we must begin with crude oil.
EXECUTIVE SUMMARY iii