Monday, May 05, 2008


Just to make clear earlier what I meant about the gas tax and being at capacity, here's our friend the supply/demand curve.

The markets for oil and gas aren't the same, but this graph can provide a representation of both.

Basically over the flat horizontal part of the supply curve (S), increases in demand (represented by rightward shifts of the demand curve, reflecting a greater quantity demanded at any given price) lead to an increase in quantity supplied by oil firms or gas refineries without much increase in the price. This is because they're operating at levels such that they can pull a bit more oil out of the ground, or refine a bit more oil into gas, without any significant increase in cost.

But these are both capital intensive industries, and oil requires exploration and discovery as well, so the capacity to keep cranking out product at the same or similar cost is limited. At some point, as the demand curve continues shifting to the right (remember this is the world market, so with more and more Chinese consuming...), we reach the a point where the curve tilts upwards. Over some range, more oil/gas capacity can be provided without costs going too much: perhaps increased 3rd shifts or shifting focus of refineries, or tapping known but more costly oil wells, but at some point you hit capacity. There is no more oil to be pumped out of the ground at any price, at least over the short run, and US oil refineries can't crank out an extra gallon at any cost. At that point, continued increases in demand simply raise the price without resulting in any additional quantity supplied. Prices go up to equate supply and demand, while output and consumption remain the same.

I won't do the full lecture on tax incidence (who actually pays a tax, buyer or seller, when it's levied on a transaction), but it depends on the shape of the supply/demand curves. And when we're in the verticalish region of the supply curve, any sales tax levied is almost entirely paid by the seller. Increasing the gas tax cuts into profits without increasing the price consumers pay (though causing them to consume less). Decreasing the gas tax increases profits without decreasing the price consumers pay (though leading them to consume more).

And this has been your Econ 101 lecture of the day!