Econ 101: Gas Tax

500px-Supply-and-demand.svgFor those of us who have not taken a survey econ course never fear…I’ll get you up to speed.  The graph above shows supply and demand curves.

The horizontal line (Q) is Quantity of a product or service and Q2 is a larger quantity (more supply) than Q1.  The vertical line “P” is Price to purchase the good or service.  P2 is a larger price than P1.

The blue line S is a supply curve for the product or service.  As with most supply curves is increases and tells us that as price (P) rises, the quantity (Q) of the product supplied also rises. Simply put if people are willing to pay more for pizza then more people will go into business selling pizza.  Common sense made difficult as a professor of mine used to say.

The line D1 is a demand curve for the product and tells us that as the price falls, the quantity Q of the product demanded rises. So, if the price of pizza drops more people will buy it.

The point where S crosses D1 is a market equilibrium, where the supply and demand for the product are equal. Easy to graph, hard to achieve.  If the price is below equilibrium, less of the product will be supplied resulting in a shortage and the price will rise.

Now, John McCain has proposed a Gas Tax holiday which would suspend federal gas taxes for three months.  The gas tax is 18.4 cents and 24.4 cents on diesel.  Some estimates have the government losing 10 billion in revenues.  McCain argues that the savings would trickle down to the consumer (you & I) and “help spread relief across the American economy.”

Being the dismal science that econ is, it’s impossible to say what the results of this gas tax holiday would be in reality.   However here are some more believable scenarios:

  • Assuming we are currently at a market equilibrium (debatable given how much gas prices change) reducing the cost of gas will increase demand which could increase supply but since summertime gas supply is mostly fixed…supply cannot increase. So price will rise but not supply and the benefits will go to the oil companies.
  • The tax reduction will be split between the producers and the consumers (you & I). In a real reduction of price, demand will rise raising the price slightly but not as much as in the first scenario.  This will increase consumption and therefore increase U.S. carbon footprint.

Either scenario seems like a losing proposition to me but it does make for a good speech.

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