Monday, April 24, 2006


Review: In my first article regarding price gouging I discussed how fuel markets are characterized by a Nash Equilibrium strategy that prevents long term 'price gouging.' In the second article I discussed how the Clean Air Act has increased capital expenditures by nearly 400% and reduced ROI by 42% between 1996 and 2001. This I explained has reduced investment and production capacity.

What happens when we take both of these effects into account? The decreased profitability acts as a barrier to entry preventing competitors from entering the market or increasing capacity. In fact there hasn't been a new refinery built since 1972. When demand exceeds supply, prices rise but there is very little supply response. As a result prices remain high for longer periods of time.

With barriers to entry, there are fewer 'players' in the price gouging game. With fewer players, it takes longer for the market to converge to the lower priced Nash Equilibrium.

Although environmental regulations have reduced return on investment, the resulting barriers to entry have increased the market power of existing firms. In essence, it is environmental regulations that make it possible for firms to ‘price gouge’ because of the increased market power that these laws create for oil companies.

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