Thursday, May 10, 2007

More Economic Lesson Opportunities on Gasoline

There's was an interesting piece in the May 10, 2007 issue of the Miami Herald about gasoline prices by columnist Andre Oppenheimer. In it he notes that he recently paid $3.41 a gallon to fill up his tank. He also says he's hoping for and would welcome prices above $4 a gallon. This brings up an interesting opportunity to discuss some basic economics in the classroom.

Perhaps the most basic concept to use this with is discussing prices, and supply and demand. In its most basic form, price influences quantity supplied and quantity demanded. On the supply side, higher prices will encourage development of alternative sources of petroleum that can not be efficiently exploited at lower prices. Additionally, at higher prices, not only alternative petroleum sources, but alternative energy sources in general can be brought on line. Alternative sources that are more expensive to bring on line become economically feasible and competitive when the price of oil rises high enough.

On the demand side, higher prices should reduce demand. This reduced demand can take the forms of reduced driving, or a switch to more efficient vehicles (higher mpg or hybrid both fit the bill here), or some combination thereof. The question becomes how high do prices have to rise before we see an appreciable drop in demand? This gives us an opportunity to examine price elasticity. The demand for some goods and service react less to price changes than others. These goods are "price inelastic." Price changes result in small or negligible changes in the quantity demanded. This pattern is frequently associated with necessary goods and services. (It is also not infrequently associated with goods to which one has an addiction. That can be another issue.)

An additional topic to discuss at this juncture can be the substitution effect. As the price of certain goods and services rise high enough, they encourage the seeking for substitutes (see above). Alternative methods of transportation and alternative energy sources become viable substitutes when the price of a good makes them competitive.

Oppenheimer is basically saying, the sooner we see the higher prices, the sooner we will see economically feasible alternatives and significant changes in consumption patterns.

As a further point of discussion, one can also debate why our supply of gasoline is so inadequate. One doesn't have to research long to find out that refining is a key kink in the hose (so to speak). An expansion of refining capacity would allow oil companies to bring more supply to the market, sooner (and with backup capacity in case of Katrina-like disasters), which would have the ability to mitigate price swings, somewhat. For an interesting post on this issue, please see William Polley's May 10, 2007 blog entry.

What direction are discussions with your students about oil/gasoline prices and economic principals are you experiencing?

Posted by TSchilling at 9:56 AM Comments (0)

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