The Business Analysis of Summer Gas Prices In California
It is summer again, which for drivers in California means higher gas prices and baking in the hot sun while stopped in traffic. This article from The Mercury News discusses how events have conspired to make these prices even higher than usual for businesses and consumers.
The following factors conspire to affect gas prices through the supply and demand curves.
Factor 1: A 12-cent Federal Tax Hike on Gasoline
The market for gasoline begins at its winter equilibrium price and quantity, but the first blow comes from the federal government in the guise of a 12-cent per gallon hike in gasoline taxes. This causes the demand curve to shift to the left by 12 cents and results in a higher price per gallon for consumers, even with decreased demand. How does this happen? Elasticity. Consumers’ short-run demand for gasoline is inelastic, which is to say that in the short run, consumers are unable to respond to rising gas prices with lower consumption. They still have to drive so they still have to consume gasoline regardless of the price. One of the principles of elasticity is that whichever party has the least amount of elasticity will bear the brunt of any tax burden. Because of this, consumers will demand at the new intersection of the supply and demand, but will pay the price indicated by the old demand curve. As a result of Factor 1, consumers will pay an additional cost per gallon of gas that is less than or equal to 12 cents.
Factor 2: A Rise in the Cost of Oil
Oil is a supply input for the manufacture of gasoline. When the cost of an input rises, the supply curve shifts to the left reflecting the new cost of production faced by refineries. This causes the equilibrium price of gas to rise for the consumer to the intersection of this shifted supply curve and the shifted demand curve described in Factor 1. The tax is still in effect, and this is still the short run, so consumers still have inelastic demand. The consumers in California then have to bear the cost of the increased cost of oil in addition to bearing the majority of the tax burden.
Factor 3: Maintenance and Repairs at California Refineries
This is a situation where the consumers of gasoline in California get hit twice by the same blow. As a result of California’s strict emission standards, all gasoline consumed in California comes from California refineries. This means that when the refineries in California are forced to undergo routine maintenance and repair, the lost supply cannot be made up by out of state suppliers. When refineries are shut down for repair, they can no longer produce gasoline, which decreases the supply available. The supply curve again shifts to the left, raising prices for inelastic demanding consumers who are still paying the largest share of the tax burden resulting in an even higher price paid by the consumers.
Factor 4: War in the Middle East
As if the federal government had not stuck it to these consumers enough with the 12-cent tax hike, it further aggravates the gas prices in California by creating uncertainty in the Middle East. Missile strikes in Syria, an unclear policy on invasion or retaliation, and a rapidly disintegrating situation in Iraq all make commodity traders nervous. When commodity traders get nervous, the price of oil on the international market goes up. As discussed in Factor 2, oil is a supply input for the manufacture of gasoline. This means that the sequence of supply and demand events described in Factor 2 also apply here. The supply curve will shift left, the equilibrium price will rise and consumers are still bearing the tax burden and paying a price higher than equilibrium that lies along the original demand curve.
Factor 5: Switch to Summer Gas
Again, the well-meaning environmental regulations in California serve to create higher prices and financial strain for California’s consumers. “Summer Gas” is a specific blend of gasoline used only in California during the high demand summer months. This blend is costlier to produce than the lower demand winter gas. Higher manufacturing costs, of course, mean that the supply curve will once again shift to the left. This creates an even higher short run equilibrium price for the consumer, who once again bears the tax burden from Factor 1 and pays a price for gas along the original demand curve.
Gas prices are always higher for Californians in the summer months, but this summer a demand shift (Factor 1) combined with three successive supply shifts to create an astronomical equilibrium price and an even higher price paid by consumers. Is there any light at the end of the tunnel for Californians? Well, of course summer will end eventually, which will at the very least eliminate Factor 5 from the equation. More importantly though, consumers’ demand for gasoline is only inelastic in the short run. In the long run consumers are able to temper their demand for gasoline by buying more fuel-efficient cars, joining carpools and ride-share programs, or taking advantage of public transportation. This long-run trend towards greater elasticity will shift some, if not most, of the tax burden onto the gasoline suppliers, further easing the prices faced by California drivers.
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