Gas Price Increases Mike Rappaport

One of the comments to my earlier post on increases in gas prices is helpful because it makes a common mistake about how markets are supposed to work.  The commenter seems to suggest that the increase in prices at the pumps is a market defect because some of this oil was extracted before the price increase.  The argument seems to be that oil should reflect its historical cost, not its current cost. 

This is a mistake.  In a market, one would expect sellers to raise the price of goods when the market price increases, even if their historical cost was lower.  Similarly, if market price falls below the historical cost, the sellers will be forced to lower the price below the historical cost. 

This is neither unfair nor undesirable.  If you deem it unfair, ask yourself the following question.  If you buy your house for $400,000 and it has gone up to $800,000 over the last 5 years, should you sell it for $400,000 or $800,000.  No one thinks it is wrong to sell it for $800,000.

It is also desirable.  If the market price has risen, we want those oil resources to be treated by society as a valuable commodity, which they are, and the price increase ensures exactly that.  If the price were kept low, people would not have as much of an incentive to conserve this gas.

Finally, the increased profits of oil companies is not problematic.  It does not suggest a lack of market competition.  Rather, it is, to a large extent, a one time increase in the value of their inventories.  Oil that was produced when the market price was $40 will create much larger revenues when the market price is $80.