There’s no doubt that Americans are currently frustrated by high gas prices. And certainly many voters believe that “something oughta be done about it.” But why? Here’s a simple taxonomy of concerns:
1. Relative prices: Are people frustrated that a gallon of gas now requires more foregone “stuff.” Or alternatively phrased, are they concerned about the low relative price of “stuff”? Stated this way, it sounds a bit odd that we are so upset that the benefit of giving up one more gallon of gas is now a heckuva lot more stuff. (Indeed, environmentalists should be thrilled.)
2. Absolute prices: Are people concerned about the change in the absolute average price level? The consumer price index is currently 216.632; is this too high? If so, what is the right average price level?
3. Real wages: Is the real concern about the average price level relative to (nominal) incomes? That is, if the average price level rises but our money incomes stay the same, we tend to cut back on both gas and “stuff.” If so, I have some good news: money income typically rises roughly in tandem with the average price level, keeping the real wage constant. And if you think the current episode will be an exception to this rule, then are your concerns about the gas market or the labor market — and does this change what “oughta be done”?
4. Inflation: There are also concerns about the rate of change of gas prices (#2 is about the level, not the change) and how this may impact inflation. However while gasoline and oil futures markets suggest that current high prices are here to stay, they aren’t expected to continue rising.
5. Reallocative costs of changes in relative prices: In the long run we will learn that a Pruis does as good a job at getting you to work as a Hummer and at a much lower cost. But in the short run, it will be expensive to shut down Hummer production and expand Prius production.
6. Redistribution due to changes in relative prices: It is unsurprising that the loudest gas-price whining is coming from those in the exurbs whose house prices have fallen due to higher commuting costs. But what is missing here is the urban homeowners who have simply kept quiet about their gains. In many cases one group’s losses are roughly offset by another group’s gains.
#4 is the focus of discussion by serious macroeconomists, although inflationary concerns should not be overstated; #5 is important, but in popular discussions it gets too easily confounded with #3 and #6. And because we rarely see pictures of workers enjoying their compensatory cost-of-living wage rises or investors in urban housing or green companies rejoicing that their investments have paid off, too often we focus only on the losses but miss the gains.
My favorite is a behavioral variant of #3: wages will probably continue to rise in line with the average price level, but when each of us gets our wage rise, we think that this is a reward for our hard work and not something as trivial as a cost-of-living adjustment. So each year we think that our employer realizes we are ever more brilliant, even as rising gas prices steal more from our paychecks. But workers should be tipped off that it isn’t just a coincidence that each year these two forces tend to balance out. (More: see Shafir, Diamond, and Tversky.)
This leads me to think that we are over-emphasizing the importance of high gas prices. What have I missed? And what exactly worries you about current high gas prices?
See my commentary on NPR’s Marketplace for more (or just listen here).
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We’re missing another simple explanation: public perception. It is no secret that President Bush has ties to Big Oil, and a lot of people see a connection (even if there isn’t any) between rising oil prices and personal profit for the President. And besides this is the vitriol directed at oil companies just for posting record profits at a time when people feel their own wages decreasing and are forced to budget. It appears to the general observer that oil companies are simply jacking up the prices to line their own pockets, and the White House is in on the scam.
Regardless of whether the conspiracy theories are true, they’re enough to explain a lot of the complaints about gas prices. Hysteria will win out over level-headed economics in the public’s hive mind.
One concern that seems missing from the list, although it is a version of (1) and (6), is deterioration of the terms of trade for an oil-importing country such as the US. This is an effect that theoretically reduces American real incomes, at least in the short term.
And some political rhetoric appears consistent with a fear that high oil prices redistribute from the US to oil-producing countries.
re: #1 – Serious environmentalists are thrilled. However, there’s a bunch of wannabe environmentalists who drive SUVs and drive many miles daily to work. Naturally, they’re not thrilled.
In general, you’re right – the cost of gas issues are overstated. The problem with gas is that every day, even when we’re not buying, we look at we see what the current price is. I’ve burned less than 20 L in the past month, meaning the total cost even at today’s price ($1.329/L – about $5/gallon) is less than $30/mo. And yet the psychology of seeing it go up constantly still causes me to think about it.
In reality the things that are worth worrying about, because they have less elasticity, are home heating costs and food costs. Yet it’s been months since food costs were front page news, and yet I’m just now starting to notice the big jumps at the store, and even then, it doesn’t seem like much until I add up all the bills for the month. It’s not sitting in front of me every day, so I don’t worry about it.
“money income typically rises roughly in tandem with the average price level, keeping the real wage constant”
This ignores the lag between individual wage increases and price. AvgJoe buys gas daily, but sees a raise once a year. That lag (correctly) leads to the perception that each raise is just enough to “catch up”, followed by another year of falling behind.
When the rate is higher, the shortfall is larger, which results in calls for something to be done.
I think that the major factors in our complaining about gas prices is a combination of #2 and #3.
On reason #2: The price for gas is displayed loudly at gas stations (unlike any other product or uility we buy – quick, how much do you pay per kW-h for electricity?). This extreme price advertising leads us to view the price of gasoline differenty than prices for other goods: we track pennies of difference between gasoline vendors and will cross town to save a nickel per gallon. For what other product would we drive across town to take advantage of what equates to a “1% off sale”?
On reason #3: We currently see the price of gas rising considerably faster than incomes. This makes us feel poorer and complain about it loudly. Oddly, fifteen years ago as the price of gas dropped impressively, we neither felt less poor nor rejoice in the low price – we just bought bigger SUVs.
On my worries: I worry about the price of gas in about the same way as I worry about the sun going down at night: I can worry all I want, it’s still gonna get dark.
When gas comes close to $5/per gallon, I’ll buy a small motorcycle for commuting. Meanwhile, I’m adding more insulation to my house (burning oil/gas makes a lot of our electricity too), deliberately condensing car errands, and biking to my pub for beer.
Chris S.
It must be nice to be a wealthy economicst and not have to deal with the real world impact of prices going up. Out here in the blue and green world we’re not getting a cost of living raise. I in fact do not get a raise until March meanwhile everything is costing more.
For those of us that live on a shoestring, it doesn’t take an economics degree to see the downside of an increase in the price of anything.
In the case of #3: Where is the money going to come from to pay compensatory higher wages when we are sending more of our GDP to the middle east?
I generally agree with the article.
The only cause for concern due to higher wages with a roughly equal purchasing power is that federal income tax is progressive and does not take inflation into account.