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3Qs: Paradox at the pump

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Gas prices nationwide continue to surge. The Energy Information Administration reported that at an average of $3.79 per gallon for regular gasoline, prices in the United States were nearly a dollar higher last week than they were the same week in 2010. Zhongmin Wang, an assistant professor of economics at Northeastern University, is an expert in strategic pricing behavior in various gasoline markets. Here, he discusses the ebb and flow of gas prices throughout the year, why they are at record highs, and their economic impact.

What factors play a role in determining how gas is priced? Why are gas prices approaching record highs?

The retail gasoline price that consumers pay at the pump reflects the costs and profits of refiners, distributors, and retailers, as well as federal, state and local taxes. Environmental regulations also affect gasoline prices somewhat by inducing or forcing the use of ethanol and “boutique” gasoline blends. Here, the cost of crude oil is by far the largest and most variable component of gas price. Gas prices are approaching record highs because the crude oil price is approaching record highs.

What periods throughout the year do gas prices tend to peak and why?

Gas prices tend to be highest during the summer and lowest during the winter. This seasonality in gasoline price is due to simple demand and supply. First, people drive more during the summer, which increases the demand for gasoline. Second, it is more expensive for refineries to produce summer gasoline blends than winter gasoline blends. Summer gasoline blends, due to a lower vapor-pressure allowance, can only have a small proportion of butane, a relatively cheap and abundant blending component that has a high vapor pressure. Increased demand and cost both cause gasoline prices to peak in the summer.

How will increased gas prices affect the economy in the short- and long- term?

Higher fuel prices hurt the economy in the short run. Having to spend more money on fuel, people have less money to spend on other things, and fuel-dependent businesses—such as airlines—may earn less profit. However, high gasoline prices are not all bad for the economy in the long run. This is because consumers and firms make adjustments to higher fuel prices, which may benefit the economy over time.
As gas prices go up, consumers have greater incentives to drive less and buy more fuel-efficient vehicles. We as a society would be better off if we drove less than we do now.

Most of us do not take into account the fact that our driving leads to pollution, congestion, and noise, as well as energy consumption. This is one of the rationales used to justify very high taxes on gasoline in some European countries. In the U.K., for example, gasoline prices are over $9 per gallon because of high gas taxes. Economic research suggests that it would be better for the nation if the U.S. government were to increase gasoline taxes, albeit not to the U.K. level. High fuel costs also offer businesses stronger incentives to produce fuel-efficient vehicles, adopt fuel-efficiency technologies and to invest in alternative energy sources.