Anticipation

Under the heading of "Markets Anticipate the Future", Don Boudreaux posts a copy of the letter he sent to a local radio station:

Dear Sir or Madam:

This morning your reporter interviewed a resident of Galveston, Texas, about the effects of hurricane Ike.  The person interviewed said that she went to the gasoline station before Ike hit to "top off" her tank.  But she was angry to find that gasoline prices had jumped 50 cents per gallon from the day before.  "It's ridiculous," this woman opined. "Ike hadn't hit yet!"

Your reporter should have immediately asked this woman: "Well, why were you topping off your tank?  Ike hadn't hit yet."

Gasoline became more scarce -- more precious -- in Galveston the moment Ike's arrival became likely. Gasoline retailers acted in anticipation of the future no more or no less than did motorists (such as your interviewee) who topped off their tanks.

Sincerely,
Donald J. Boudreaux

Windfall profits?

(A blast from the past)

Remember the hue and cry a month ago, about the oil companies "gouging"?

[I]n our nation's capital, the town of a thousand-and-one second chances, Congress designed something dubbed the Windfall Profit Tax (WPT) in 1980. Less than a decade later - mere days on the bureaucratic time-clock - the tax was lifted after being judged by almost everyone to be a colossal failure.

Consider the recent Congressional hearings over the run-up in gasoline prices following the worst hurricane season in record and its flagship storm, Katrina, the worst natural disaster in American history. Treated like criminals for making profits, oil company CEO's were paraded before a joint hearing of the Senate Energy and Commerce committees to justify their earnings as senators from both parties beat them like piñatas on national television.

According to a study by the non-partisan Congressional Research Service, the original windfall profit tax a quarter of a century ago, reduced domestic oil production by somewhere between three and six-percent from 1980-1988. As a result, it increased foreign oil imports from between eight and sixteen-percent - exactly the opposite of its stated purpose. To top it off, by the end of its run, the WPT had generated virtually no revenue. It was repealed and left for dead in 1988.

"Gouging"

People will occasionally point out how much I seem to "believe in" capitalism. Or the law of supply and demand, or comparative advantage, or some other part of economic theory. And I'll admit it's true.

I also "believe in" gravity, thermodynamics, and Newton's laws of motion.

Now what?

I'll tell you one thing I don't believe: that capitalists are angels or saints. My "belief in" capitalism does not mean I believe people are going to be generous to the poor and do good to their neighbors for the hell of it. It means that there are certain inevitable consequences of anything that has any kind of impact on the marketplace.

Just as every engineering project has to take the law of gravity into account, every social engineering project has to take the laws of economics into account.

Take "price gouging", for example.

...continued in full post...

Now, greed does happen to enter into the equation, but if you blame the oil price increase entirely on greed, you need to find some way to account for the timing. Why did the oil companies wait so long to jack up prices? The answer is, they couldn't.

Many people think the recent spike in oil and gasoline prices was due to the oil companies' greed, and the recent fall was due to the threat of congressional action.

What businesses do is they try to charge as much money as they possibly can for all of their products. And the question for the economist is, well how can they do this? And under what circumstances can they do this? So each business is facing a dilemma. If they raise their prices, they get higher margins but they lose customers. And if they lower their prices they get lower margins but they gain customers. So you know you have the old joke, we’re losing money on every sale, but we make up for it on volume.

There are some industries that have figured out ways to keep customers from leaving for a cheaper competitor. Take, for example, "premium" products."

...if they could split their customers up somehow and identify the customers who are not willing to pay and the customers who are willing to pay, charge a high price to the customers who will pay it and a low price for the customers who won’t, you get the best of both worlds. You get all the high margins on those sales you are going to make. Plus you get the volume. ...<snip>... the cleverest way of price targeting is to get the customers to identify themselves as price sensitive or not. So if you offer them some choices you may be able persuade some of your customers to reveal themselves as not looking at the price.

Some examples:

...sometimes you just offer the same product packaged two different ways at different prices. And if a customer is looking at the price they will buy the cheap one. And if they are not looking at the price, well 50/50 chance they will buy the expensive one.

There are some coffee chains in the U.K. who are charging markups of about 20 cents on a fair trade cappuccino. And the natural assumption of the customer is that that 20 cents is going to go to some poor farmer in Guatemala. But actually hardly any of it does. It’s not because the company is stealing the money. It’s because there is just not that much coffee in a cappuccino. And while the farmer is getting much more money for his coffee, most of that 20 cents is markup. Just pure extra profit that goes to the cappuccino seller.

A lot of people like to buy organic food for various reasons. Some people say it is better for the environment. And some people say it is better for their health. Some people say it tastes better. I don’t have a strong opinion on any of this. I have not studied the evidence. What I do know is that the markup is higher on organic food. Substantially higher. Organic food is more expensive to produce. But most of the costs of getting something on the supermarket shelves – staff time, electricity, rent, distribution costs – they are not actually the raw cost of the produce.

If you dislike "corporate greed", you might consider a boycott of these premium-priced goods.

Oil prices – again

Cafe Hayek has a thought on the "obscene" oil company profits.

Here is the text of the commentary I did this morning at NPR's Morning Edition.

Those Senate hearings on the cause of high gasoline prices should be really brief. Three words. Supply and demand.

When hurricanes destroy refining capacity, pipelines and drilling platforms there’s less gasoline to go around and prices rise.

Everybody knows what’s bad about high prices. Less money for us. More money for the oil industry.

But high prices are good, too. When prices are high, some people will drive less, car pool, buy more energy efficient cars allowing the people who really want gasoline to have it.

There’s another benefit of high prices. They encourage greedy oil companies to pull oil out of the ground that isn’t worth pulling out of the ground when prices are low.

But isn’t the recent run up of prices just corporate greed run amok? I don’t know. At my local station, prices are down 85 cents per gallon from the peak of a few weeks ago. Did the owner just get nice overnight? Did he forget how to gouge? Did he figure he’d made plenty of money and it was time to give me a break? I actually think he’d still charge $3.50 a gallon if he could. But now that there’s more gasoline on the market, he can’t charge what he did before and still get my business. Too many competitors are charging less.

If the Senate does have hearings on oil industry profits. My fantasy is that an Exxon executive will have the courage to say:

“Yes, we made a lot of money last quarter. We earned it and we’d like to keep it. And in those times when we make a lot less, or even lose money, we won’t expect to be bailed out.”

As I noted last week, the profit made by the largest oil company was a little less than 10% of its gross revenue. I haven't checked to see how that compares with the percentage compares with its percentage profit in previous quarters. I also haven't compared that percentage with what other oil companies are making, though I suspect it's slightly less, based on news I heard in passing.

Even if we're the sort to begrudge the oil companies even a 10% profit, there's another fact we can derive from that number: If oil companies were to shrink their profit margin all the way to zero, that would lower prices at the gas pump by no more, and probably rather less, than 10%. It'll make some difference, but it won't get the pump price back below $1 per gallon.

Obscene profits?

Are the oil companies making obscene profits?

Part of the answer depends on what "obscene" means.

Exxon Mobil Corp.'s profits surged 75 percent to a record $9.92 billion in the third quarter, fueled by high crude oil and natural gas prices, the world's largest publicly traded oil company reported yesterday.

That's a lot of dollars. And a 75% increase is pretty good. But...

Revenue for the Irving, Texas, oil giant neared $101 billion in the quarter – the first time a U.S. company has broken the $100 billion mark in a three-month period.

That works out to 9.8 cents on the dollar. Most places, a profit under 10% is considered reasonable.

It's common for lay people to imagine the oil company having ten billion dollars sitting in a vault somewhere. I have a hunch, though, that they don't. It's kind of in the nature of money to get spent.