Applying economics to gas prices (With pictures yay!)

Alright, so I was thinking about the changes in gas prices over the year. It made sense to me why prices were going up, but it didn't make sense why prices went down drastically all of the sudden. So, I figured I would apply what I've been learning so far in class to see if I could come up with something.


Alright, so a year ago, gas was getting up there. Some places experiences prices of $4.00 a gallon. Merciful heavens; that is just darn tooting ridiculous!

So, I put my noodle to some thinking.

Now, we all know the supply of oil is decreasing, so in economic terms the oil supply curve would be shifting left. Let's take a gander:




Now, S1 is the original supply of oil, and if it's decreasing over time, demand is going to shift to the left. This means, a lower equilibrium quantity and a higher equilibrium price.

Uh oh, our market is going to be unhappy with these high prices!



Now, this all made sense to me so far. Like, I said, we know quantity is getting shorter, so prices would naturally rise.


But then...
This winter, there were some major decreases in the prices.

The market became happy once again.




I called my friend Thomas Gerbrolius. I was like, "Thomas, what is Sam Hill's tarnation is going on here? These are some of the lowest prices on this side of the Mason Dixon line. Why are prices now almost $1.00 a gallon. Something ain't right, Thomas." He was just as confused as I was...


I was so confused. There had been no major gas discoveries, so what had happened?

So, I put my noodle to some more thinking. I remembered that many people had decided to drive as little as possible. They were carpooling, riding their bicycles, walking, riding their scooters they received from the Scooter store, and so on. All of these in attempts to avoid paying for gas.

So, I thought, "Aha, DEMAND, has decreased."

What happens when demand decreases, well, let's take a gander:



As you can see, equilibrium quantity and equilibrium price go down.


However, I realized this wasn't the case. Yes, people were not driving as much, but prices were still high. The serfs were still unhappy!!!!




So one night, I did some more thinking. I sat back in my chair, eating some Corn Pops or something, and then it hit me! These people were reacting to a change in the PRICE of gas. Therefore, the actual demand curve would not have changed, there would have just been a change in the QUANTITY demanded. Also, as the price creeped up little by little, more and more people tried to reduce gas as much as possible, so I considered gas to be an elastic good. This meant quantity demanded would vary greatly in response to little changes in price. And this is true, if gas went down by 10 cents, people would rejoice and flock to the stations. At least Mother Brown would...

So what does all this mean? Let's take a gander.



Whabam! If there's a decrease in quantity demanded (going from QD1 to QD2) there will be a increase in demand, but prices will still say high until they have time to adjust. I believe this is what happened. The high gas prices caused a decrease in "quantity" demanded, so prices remained high until downward pressures on supply would make the prices go back down to an equilibrium point.


So, these downward pressures on the the price were not happening right away. But then, we entered our recession. Now the market was even more sad, as could be noted by millions of people changing their myspace profile pictures to "emo-angled" portraits of themselves.





To make matters worse, people were starting to get laid off left and right. Not only that, but companies themselves were starting to file for chapter 11. As unemployment started to reach a high level, and as quite a few large organizations started to go bankrupt, I realized, this impact was large enough to shift the demand curve itself. I mean, a company is not going to need gas for any of its operations anymore if it's going out of business, and people are going to need a lot less gas if they are unemployed.


Now, I am no economics genius here, but my guess is the supply curve looked something like this.



Whoops, wrong picture.

Something like THIS:



Actual demand had decreased tremendously because of the combination of high prices and then the negative effect of the current recession. Obviously, the prices of gas had to be adjusted accordingly. Since demand had shrunk so low, prices were forced to just accordingly.

So, if we hold all else equal in the world, and just look at the gas market in terms of this supply and demand graph..




...the market is happy! Gas prices are low enough, so me and Bill could drive out to play the back 9 at the golf course without worrying about gas.

It had gotten cheap. Now, prices are once again beginning to rise. I think this is both because the demand curve has shifted back to the right slightly since almost everyone could afford the gas that was approaching almost $1.00. Also, as quantity demanding is rising, there will be upward forces on price to push everything back to equilibrium.


So yeah, this is how I see the the world through my lens of economics. It's kind of like hitting a pinata. If you think about it, the person hitting the pinata is like the people in the market. They've been spun around and are blindfolded at first. They are confused. They start swinging, and hit a couple of their friends. They think they are hitting the pinata, until they hear crying from what they are hitting, so they move on, and eventually, they approach equilibrium, which would be hitting the pinata. Similarly, we start out confused in the gas market, until economics helps guide us to equilibrium.



Thank you,
Michael Brown.