Sunday, April 27, 2008

McCain, Clinton Propose Summer Giveaway to Oil Companies

As Dean Baker, pointed out, McCain's proposal for a summer "gas tax holiday" is just about as bad as policy can get. Since oil companies are already producing at full capacity, supply is essentially fixed, meaning that we're at the near-vertical portion of the supply curve, and the price is determined by demand, not supply. As a consequence, temporarily eliminating the gas tax will just just shift the vertical curve downward, resulting in no change at all in the price consumers face. I've drawn the relevant supply and demand curves below. The only effect of eliminating the tax is that the producer surplus increases, i.e. the value of the tax is now captured by oil companies rather than the government.
Now, lo and behold, Clinton has embraced the same pandering proposal. Obama responded correctly:

Obama spoke out against halting a tax on gasoline during the summer months, a move supported by Clinton and presumptive Republican nominee John McCain, saying it may not bring down prices and would deplete a fund used for building highways.

It was bad enough to see Clinton and McCain double teaming Obama with bogus attacks. It's even worse to see Clinton latch on to McCain's bad economics.

UPDATE: There's a post by Poblano at Daily Kos with more detail on this.


Pantograph Trolleypole said...

Why doesn't Obama start telling it like it is. That living in the suburbs and driving is what is causing all of the headache at the pump. We need him to talk more about things like this...

lerxst said...

...its also a shame that Krugman is silent on Hillary's pandering on this issue.

Brooks said...


Your graph shows a demand curve that is significantly elastic, which misrepresents the short-term demand curve for gasoline, which is highly inelastic. If supply and demand were both perfectly inelastic (or very close to it) over some range of prices, we'd have overlapping vertical supply and demand curves over that range, and therefore multiple equilibria. Either suppliers would price at the top price of that overlapping vertical segment if they wanted to maximize short-term profit, or they'd price somewhere below that price due to objectives other than maximizing short-term profit (e.g., wanting to slow the development of substitutes or of conservation, or reducing the risk of governmental intervention such as a windfall profits tax or price controls). If it's the former, then removal of the tax will simply lead to suppliers raising the price by the equivalent amount, resulting in no retail price change and increased profits for suppliers. If it's the latter, suppliers would allow the retail price to decline by some or all of the amount of the (removed) tax.

donpedro said...

Brooks: Here is a discussion of two meta-studies of the price elasticity of gasoline:

Both studies find a short-term price elasticity of demand of about -0.25.

I think most analysts think the short-term price elasticity of supply is very close to 0. If that's the case--and the price elasticity of demand is something like -0.25--you'd see little or no effect of removing the tax on market price.

Brooks said...


Thanks for your reply.

I've heard of studies that put the short-term elasticity of demand at 0.10, but in any case, if we assume some elasticity, there's something I don't get.

If, as your graph suggests, suppliers are at capacity, and if we assume that they have been at capacity for some time now (i.e., since the price of gas was substantially lower) and if demand is somewhat elastic, then we would expect that as the price rises (adjusted for seasonality), suppliers would then fall below capacity. But if that is NOT the case -- if suppliers were at capacity at, say $3.00/gallon, how can you explain suppliers still being at capacity at $3.50, assuming industry capacity has not contracted in the interim?

That's why it seems to me that either suppliers have NOT been at capacity, or they have been and both demand and supply have been perfectly (or near perfectly) inelastic over the relevant price range -- in other words, overlapping vertical lines over that range, with multiple price equilibria, and the price determined by whether or not suppliers are seeking to maximize short-term profits (in which case they'd price at least at the top of the overlapping vertical segment) or not (in which case the price could be at a lower point along the vertical segment).

See what I mean?

donpedro said...

No, I don't understand what you're saying. The multiple equilibrium scenario you would get with supply and demand elasticities exactly equal to zero is a theoretical oddity, not something which has relevance to the real world.

Brooks said...


Your graph assumes short-term supply is perfectly inelastic over the relevant price range. I'm suggesting the possibility that short-term demand could be perfectly inelastic (or darn close to it) as well, which would produce an overlapping vertical segment of the supply and demand curves, with multiple price equilibria.

But let's start with the question I asked you: If short-term demand is NOT perfectly price-inelastic (if there is some elasticity, as you contend), and if suppliers were at capacity at, say $3.00/gallon at a corresponding time (season) last year, how can you explain demand still equalling supplier capacity quantity at $3.50, assuming industry capacity has not contracted in the interim? If demand is not perfectly inelastic, then by definition less quantity would be demanded at a higher price, unless the demand curve has shifted sufficiently to the right to prevent that decrease in demand. So unless a rightward shift of the demand curve explains how demand could still equal supplier capacity at a higher price (seasonally adjusted), either capacity has shrunk enough to explain it (i.e., supply curve has shifted to the left), or changes in inventory levels can explain it, or...demand over that price range is perfectly inelastic, meaning a segment of overlapping vertical supply and demand cuves.

So, how do you reconcile the premise that short-term demand is NOT perfectly price-inelastic (i.e., that demand is somewhat elastic) with the premise that demand equalled supplier capacity at a much lower price (seasonally-adjusted) and demand still equals suppier capacity at a much higher price?

Can you show THAT on a graph?

donpedro said...

The short-term supply and demand curves are not what you would use to consider why the price has changed over the course of a year. Clearly, the longer-term elasticities are substantially different than zero.

Why are prices increasing over the this longer term? I don't know and I haven't looked at the question. But a pretty good guess is that the demand curve is continuing to shift out due to ongoing worldwide economic and population growth, while worldwide increases in worldwide supply (meaning, shifts outwards in the supply curve) have stalled.

Denis Drew said...

I've got an idea -- I usually do :-] : since the price of gas wont be affected by LOWERING the federal tax, maybe the price of gas wont affected by RAISING the gas tax either. If we add a dollar to the tax maybe the gas companies will be forced to lower their price a dollar to get rid of all the supply on hand. So, with allowance for a fair return for the refineries, whenever they are running full out maybe we could up the tax on gas a dollar or so in order to take back much of the excess price for taxpayers.

Don't forget to vote for me. :-]

Brooks said...


I used an apples-to-apples vs. same point last year to avoid the seasonality factor.

But I could have instead pointed to the 8.1% rise in the price of gas over just a 3 week period last month (April) and asked the same question.

I'm guessing that seasonality does not account for demand staying equal after a price increase of that size during three weeks in April, although I'm not sure.