Congressionally mandated shortages

Last week the U.S. House of Representatives voted by an overwhelming margin to guarantee gasoline shortages the next time we face a significant disruption in petroleum supplies.

One of the common complaints I hear from noneconomists is, why should the price of gasoline go up as soon as there is any news of a disruption in oil flowing from somewhere like Nigeria, when the gasoline in the pipeline and the station’s tanks have already been bought and paid for by the company at a lower price?

Why, indeed? The answer is, because if the price didn’t spike up immediately on the news, the result would be a disaster for the public. I presume we can agree that the supply disruption will eventually mean that the price will have to be higher and consumers are going to have to make do with less gasoline. How should you as a consumer behave, if the price did not go up today, but you know that in the future, you might not be able to buy gas or will have to pay a much higher price than you do today? The answer is, you should rush out and top off your tank right now, while gas is still available and cheap.

Of course, when all your neighbors get the same idea that you had, the result is a huge surge in the quantity of gas everybody is trying to buy, which the system won’t have the resources to deliver. Panic buying by consumers would create shortages even if there had been no disruption in supply.

Fortunately, it would not ever be in the personal financial interests of gasoline station owners to allow this to happen. Why should they run their tanks dry selling gas for $3.00 a gallon, if there would be someone willing to pay them $3.50 for that same gas? A station owner who was trying to maximize profits would never do this. What we would expect to see in a properly functioning market is for the price instantly to jump significantly above the value it will be at next week. That creates an incentive for consumers to let their tanks run a little lower right now rather than top them all off, which is exactly what we need to see happen in order to deal with the crisis.

Anyone who has taken an introductory economics class will recognize this as an example of exactly how capitalism is supposed to function. The gasoline seller and buyer are both just doing what is in their own selfish interests, yet the outcome is a sensible and appropriate response to the challenge.

Unfortunately, 389 members of the U.S. House of Representatives evidently skipped that econ lecture, and think that if the owner’s already paid for the gas in the pipe, you shouldn’t have to pay any more at the pump. At least, that’s the margin by which representatives voted for the Federal Energy Price Protection Act of 2006, which declares

It shall be an unfair or deceptive act or practice in violation of section 5 of the Federal Trade
Commission Act for any person to sell crude oil, gasoline, diesel fuel, home heating oil, or any biofuel at a price that constitutes price gouging as defined by rule pursuant to subsection (b).

And how do economists define “price gouging?” Here’s Professor Craig Depken from the University of Texas:

I bet my students a full letter grade that they can’t find a published definition of price gouging in an economics textbook. There might be one out there, but to date I have never had to pay up.

It is thus with great interest that we turn to subsection (b) of said Energy Price Protection Act:

Not later than 6 months after the date of the enactment of this Act, the Federal Trade Commission … shall define “price gouging”, “retail sale”, and “wholesale sale” for purposes of this Act.

I suppose this little finesse, of leaving a minor detail like the definition of what the heck this law is supposed to prohibit, up to the FTC to decide, is part of what helped garner the votes of at least some of these 389 representatives who must know better. I have no doubt that, whatever the FTC ends up deciding that “price gouging” means, it will be a more sensible definition than anything the current Congress is capable of coming up with.

gas_lines.jpg

Even so, I also have to believe that, whatever definition the FTC comes up with, it has to alter the calculation of the gas station owner in the situation I described above. With this legislation, if I were the owner of a gasoline station, I would not see it as being in my best interests to raise the price on the news of a major disruption in shipments from Nigeria. The picture at the right of gas lines in China’s Guangdong Province last summer, is a reminder of what that means.

Communist China, of course, is another place where the government does not believe that the appropriate price is the one that equates supply with demand.



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36 thoughts on “Congressionally mandated shortages

  1. odograph

    a trivial observation
    i notice that costco (warehouse store) is the place to buy gas in tims of rising prices, and the place to avoid when prices are falling. i’ve guessed that they, perhaps because the are a “club” use a simpler model, and do charge a price based on their cost for each load.
    i could live with costco prices everywhere, but i agree that it is sub-optimal.

  2. Paulo

    I too am outraged at our government getting in the way of oil companies being allowed to abuse consumers in times of crisis.
    I am thankful though that we have economists like James Hamilton who are ready to do the heavy intellectual lifting by arguing so passionately about the dire run-on-the-bank economic consequences of laws that will not even be defined for another six months.
    I’m sure he can make even stronger arguments about other imaginary laws that don’t exist but which would bring devastating economic catastrophe if they did.
    Stability for consumers has no place in economics, especially if it gets in the way of my profits.
    Such terrible laws risk shaving literally full tenths of a percent from my capital gains.
    Most Republican pundits argue against consumer protections that are already in effect. I’m glad to see we have someone out there on the cutting edge going after imaginary ones that don’t even exist yet too.
    Thankfully intellectual honesty has no place here at the Hamilton/Cato Institute.

  3. Mike

    I too am very outraged at this.
    How is congress supposed to know how the economy *should* be working?

  4. Rich Berger

    Professor -
    Your post is so full of common sense that you are sure to attract scorn.
    What frightens and discourages me is that these idiots in Congress can really do a tremendous amount of harm. Shame on the Republicans especially – they should know better.

  5. jalrin

    Defining price gouging to avoid the problems you discuss is not that hard. All one has to do is to exclude costs resulting from higher supply costs (e.g if the wholesale price of gasoline goes up $0.10, then you would be allowed tp pass that through plus maybe a small extra margin. The same would go for crude oil at the refinery level). What would be prevented would be the opportunistic prices increases where a company fleeces vulnerable people by using disruptions to jack up the right without cause. My home state has such a law for disaster situations and it has proved itself quite useful.

  6. Jon

    Paulo
    Since you are such a “fan” of economic liberty and choice, it is safe to assume that you are equally supportive of governmental interference and restrictions in the social/moral sector?

  7. JDH

    Jalrin, an increase in the price before the cost has gone up, and by more than the cost will go up, is exactly what I claim is necessary in the situation I analyze, and exactly what you claim should be outlawed.
    Paulo, I perceive a particular harm resulting from the ambiguity in the law itself. Specifically, the possibility (not necessarily the certainty) that one may be legally prosecuted will by itself serve to deter the actions that I say are socially desirable.
    The fact that the law is written ambiguously makes it a worse piece of legislation, not better, in my opinion.

  8. Hal

    A couple of comments with regard to gas lines. Many people will remember or at least have seen pictures of the gas lines that resulted from the oil shortages of the 1970s. People had to routinely wait in line for an hour or more to get gas. The reason for this is because there were price controls in place. Today, when we have shortages, we don’t generally see gas lines. Instead the price is allowed to rise so that demand is reduced. Putting controls back into place is going to bring back lines.
    Another point I’ve never seen mentioned. Even today there is considerable variation in gas prices around town – probably 20 cents or more difference per gallon of regular unleaded. One of the reasons this is sustainable is because of lines. The cheaper stations tend to be much busier and have constant lines. It’s also a struggle to get in and out of those because of the infuriating refusal among auto makers and gas station designers to standardize on placement of gas caps on cars and on flow patterns at the stations. Cars get stuck behind one another, cars fight over who is next in line, it’s a mess.
    Going to an expensive gas station, you pay more for the gas but you save time spent in lines and trouble spent negotating your way through the crowds. You can get right in and out, for the price of a cup of coffee. For many people this is definitely worth it, and it’s probably a good part of the reason why we see such disparaties in gas prices. This is another example of the tradeoff between lines and prices.

  9. T.R. Elliott

    Let me make JDH’s point very clear:
    In the year 2007, congress passes the following law: “All US citizens who are convicted of crimes against America will be put to death.”
    Fine print: “Congress will leave it up to the justice department to define “crimes against america.”
    Orwell’s Big Brother would be pleased.

  10. Nick

    I’d feel a little better about allocation of resources via a pricing mechanism if the integrated oil companies weren’t such a small oligopoly; if low income consumers had a better deal from a less regressive income tax/FICA and lower sales taxes; and if “big oil” weren’t returning the majority of it’s profits to its shareholders, instead of re-investing them, on the assumption that these prices are temporary (in other words, that this is a windfall).
    Yes, I know, “big oil” only controls a small fraction of the market, but that’s world-wide. They control a very large portion of US gasoline sales.
    So, what do I suggest? Not price controls – that would indeed be counter-productive, even if oil companies are charging a few pennies too much. Nor would I suggest windfall taxes – that would scare energy investors, and we can’t risk that, even if oil companies are investing too little. Perhaps especially if they aren’t.
    No, my suggestion is something completely different: we need true election/campaign reform. The true problem is that the oil & gas industry is blocking competition from alternatives.
    How do they do that? Well, it started when the Reagan administration stifled Carter’s energy R&D, and turned the DOE into a handmaiden to the NRC. It continued with stagnation in CAFE rules. It went further when the Bush admin killed the PNGV program. There are many more examples, and they continue today.
    The US’s energy program is an embarrassment, and that’s the big problem. Current gas prices are just a symptom.

  11. spencer

    Hal — I will be very happy to debate with you the argument that price controls created the gas shortages of the 1970s. the gas shortages of the 1970s stemmed exclusively from the drop in Iranian output following their revolution.
    The meme that the price controls created the gas shortage is a complete fabrication created by right wing think tanks years after the fact.

  12. dis

    [i]I will be very happy to debate with you the argument that price controls created the gas shortages of the 1970s. the gas shortages of the 1970s stemmed exclusively from the drop in Iranian output following their revolution.[/i]
    Q. If prices were $1,000,000 per gallon at the pump would there have been gas lines?
    A. No.
    You just lost the debate.
    Supply shocks don’t causes shortages if price is allowed to moderate demand.

  13. dis

    It’s also probably worth noting that the price controls ended in 1976, while the Iranian revolution was in 1979.
    There is obviously a short term logistical impact that losing a lot of crude oil has on the system and some stations ran out in 1979, just as some stations ran out in the 2006 ethanol change-over.

  14. Davey

    Paulo,
    “I too am outraged at our government getting in the way of oil companies being allowed to abuse consumers in times of crisis. ”
    Crisis? Crisis? Katrina was a crisis. 9/11 was a crisis. Russian missiles in Cuba was a crisis. $3 gas is an inconvenience and only a minor one at that. And I drive 150 miles per day.
    And how are the oil companies abusing consumers? Last time I checked, most of us need gas and oil and they do a pretty good job of getting it for us.

  15. wcw

    In re: price controls, I’m afraid Mr. Dis has it a little off. When, in US experience, have there been longstanding price controls to ration critical raw materials? Why, during wartime, like WWII. Are there problems with this sort of rationing? Why, of course, mostly the usual forms of evasion and corruption. Are there problems with classical rationing via pricing? Why, of course, mostly the usual forms of misallocation and unfairness.
    Who wins, I just don’t care, but I hate the pretense that there aren’t two sides to the argument.
    In re: local price variation, here in San Francisco at 6th and Bryant there are two filling stations on opposite corners, of which one is perpetually $0.30/gal higher than the other — and perpetually empty. It baffles me, but almost nobody ever pays the price of a latte for quicker service here.

  16. Boss

    With all the indignation from the academic ecomomists one would think they would demand that collegiate tenure be stopped immediately as an impediment to the free trade!

  17. Tim Worstall

    Idiots in Congress

    James Hamilton has a lovely little piece showing that the US Congress does indeed have at least 389 idiots amongst its members. (If you think that too strong, replace with 389 members willing to pander to the ignorance of idiots.)

  18. Dr Dan H.

    This sort of lesson has been learned, forgotten and re-learned throughout history. A Roman emporer once tried to prevent the price of grain escalating in response to him adulterating the silver coinage.
    Even the death penalty for such a crime failed to prevent the market prevailing; he was forced to repeal the price-fixing order or face rioting and possible loss of his position and life.
    The bottom line is simple: leave markets alone as much as you can, they work better that way.

  19. Stormy

    Because a definition or fact does not exist within textbooks does not necessarily mean that the fact itself is not real. This kind of argument stops any thought, relying simply on authority.
    I would suggest that hoarding a commodity to drive its price up is a form of price gouging. He who has the power to hoard controls the price.
    I would suggest also that when labor is close to slavery and the price is thereby inflated that this is a form not only of price gouging but also of exploitation.
    On this score, why is it that economists who tout free market forces rarely speak of the true cost in wasted lives and environmental resources? To me, this is a form of gouging. (At some point the piper will be paid. Infinite growth is simply not possible.)
    There is no such animal as Free market, nor should there be. Laws against monopoly and exploitation are necessary. Once we have established this principle, then we are on our way to discussing regulating unbridled greed and cruelty.

  20. The Glittering Eye

    The return of scarcity

    It seems like only yesterday that scarcity had ended. And, yet, here it is again as big as life. Anyone who’s taken out a loan and bought gas lately knows that the price of oil has gone up sharply. Not enough supply or excess demand or both. …

  21. Bill

    The only dangerous “unbridled greed” is that of people who demand the use of government force to make others fulfill their own materialistic desires.

  22. Stormy

    Let’s try another form of gouging: CEO wages and benefits.
    Now, do we support them because CEO’s are getting “market price” for their services?
    These are not trivial questions.
    Economic activity is a human artifact, not something akin to natural law. As such, we are creating the thing we wish to measure. We can change how its shape and structure.

  23. Ed

    “The only dangerous “unbridled greed” is that of people who demand the use of government force to make others fulfill their own materialistic desires.”
    Like the people who invaded Iraq to stabilize the region’s oil exports?
    “Clearly, there is more than just oil at stake” in Iraq, says Alan Tonelson, a research fellow at the US Business and Industrial Council Educational Foundation who has written extensively about US economic interests in the Gulf. CSM reporter Peter Grier writes: “But neither is the face-off with Hussein not about oil, says Mr. Tonelson. The presence of so much petroleum in and around Iraq is at the very least a complicating factor as the US and the world weigh their options. ‘If Saddam Hussein were located on a remote Pacific island and he were developing weapons of mass destruction, we would not be so concerned,’ says Tonelson.”
    And that’s a conservative, understated, business point of view.
    How about the Carter Doctrine? The US role in overthrowing a democracy in Iran in 1954, in part because it had nationalized oil? How about FDR in 1945 “I hereby find the defense of Saudi Arabia is vital to the defense of the United States”?
    Not a very free market. Not so libertarian.
    Not to mention the costs of all this military coercion: the Iraq war may cost a trillion dollars, in addition to $50-100B per year to police the middle east: when do we make that cost part of the market?

  24. Bill

    Ed:
    I’m mildly confused about your post — the tone sounds like a rebuttal, but the content suggests that overly powerful governments can do things we dont like, which was the point I was making. (Pardon if you were being supportive.)

  25. Bill

    “…do we support them because CEO’s are getting ‘market price’ for their services?”
    We don’t (shouldn’t) care. If you think they’re getting paid too much, just pay them less. If you’re not paying them now, then it’s none of your concern. A CEO can do nothing to force you to pay him or her, only offer you something beneficial enough to you that you want to pay him or her.
    Economic activity is a human artifact, not something akin to natural law.
    Not such as gravity, no. Economic activity is the sum total of individual desires and activities, which are fairly consistent and predictable in a number of situations.
    We can change how its shape and structure.
    And that, my friend, is foundation of all totalitarianism. Because when your pro-noun there, its, refers to Economic Activity, that is not some nebulous concept we can mold into any shape we please; it is people. What you are saying is We can change the shape and structure of individual peoples lives, their own desires, their own choices, and their own actions, to make them how we want them to be.
    Im sure all your intentions are well and good, to spread peace and prosperity, bunnies and rainbows, across the land and I cant fault you that. What I can do, however, is remind you that one of the fairly consistent and predictable ways people do act is to make total mess of things once they get too much power. And any move towards structuring each and every persons desires and actions is a giant leap in that direction.

  26. Ed

    Bill,
    I’m trying to make a fairly nuanced argument, by implication.
    When people object to regulation of business, on libertarian grounds, I believe they often wander into an intellectual briar patch. They often seem to have a naive faith that large business entities are behaving according to the principles of classical economics, and that just leaving them alone will bring a good result. I am astonished at how often people seem to think that monopolies are free markets, and that large businesses don’t have their hands on the levers of government power.
    Regulation needs to be examined on it’s merits, not dismissed as government intervention. It is certainly possible to screw up free markets with price controls. On the other hand, taxes that internalized the costs of pollution would bring us closer to a free market, rather than farther.
    My original point was that people often seem to use the libertarian argument against government intervention that they oppose, while favoring a multitude of other government interventions that are as bad or worse. For instance, they will object to gasoline price controls, while favoring a war intended, ultimately, to keep the price of gas down.
    Perhaps you see this exactly as I do. I think, perhaps, that your comments on executive pay suggest that you have not entirely gotten to the same perspective. Executive pay is supported by a network of inter-locking boards, and a culture of tacit quid pro quo’s. This is a product, in part, of corporations which have been allowed to get too large by lax antitrust enforcement. Further, excessive corporate pay is supported by a lack of disclosure, which is related to regulation by the SEC and the FASB. For instance, resistance to expensing of stock options. These organizations operate in a public culture, and from social consensus, and it is entirely proper for the public to comment on their policies.
    A true libertarian doesn’t allow overly large and powerful corporations to get away with inappropriate things, like warping government in its favor, or using excess market power to steal from it’s customers.

  27. Stormy

    Ed,
    You flesh out the argument nicely. As you point out, distortions occur and need to be rectified.
    Bill,
    By equating “regulations” with totalitarism, you create a straw man. Kicking staw is easy.
    Economics is not always the sum of everyone’s desires. As the Napolean the pig in Animal Farm said, “Everyone is equal, but some are more equal than others.” No regulations leads either to anarchy or to rule by the select and powerful few. It is easy to turn your “totalitarian” argument on its head. There are many roads to totalitarianism. Pure libertarianism is one.
    Regardless, my point remains: No society long exists without regulations. No economic activity can be conducted without regulations. Without rules and regulations, then any kind of action is permissible if one has the power to enforce it.
    As soon as that point is granted, then we are ready to discuss the kinds of regulations that are necessary and that can work within a democratic society. And we once again return to my additional point: Economic activity is a human artifact. As such, we determine its shape and its activity. How we do business is everyone’s business.
    If you do not grant my point, we really have nothing to say to one another. I wish you well in your anarchic world.

  28. Mace

    From someone who works “oil patch”:
    1. Is the 11th commandment “gasoline shall be cheap in the USA.”
    2. If intangible drilling costs are no longer deductable as an inexpense, would the reduced profits to producers satisfy anyone in this debate, or would it reduce production?
    3. If there is so much money being skimmed by the evil producers, why are not others entering the market to take away these “excess” profits, as is economically called for?

  29. Nick

    “If there is so much money being skimmed by the evil producers, why are not others entering the market to take away these “excess” profits, as is economically called for?”
    There is new competition for oil and natural gas.
    Natural gas has competition: wind is 40% of new electrical generation planned in 2006 and 2007, and about 12 nuclear plants are in the planning process – both replace NG electrical generation. Geothermal heat pumps are growing 20% per year for least-cost home heating.
    Gasoline has competition: Hybrid car sales doubled this year over last; ethanol is expanding quickly; efficiency in the form of falling SUV sales is here, and new CAFE rules look likely. Plug-in hybrids are being investigated by all the major car companies.
    Oil has competition: Coal to liquids is growing very quickly, albeit from a small base. Canadian tar sands are attracting enormous investment.
    High oil prices are a recent thing, and it’s competitors (as well as new production in the oil & gas industry itself) are generally capital-intensive, so there are time lags, but they are happening.
    I predict a painful period of roughly 10 years of high oil prices and increasing debt for the US, followed by greatly decreased oil imports and a relative decline in oil prices as alternatives take hold. At that point the US could be the “Saudia Arabia” of wind, solar and coal…if we get there without a painful dollar crash due to all that debt. Cross your fingers.

  30. Mcwop

    Congress passes a law stating that noone may sell their house for more than 7% over the price paid for that house.

    After all, the house is already bought and paid for, and why should the homeowner be able to gouge a new buyer – regardless of demand for the house. I wonder how well that would go over with consumers/homeowners.

  31. Seeker Blog

    How to create gasoline shortages

    It shall be an unfair or deceptive act or practice in violation of section 5 of the Federal Trade Commission Act for any person to sell crude oil, gasoline, diesel fuel, home heating oil, or any biofuel at a price that constitutes price gouging as def…

  32. The Dead Parrot Society

    Did I just price gouge myself?

    Congress has asked the FTC to define price gouging. The difficulty of this task is well documented in that link, and at various places in the blogosphere, including Econbrowser. I am left with a few basic questions, which I haven’t seen anyone ask (ver…

  33. Republican Forums

    Why are gas prices so high still?

    I’m trying to figure out why gas prices are so high still. We just captured one of the last biggest terrorists in Iraq and the prices didn’t go down at all?

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