Gas prices in rapid decline

I must have missed the blaring headlines about this, but the local price of gasoline has fallen ten cents a gallon in just the last two days, and is 35 cents off the post-Katrina peak. The price is still historically lofty, of course, even above the 1980 levels in inflation-adjusted terms. But "lofty" is a substantial improvement over "crazy."

As a driver of an old, fuel-inefficient vehicle, I have tried to be cagey in my fuel purchases. Even before that though came simple conservation efforts: fewer side trips, combining errands and the like. But a guy still has to get to work and back. When the price of gasoline is rising quickly, day after day, the proper strategy for purchasing is to fill up as often as possible. Better to buy all the fuel I can at today's lower price than at the new elevated rate of tomorrow. One just has to watch for the inflection point, noting when the runup has peaked.

The present, declining price environment calls for the reverse strategy. Don't fill up. Put in only a half tank today, because tomorrow's price will be lower. Go back to the usual fuel purchase patterns only when the price stabilizes for about a week. Furthermore, if you have five or ten gallons in cans as reserve, consider using that fuel now. It'll save you from buying at $2.75, and you can refill your reserve later when the price has bottomed.

This whole episode has been an interesting demonstration of the market at work; proof, I would think, that it is possible to endure a supply shock without running out of product as long as you allow the price to rise. I had to argue this with my coworkers a couple weeks ago as gas hit $3. One coworker, surprisingly, was alleging gouging and conspiracy. My case was straightforward. I first got my coworker to agree that a supply disruption existed. I then pointed out, "If you hold the price the same, you'll run out. Nixon tried that, and you had lines and shortages. Why would it be any different now?" The coworker was obliged to concede, at minimum, that some price increase had to occur to curtail demand.

That's when the other coworker jumped on me. "But people aren't going to drive less. They still have to get to work. They still have to go to the store." I replied that it's true that people will still do those things, and yet they will drive less all the same. For example, I switched around a visit with my extended family. Instead of the original plan of having them driving one or two large vehicles to visit me in my home over the weekend, my wife and I instead went to visit them, driving only my wife's compact car. As another example, this time of year I often have league sports events at seven in the evening. It's tempting to leave work at five, have some time at home and then go to the game, but that's more driving. So instead I have been staying late at work, saving on the driving. It's true that people are just trimming consumption on the margins, but you only need 4% trimming to get through a 4% supply shock. That's all it takes.

What the second coworker's statement is really about though is the inelasticity of American gasoline demand in the short run. People "need" to do a certain amount of driving, and those habits don't change easily. That's why it took about a fifty cent per gallon increase to result in the necessary curtailment of demand. But "inelastic" is different from "no elasticity at all," which is an exaggeration that my coworker was alleging.

Furthermore, over medium periods, we find more demand elasticity. The longer price pressure is applied, the more people will make long-term adjustments in their consumption. I know of two coworkers already this month who have purchased small used cars for the express purpose of saving on fuel costs, particularly in commuting. Behold, the free market at work!