Monday, October 24, 2011

Fluctuation Means Competition

Every now and then, someone says something silly about economics to me that makes me cringe a little.  A few weeks ago, my mother did exactly this. 

We were watching the news and a reporter said that an impending hurricane had caused a rise in oil prices.  My mother, frustrated that she would now have to pay more for gas, exclaimed that, “They’ll use any excuse to charge more.”  She seemed to think that there was a monopoly or cartel of some kind that controlled the price of oil and would raise it whenever they could. 

This is actually not  an uncommon misconception.  There are always plenty of people seeing evidence of collusion amongst oil companies whenever oil or gas prices spike.  Accusations of “price-gouging” were rampant a few years ago when gas prices jumped quickly and the price of oil increased by nearly 600% in only a few years*.

Fluctuating prices for a commodity as important as fuel is a cause for concern and should be addressed (the question of whether it should be addressed by the innovators in the free market or bureaucrats in the government is another topic entirely.)  But while fluctuating prices may be a cause for concern, they are most certainly not evidence for collusion.  In fact, they are strong evidence against collusion. 

A monopolist seeks to extract the maximum amount of profit from the service or product they control.  For the nonexistent oil monopolist, this means keeping prices just below the level at which people stop finding it profitable to travel places by car. 

More importantly, it means keeping prices at this level consistently.  Raising them above this level would mean that the monopolist would see lower sales, and therefore less profit.  Allowing them to fall below this level would mean losing potential profits unnecessarily.  Neither action makes sense.

Therefore, the one thing we can count on a monopolist to do is to keep prices steady.  Granted, they will be exorbitant, but at least they will be steady.  When we see prices fluctuating widely, that means other forces are at play. 

In the case of oil, these other forces are the increasing demand for gasoline and plastic products in the developing world, war and turmoil in oil producing nations and the falling value of the dollar.  Another factor at play might be that we are closing in on the point in time when the maximum rate of global petroleum extraction has been reached—an idea known as “peak oil”—but this remains a mostly unsubstantiated concern. 

What we do know is that monopolists do not raise prices sporadically or, for that matter, seasonally.  They raise them up to the highest possible level that they can without losing customers and keep them there.  So, the next time someone tries to tell you that high summer gas prices are evidence of an avaricious monopolist, ask him what accounts for the relatively low winter gas prices—an altruistic monopolist perhaps?    

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