Falling Oil Prices and Gasoline Consumption:
A confused look at the drop in oil prices
24 Nov 2008 in Regulatory Economics, Regulatory Policy
The world price of oil has fallen from about $140 per barrel to less than $50, all within just a few months. Global macroeconomic conditions have deteriorated, of course, but that does not seem to explain what has happened.
Wall Street Journal columnist Joe White discusses the drop in oil prices, and he cannot seem to decide whether this is a good thing or a bad thing.
White writes in his weekly Eyes on the Road column (temporarily available to nonsubscrtibers) that the drop in prices has been a boon to consumers:
[T]he collapse of gasoline prices since the summer -- a drop of more than $2 a gallon in my neighborhood -- is an economic stimulus worth more than $200 billion a year.
But he seems to be ambivalent:
At current gasoline prices, however, consumers who buy expensive electric or plug-in hybrid cars would find it smarter financially to buy a reasonably efficient, conventional subcompact and work from home one day a week.
If gasoline prices stay low, demand for vehicles that use sophisticated technology to consume less gasoline per mile will depend on consumers making long-term decisions that aren't in their short-term economic interests. Otherwise, these new high-mileage cars might not sell for high enough prices to cover their higher costs.
White says consumers' response to high prices caused consternation:
By jamming the brakes on driving, rediscovering mass transit and walking past Hummers to buy compact cars like the Honda Fit, American consumers caused big trouble for powerful interests. The question now is how will those interests respond?
The "powerful interests" White has in mind are the "oil industry and oil-producing nations," but it is useful to remember that they did not predict that oil prices would rise to $200 per barrel and stay there. OPEC members said they could not explain why prices were so high, and oil industry executives said prices were going to fall. Indeed, the most important "powerful interests" saying prices would stay high were speculators betting prices would rise, those promoting alternative fuels, government officials, and candidates.
The crux of White's argument seems to be that it is a bad thing to allow market forces to set prices, because markets will set prices that are "too low" based on criteria he does not discuss. White's preferred policy is one in which oil prices stay high to discourage consumption:
A lot depends on whether Americans keep doing what they're doing, regardless of what the numbers are on the gas station signs.
Of course, if Americans had done that when oil prices skyrocketed, they would not have reduced their gasoline consumption or made long-term investments in more fuel-efficient vehicles. It is unrealistic (and economically illiterate) to expect consumers to respond when prices rise but do nothing when prices fall.
