Saturday, June 16, 2012

Gasoline Price Swings and the Boy Who Cried Wolf: The Mantras of The Gasoline Price Increase Creates a Consumer Tax and Gasoline Price Reduction Creates a Tail Wind

When gasoline prices rise in the U.S. media sources depict the increased price as a “tax”. When gasoline prices decrease in the U.S. media sources depict the decreased price as a “tail wind”. The basic concept depicted is that as gasoline prices increase consumers have less to spend on other consumption items and as gasoline prices decrease consumers have more money to spend on other consumption items. A nice neat package of price sensitivity and allocation of resources…. or is it?

Obviously price is a signal. However, price is a relative signal. That is, consumer A might be very sensitive to certain price increases where as consumer B is not. Also, what is the exact price level that creates sensitivity? And what ever sensitivity exists, the result is somehow purely demand driven consumer consumption of goods and services?


If one assumes consumer A has a household budget then one would assume that consumer A makes an assumption regarding gasoline prices. Lets assume consumer A decides $3.00 per gallon of gasoline will be the average. Hence if gasoline goes to $4 per gallon then consumer A must reallocate the budget. One could say the price increase is a tax upon consumer A’s budget. However, if prices retreat to $3.50 per gallon from $4 per gallon has a “tail wind” been created -or- is the tax on consumer A’s budget merely been reduced but not eliminated. In this example a “tail wind” would only occur if gasoline prices fell below the $3 per gallon assumption in the original budget. However, media sources depict any decrease in gasoline prices as a “tail wind” when in fact it all depends on the base assumption of average gasoline prices used by all the James and Jane Goodfellow(s).

The reverse is true. If consumer B made a bold assumption of $5 per gallon for gasoline and prices only rose to $4, then a “tail wind” existed through out the price changes and a “tax” never occurred.

Moreover, if James and Jane Goodfellow set a price for gasoline within a budget, do swings in price change behavior significantly or do we have more of the-boy-who-cried-wolf phenomena? Tax or tail wind, do constant price swings cause the consumer to create a sinking fund of sorts to deal with the price swings? That is, does the consumer apply risk management to the tax and tail wind price swings and hence neutralize the tax and tail wind phenomena through risk management of gasoline prices?

Finally, the tax or tail wind mantra makes an explicit and implicit assumption: any price change only affects consumption of goods and services. What about savings and investment? What if gasoline price changes only affect savings and investment for certain consumers? Why is gasoline price changes only equated with demand side items?

The next time one hears media sources making sweeping statements regarding gasoline price changes and the supposed tax or tail wind, one needs to consider sweeping macro economic statements of such types need considered on more micro economic grounds.

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