Economics in Plain English » price gouging

Bali’s Oligopolistic Scuba operators

Jason Welker — Tue, 14 Sep 2010 04:00:53 +0000

A few summers ago, my wife and I spent three weeks travelling around the island of Bali in Indonesia. For six of those days we rented a jeep and circumnavigated the island. Our first stop was for two days of scuba diving in the northeast region of Ahmed. As we drove along the seven beaches near Ahmed, we observed there were around ten dive operators offering packages for the local dive spots (including one of Asia’s most famous dives, the WWII-era USS Liberty wreck). Based on our Lonely Planet recommendation, we settled on Eco-Dive, where we paid $60 a day for two dives and all our gear rental. We felt good about this rate and agreed that $60 was a fair and competitive price for a day of diving.

Our next stop, Pemuteran, a remote and relatively undeveloped area on the northwest coast just across the straits from Java, is also known for its great diving. On our first morning in Pemuteran, my wife and I strolled along the beach and found that there were only three dive operators to choose from! And guess what, they all charged between $95-$105 for a day of diving. That’s around 60% more than the operators in Ahmed charged! In the end, we decided to do only one day of diving in Pemuteran, and elected to spend our second day there reading by the pool.

Discussion Questions:

What was the difference between the scuba diving markets in Ahmed and Pemuteran? Which market was more competitive? Which of the four market structures did the two markets most resemble: perfectly competitive, monopolistically competitive, oligopolistic or monopolistic?
How were the dive operators in Pemuteran able to charge 60% more than the operators in Ahmed?
What do you think is keeping one of the three dive operators in Pemuteran from lowering their price to, say, $60 for a day of diving? How would the other two operators respond? Would this be good or bad for the dive operators of Pemuteran? Would it be good or bad for scuba divers?
Assuming that the cost of opening a dive operation was relatively low, and there were no government or other barriers to doing so in Pemuteran, what do you suspect will happen in the Scuba diving market as the tourism industry continues to develop in the remote town of Pemuteran? Explain.
Which village’s dive operators do you think were more “efficient” in their use of resources? Explain.

Gas prices continue to rise: Who’s worried?

Jason Welker — Mon, 21 May 2007 03:54:05 +0000

Gas hits record high price for eighth straight day – May. 20, 2007

According to CNN.com:

“The run-up in prices is a big concern for store chains, according to the retailers’ trade group. Its survey of consumers released early Friday found the average consumer believes that the price of gas will reach $3.32 per gallon by Father’s Day… As a result, 40.2 percent of consumers are taking fewer shopping trips, while 37.9 percent told the survey they plan to shop closer to home.”

“To offset the effects of higher prices, more consumers are giving their wallets a little extra cushion by cutting back on discretionary spending or choosing to frequent retailers closer to home.”"

And this is a bad thing? To big chain stores, perhaps, but what about the neighborhood businesses (are there still any of those?) that will benefit after years of losing business to big box retailers like Wal-Mart and Home Depot? Consumers driving less may harm major retailers whose stores tend to be clumped together in mega shopping strips on the outskirts of towns, but surely the benefits of less driving outweigh the costs.

Fewer cars on the road mean less traffic, less noise, more space for cyclists, less hazard to pedestrians and children playing ball in their yards, cleaner air and a deceleration of global warming, more customers at neighborhood businesses, and perhaps even more quality time with family and friends (if we can assume less time shopping means more time with each other).

So if high gas prices result in so many improvements in our environment, relationships, communities and health, why are they such a bad thing? Perhaps because higher gas prices overburden the poor. Since fuel makes up a larger proportion of a poor family’s budget than a rich one’s, higher gas prices put a bigger dent in the disposable incomes of the poor than the rich. Economic theory would indicate that the poor’s demand for gas is more elastic than the rich’s, meaning that price increases are met with a greater decrease in consumption than someone for whom gas makes up a relatively small part of their overall budget. This, again, may not be so bad. Perhaps the poor will begin limiting their outings to those that are deemed most necessary (such as to and from work, school, child care or clinic) and cut back on unnecessary trips (such as to mall, the movie theater, the go cart track or the Wal-Mart across town). Less consumption may not lower overall standard of living when we consider that much of the consumption going on by Americans (rich and poor alike) is frivolous and ostentatious.

Even acknowledging the regressive nature of the burden of high gas prices, it still seems to me that higher prices are necessary to achieving a cleaner, healthier, better functioning society. The problem is, if prices are kept artificially high through price gouging, as the Democratic leadership in Congress seems to believe, then the full benefits of higher gas prices are being passed on to oil companies rather than society, as could be achieved with an effective gas tax.

CNN presents their own solution to the problem of high gas prices:

From higher taxes to more drilling, ways to cut gas prices – May. 10, 2007

1- Pass a carbon tax
2- Increase efficiency
3- Push alternatives
4- Require oil companies to make more gas
5- Build a gasoline reserve
6- Drill more oil

It’s too bad my AP class has finished for the year. I think a great quiz would be to hand them this list and ask, “What’s missing?” Anyone who’s completed a semester in a Principle of Microeconomics course should be able to get an A on such a quiz. Can you tell what’s missing? If so, please post your comment here. (Hint- fill in the blank: Supply and ______?_______)

Federal Price Gouging Prevention Act: aka the “STUPID” bill

Jason Welker — Fri, 18 May 2007 03:44:59 +0000

Here’s a follow-up to the previous post about stupid Americans acting stupid. Looks like the stupidity is not limited to the idiotic idea of boycotting gas for a day, rather it is alive and well among America’s leaders. Here’s the Democrats’ solution to the high gas prices faced by Americans today:

Join the Campaign to Change America / John Edwards ’08 Blog

“The ENERGY PRICE GOUGING PREVENTION ACT will provide immediate relief to consumers by giving the Federal Trade Commission the AUTHORITY to investigate prices–focusing on the causes, the burdens they put on American families and businesses, and solutions.”

And here’s an insightful and entertaining critique of the Democrat’s proposed bill by economist Tim Haab:

Environmental Economics: All politicians are idiots and other obvious thoughts on high gas prices

“There are two possibile explanations for the Democrats proposal of the STUPID bill. 1) They think the public is too stupid realize they are trying to “do something” by proposing a STUPID bill, or 2) They are idiots. Since Env-Econ readers obviously represent a cross-section of the public, and since Env-Econ readers are smart enough to know that this bill is STUPID, I have to conclude that 1) is logically impossible and therefore, 2) must be true. So we’ve now proven that Democrats are idiots. We’re halfway there.”

The stupidity of this proposed bill lies in the fact that Democrats seem to champion environmental protection, reduction of greenhouse gas emissions, and a solution to the global warming problem, while simultaneously fighting for regulations that REDUCE the price of greenhouse gas emitting fuel, the repeal of gas taxes, the expansion of oil refineries’ capacity, and other measures that will assure the cheapest gas possible for American drivers. The two goals are incompatible, as the solution to the greenhouse gas problem requires HIGHER gas prices, not lower gas prices.

What policy makers don’t realize is that “high gas prices are NOT an economic or political problem.” Markets allocate resources efficiently when markets are allowed to work. Higher gas prices reflect the basic economic law of scarcity, supply and demand. With developing countries like China demanding a greater proportion of world reserves than ever before, American drivers preparing for their summer road trips and a war raging in the middle east, higher prices at the pump should come as no surprise. Intervention in the gas market will result in greater inefficiency, as prices kept artificially low by government interfere with the market mechanism, increasing the quantity of gas demanded, and further exasperating the depletion of this scarce resource (not to mention contributing to the nation’s greenhouse gas emissions). The shortsightedness of legislators may only postpone the inevitable price rises of this resource for tomorrow’s consumers, while work in the complete opposite direction as they desire on the global warming front.

Ultimately, higher gas prices are necessary and desirable if we are to transition to more environmentally friendly fuel sources. As petrol reaches $4.00 per gallon, consumers will think more seriously about buying more fuel-efficient automobiles, using public transportation, choosing to cycle to work and taking other such steps towards reducing their carbon footprints. This, after all, is the only way Democrats will ever achieve their other supposed goal of avoiding the catastrophe of global warming and achieving greater energy independence; and this can only happen if gas prices continue to rise.

So what about “price gouging”? Concentration of market power among a handful of firms in the oligopolistic oil market may indeed result in some degree of collusion and setting of prices above equilibrium. This is inefficient, yes, but it occurs in a market in which, unregulated, equilibrium output and price would also be inefficient due to the existence of negative externalities. In other words, even were oil companies competing directly, the price would be too low and output too high since the price of gas does not include the full social cost of gas consumption. In a way, the inefficiency arising from excess market power corrects the inefficiency arising from the existence of externalities. The catch is this: consumers end up lining the pockets of oil companies rather than filling their own national tax coffers, since the higher price is a result of collusion rather than taxation.

What policy makers should be discussing is the imposition of new gas taxes, which, rather than only increasing the price consumers would pay, would reduce the ability of oil firms to price gouge, taking a chunk out of their “record profits” and turning it into tax revenues. These revenues could then be invested into research of new fuel technologies, the subsidizing of which would increase their supplies, making them more competitive as a substitute for petrol and thus more attractive to consumers. This helps politicians achieve their goal of energy independence and reduction of greenhouse gas emissions. Lower gas prices NOW will only postpone this important transition.

Here’s another clear presentation of why politicians should not meddle with oil prices: Knowledge Problem: Price Gouging – Politicians vs. Economists

May 15- “Gas Boycott Day”

Jason Welker — Wed, 16 May 2007 10:08:02 +0000

Environmental Economics: I couldn’t decide between “Gas Boycotts Don’t Work” and “Oh Crap, Here We Go Again”

So, the idea is that on May 15 (today in America), millions of Americans will boycott oil companies by not filling their cars with gas in the hope that firms like Exxon Mobil, Chevron, Shell and others will be forced to lower their prices. The goal is to make oil companies lower their price per gallon by 30 cents.

Remember my post below “Why learning Economics is SO important”? The American “Gas Boycott” is a perfect example of how people uneducated in economics can rally around really stupid and senseless ideas. The authors of Environmental Economics, a great blog, give all the reasons why this gas boycott will not achieve its goal. These are ALL basic economic concepts, which means that if ONLY the organizers of this boycott had bothered to take a principles course, they would have spared themselves of this embarrassing attempt at activism. I’ll keep finding reasons why learning economics is important, you keep learning!