President Biden as well as other Democrats in Congress say that the increase in the price of gasoline is due to oil companies “price gouging.”
Price gouding is defined as “the act of charging customers too high a price for goods and services, especially when demand is high and supplies are low.” In reality, price gouging is a myth.
When accusations of price gouging are made, they tend to occur when the market price for a good or service is much higher than the general public thinks the price should be. That’s the case with gasoline today. The price is higher than we would like it to be.
Biden argues that the oil companies are taking advantage of consumers. The president says oil companies can increase the supply, but they are not doing so in order to keep gas prices high. That too is a myth.
Let’s start off with the basics. Businesses are motivated primarily, some argue entirely, by profit. If a product can be provided to a market where there is sufficient demand to warrant a price that yields a profit, the product is produced. Because production costs tend to increase as output increases, higher market prices almost always mean more production.
Intersection of Supply & Demand
To maximize profit, businesses are always trying to sell goods and services at the highest possible price.
For consumers, the motivation is to try to maximize total satisfaction when purchasing goods and services. Given that every consumer, no matter their means, has a limited amount of income to spend, consumers try to purchase things at the lowest possible price.
Eventually, businesses’ willingness to supply interacts with consumers’ willingness to demand — and a market price is established where business will supply the same quantity that consumers will purchase. Any changes in the price, either up or down, occurs when the supply relationship or the demand relationship changes.
When price gouging supposedly occurs, there is way more demand than supply.
The example I use is this: I live on a barrier island in New Jersey. In October 2012, Hurricane Sandy was coming. Emergency Management told residents to evacuate because the resulting storm surge would flood the island from the bay to the ocean. Tens of thousands of residents left and looked for shelter in the hotels and motels off-shore.
There are a number of “less than desirable” motels that typically charge about $50 per night at that time of year. One motel owner, with a 30 unit building, raised his rates to $250 per night. Most people said that was a typical case of price gouging. Aside form being against the law, since New Jersey has price gouging laws, most people believed it was morally unethical to take advantage of people during an emergency.
This, the newspapers claimed, is a clear case of price gouging. But was it?
Normally, at this time of year, the motel owner is lucky if he can fill the motel. Suddenly, because of the evacuation, 300 people showed up to rent his 30 rooms. How does he decide which 30 to rent the rooms to?
As a profit maximizing business person, he raised the price. As he does, some people won’t or can’t pay the higher price and leave. Eventually he raises the price high enough so that 270 of the 300 people leave. The remaining 30 people agree to pay the new market price of $250.
The market is in balance because at $250, he has 30 rooms to supply and at $250, there are 30 people who will demand the rooms.
Because the government thinks that new price is too high, it calls it price gouging.
That’s exactly what is happening in the market for gasoline. Restrictions in supply are due to the Biden Administration's policies, coupled with Russian actions. Demand is increasing because the economies of the world are recovering from the pandemic.
The Real Solution: More Oil
The solution to rising energy prices is to increase the supply. That means reversing all of Biden’s policies that restrict supply. Biden should allow the Keystone XL pipeline to be built, allow drilling on federal lands, allow drilling in ANWR off the coast of Alaska, remove the burdensome regulations he recently imposed and stop telling the banking industry to curtail lending to oil producers.
In the meantime, the worst action to take is to artificially hold down prices by putting on controls and by placing blame on oil producers. They, like all businesses, just charge the market price whether that price is higher or lower than someone thinks it should be.
Michael Busler is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in finance and economics. He has written op-ed columns in major newspapers for more than 35 years.
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