Landsburg Chapter 7

Tag: Landsburg Chapter 7

More ‘Gas’ than You Can Handle

The always-on- the-lookout-for supply & demand examples duo at are shaking their heads at the continuing disconnect between how politicians talk about prices and how the price system actually works. Today’s contribution is gasoline prices.

Here’s a taste:

Increasing taxes on oil companies will not lower gas prices, so Democrats are hoping that voters see it as unfair that oil companies are making so much money and receiving tax breaks (economists don’t have much to say about equity arguments — there is no economic theory to explain differences in your “fairness” and my “fairness”).

And this:

Expanding domestic production of oil and gas will not reduce gas prices significantly

“The proposal would end a series of tax advantages for the five companies and produce about $21 billion over 10 years, Democrats say.”

Let’s do the math. Suppose the five major oil companies are able to take the entire $21 billion in higher taxes over 10 years and pass it along to consumers in the form of higher gas prices. U.S. consumption is about 132 billion gallons per year (source: EIA). Dividing $2.1 billion per year by 132 billion gallons gives a price increase of about $0.16 per gallon. A fairly typical driver (12k miles, 20 mpg) would pay about $96 more each year as a result. You can determine for yourself if this is a price increase that politicians should worry about…

Those back-of-the-envelope calculations can be so refreshing!

Where are Oil Prices Headed?

Saturday marked another wowza LSB event, with our star-studded panel presenting some great information on the “buy side” of the market.  Dean DuMonthier ’88 gave a riveting characterization of the oil market, and seemed very bullish indeed.   Interestingly, the discussion centered around a $125 price for oil, whereas there seems to be a leak in the bottom of the barrel with prices falling back to $100 this past week.

One of the key areas of interest is the ratio of oil to natural gas prices relative to the British Thermal Unit (BTU) equivalent of about 8.  That is, where the price of oil has about eight times the energy content of a unit of natural gas, and therefore the price of oil should trade at around eight times the price of natural gas (I’ve also seen this ratio at 6).  Why is that?  Because oil and natural gas are imperfect substitutes, there is money on the table on both the supply and demand side if there is an imbalance.

With natural gas prices just under $5 and oil prices north of $100, that ratio is better than 20 rather than 8.  So, the question is, is that an anomaly that market forces will correct — that is, with rising natural gas prices and/or falling oil prices?  Or, is this a paradigm shift?  I sat in a group with Guy Scott ’88, and he gave us compelling cases on both sides (despite what Timothy Siegel at Forbes seems to think).

For another complementary perspective, check out James Hamilton’s discussion at Econbrowser.

Now, for those of you who are Discovering Kirzner, you might ask yourselves, which is more important to these guys — the price theory fundamentals, or some element of “discovery” and arbitrage?

For those of you not Discovering Kirzner, I hope the panel impressed upon you the ubiquity of a relatively straightforward applications of competitive markets a la Landsburg Chapter 7.

If any of the panelists happen to be reading this, thanks for coming.  It is really great to have you back on campus.  And it is great to see you bring your professionalism to our co-cirricular events.  We hope to see you again soon.