Eric Hall
Economic major
9/05/07
Why are Gas prices more volatile than the price of newCars?
This paper discusses the reasons why the price of gas is more volatile than the price of new cars in the American market using good economic principles and reasoning. It will cover elasticity of the market’s and shifts in the demand and supply curves in both markets, such as changes in production cost, demand for the good, supply restrictions and affect of income.
Nearly everyone who fills up at a gas station on a regular basses gets frustrated over how quickly gas prices change over a short period of time or even by location. It’s not uncommon to see a significant change over just a few hours. On the other hand the price of new vehicles doesn’t seem to change at all. The price of a new Mercedes or a Ford truck will most likely be the same today as it will be next month but the price of gas may change three hours from now. So the question is why the price of a gallon of gas is more volatile than the price of a new car.
One reason is the elasticity of the markets. In other words how willing are people to buy the product regardless of the price. Gas is a necessity for most people so it is inelastic, maybe not as much as insulin would be to a diabetic but still a necessity. People will be more willingto pay a 5% increase on a gallon of gas to get to work than they would on a 5% increase on a 25 thousand dollar car. They would probably deal with their old car than pay an extra grand or so but losing their job over a $25 tank of gas might not be worth it.
A good example of the inelasticity of gas is the gas shortage in the 1970’s (1);theOrganization of oil exporting countries “OPEC” restricted the output of crude oil shifting the supply curve to the left jumping the price of gas. Even with a massive jump in price there were mile long lines for gas at some stations especially when the government started to ration the gas to the public. Why?Well because there is no substitute for gas, it is a necessity and because of that most people will buy it across a large price range. They may change their habits to reduce the amount of gas they use because it is no longer economical for them to drive to the grocery store
on a beer run three times a week but they will still buy it.
The market for new cars on the other hand is more elastic. The consumers are far less willing to cope with a jump in price so the auto makers have to be more careful with their pricing. If the price of steel increases auto makers might not pass the added production cost onto the consumer, at least not all of it because they might lose more revenue in lost customers than they would save with higher prices. One reason for the markets elasticity is that unlike gas there are many substitutes for cars. If gas prices go up people might start using public transportation, ride a bike orhey might choose to buy smaller more fuel efficient cars.
Because of the elasticity of the market auto makers can’t allow the price of cars to grow dramaticallover a short perisod of time but the producers of gas don’t have this restriction at least not to that exte. They can change the price due to circumstances in the market almost immediately and have very little lost revenue. If a hurricane hits the Gulf of Mexico and slows down production the consumer may see the results of it the next day at the pump. Regardless of elasticity both markets are affected by shifts in the demand and supply curves, consumers will see the change faster in gas than in cars but iif t is a long term trenthen they will still see it.
The markets for gas and cars are similar in that they are both driven by consumer demand; a shift in the demand curve means a shift in price up or down. One of the things that shift the demand curve is consumer taste. A coconsumer doesn’t really have much of a choice when it comes to gas but they might prefer a style or brand of car depending on their experience or even the bus. Because the car market has many substitutes it is more competitive lowering the price.
Gas and cars are also complements of each other, so a shift in the gas market causes a shift in the car market. A good example of this is the market for hybrid cars in recent years. Forty years ago everyone wanted a big V8 car with plenty of room but now they nt something that can get 40 highway miles to the gallon even if they have to sit on each other’s laps. Peoples taste in cars changed because those gas guzzlers are no longer economical at $3 per gallon of gas.
Income also plays a role in the demand curve. If a consumer get’s a new job making twenty thousand more he will more than likely consume the same amount of gas or more but his taste in cars may change to more expensive and less fuel efficient ones. If the income of the whole country increases and everyone is less concerned about the price of energy the demand curve of oil will shift to the right pushing up prices. The market for bigger less fuel efficient cars will grow and the market for mass transportation and highbred cars will fall.
Thehe Supply curve also affects the price in nearly the same way as demand. New technology will shift the supply curve to the right reducing price. The Oil industry has seen some significant technological advances like the super tankers, advanced deep sea drilling ships and platforms, and things like horizontal production wells (3). Even with the new technology the price per barrel of oil continues to rise mostly because of production caps and unstable production costs. OPEC often uses production caps that shift the supply curve to the left creating higher prices and surplus demand. Since they know we are willing to pay higher prices there is no reason for them not to charge that much. Hurricanes in the Gulf of Mexico damage oil platforms reducing their outputnd wars in the Middle East slow or stop production shifting the curve further to the left. Venezuela recently stopped selling oil to America reducing the supply jumping gas to over $3 a gallon in some states.
The automotive industry has seen manyny new production techniques such as automated welding machines that allow for higher output and in some cases reduced labor costs. There are no major production caps on the automobile market and production costs aren’t affected by natural disasters or warn other countries nearly as much. Most of the materials that go into automotive production come from America, China and Japan. All three are stable and prospering economies that provide relatively low production costs, some more so than others. The production cost of making cars is affected by fuel prices when it comes to transportation of materials but overall it’s much more stable.
The gas market has an ever changing supply curve that seems to shift at the drop of a hat and because of its inelasticity the producers can pass the cost directly onto the consumer creating extremely volatile price ranges. The market for cars in the united Sates is far more stable because production costs don’t change nearly as much or as quickly. Even if there was a shift in the supply curve of the car market it wouldn’t be passed onto the consumer immediately because of the markets elasticity. Bolt markets are susceptible to change but consumers have very little control over the cost of gas because it’s a necessity and there are no substitutes. The car market is at the will of the consumer and his or her tastes. People have a say in which car company reaches it’s expected quarterly earnings but not if the president of Iran can afford a few more fighter jets. Automotive companies are far more concerned about volatile prices for that reason. The elasticity of the markets, production caps, war and hurricanes all contribute to making gas prices more volatile than car prices in the American market.
Chart 1
1.)Dustin Coupal, Jason Toews, Historical Price Charts, GasBuddy Organization Inc., 09/05/07, 09/08/07,
2.)State of Illinois, Price Gouging vs. Price Volatility, Gas price monitoring, 07/15/07, 09/08/07,
3.)1973 oil crisis, Wikipedia, 08/09/07, 08/09/07,
3.)” horizontal production wells allow producers to run long sections of horizontal tubing through a thin layer of oil down to 6 feet draining the deposit through several perforations, or openings, along the section of pipe.” (ANWR)