Wednesday, April 12, 2006


Are oil companies price gouging? If you can define price gouging as charging a price greater than what competitive market fundamentals would support, then I wish I could say YES!

Ologopolistic markets (like fuel markets) are characterized by a non-cooperative Nash Equilibrium for defection. This means that if all of the oil companies are 'price gouging' now then there is a revenue increasing incentive for discounting.

The previous analysis indicates that with price gouging, the high prices at the pump are unsustainable, and cannot be maintained for long.

However, if the high prices we are now experiencing are related to fundamentals, like increased demand from China and India, Middle Eastern instability, reduced refining capacity due to EPA standards, and hurricane setbacks, then it is likely that we will see gas prices remaining near 3.00/gallon and oil at 70.00/barrel.

Of course, much of the 3.00/gallon is still artificially inflated. (the real price of gas since 1950 not adjusting for tax differences across time has ranged 1.90-2.00) While our gas prices are not artifially inflated nearly to the extent as in Europe, we still pay a significant portion of taxes at the pump.

In addition, provisions of the Clean Air Act make it impossible to reduce shortages in one market with surpluses from others. As a result supply fluctuations lead to price spikes.

While technological progress will lead to alternative fuels in the future, a more immediate solution can be found via changes in tax and regulatory policy.

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