Americans are understandably upset by the high prices they've been paying for gasoline. Many think that the cause is oil company greed and that the solution is government-enforced price controls. But price controls on gasoline are a terrible idea. They would cause shortages and lineups and would hurt producers and consumers.
Here's why. What determines the price of gasoline is the amount producers are willing to supply at various prices and the amount drivers demand at various prices. At the current price of gasoline, say $2.00, the amount drivers want to buy roughly equals the amount producers want to sell. That's why there are no gas lines. Such a "market-clearing price" evolves in every competitive market.
What happens, then, when the government decrees that the price of gasoline be no higher than, say, $1.80. The obvious answer is that consumers now can get their gas for 20 cents a gallon less. But that answer is incomplete.
At a price of $1.80, consumers will want more than they wanted at $2.00. One of the things economists are surest of is that we want more of a good when its price falls. At that lower price, producers want to supply less. The necessary result, therefore, is a shortage: the amount demanded exceeds the amount supplied.
Shortages lead to lineups. Consumers then compete with each other, not just by paying money but by spending time in line. Economists call this lost time a "deadweight loss," a loss to some that is a gain to none.
During the 1979 gasoline shortage, I calculated that the 80-cent-per-gallon price control caused consumers to spend about $1.10 a gallon (30 cents per gallon in lost time) and that if the price controls had been removed, the market-clearing price of gasoline would have been $1.00. Consumers actually paid more than they would have without price controls, and producers made 20 cents less. Both lost.
Many people are convinced that high gasoline prices are due to oil companies' greed. But that explanation is insufficient. Why such sudden greed? Weren't oil companies greedy a year ago, when prices were lower? To explain a change in something, you need to point to something that changed.
What changed is the world price of oil, which increased by about $14 between May 2003 and May 2004. Each dollar increase in the price of oil translates into roughly a 2.5-cent increase in gasoline prices. About 35 cents of the 50-cent-per-gallon increase in the price of gasoline, therefore, is due to world market conditions, one of which is the reduced oil production in Iraq.
Also, federal regulations fragment what was once a national gasoline market. The Environmental Protection Agency decrees that certain kinds of gasoline be used in certain regions. When a refinery or pipeline goes down in certain markets, such as California, gasoline sellers can't legally buy from other markets. The result: wild swings in gasoline prices. The regulations also make gasoline more expensive.
Price controls are a bad idea. Here's a better one: reduce gasoline taxes.