Newt Nonsense - Why $2.50 Won't Buy You a Gallon of Gas

In order to read this post objectively, you're going to need to take off your political cap.  Seriously.  Let's try to frame this debate around the issues and not the party.  I'm not endorsing any candidate.

As an economist, I'd like to poke a few holes in what I feel is an impossible promise from a presidential candidate.  Sure, they all promise things like "change" and "peace," those we can all understand when the candidate fails to deliver.  But, a $2.50 cap on a gallon of gas?  Say it ain't so Joe.

A few basic economic principles first - demand and price are inversely related.  What does that mean?  The cheaper a product becomes, the lower the price drops, the more we demand of it.  The more expensive a product becomes, the higher the price rises, the less we demand of it.  I'd rather have two pairs of shoes at $50 each than one pair at $100.  Now think about the other side of the equation - supply.  As a supplier, I'd rather supply more when prices are high because I make more profit.  That's why we say supply and price are positively related.  The graph below represents these principles:

Where these two lines intersect is the "sweet spot."  It's where the economy is in equilibrium, and prices and quantity are at the most efficient point.  This is NORMALLY how prices are determined.  What about gas prices?  They aren't determined this way.  An international cartel called OPEC determines our prices.  OPEC is made up of member countries that meet occasionally to agree to restrict their output of oil to keep prices high.  Remember when I told you that suppliers prefer high prices for high profits?  That's the same idea but to a much higher degree.

Now for Newt: his campaign is really pushing this idea that under his leadership, gas won't cost more than $2.50 a gallon.  Um, what?  Has he figured out something that the millions of economists and financial minds haven't discovered?  Sure, the idea sounds good to the single parent on a tight budget, but Newt is conveniently not mentioning that Americans don't determine gas prices - OPEC does.  Was he planning on showing up to their meeting and saying "hey guys, I know you've enjoyed lucrative profits exporting oil to gas-guzzling Americans, but I'm going to ask you politely to drop your prices?"  Let's assume for the sake of the argument that OPEC is a congenial group that only wants what's best for us (I can hear the laughter already).  Capping gas at $2.50 a gallon is the equivalent of a price ceiling - prices can only rise up to $2.50.  Here's a graph showing the effect of a price ceiling:

Because our current price on a gallon of gas is higher than $2.50, enforcing a binding price ceiling introduces a dangerous element to our society - a shortage of gas.  As a supplier, if I'm told that I can only charge a price that is lower than what I'd receive normally for my product, I'm not going to supply that much.  I don't make as much profit.  Hence, society demands more gas at lower prices, but suppliers aren't willing to meet demand.  What does a shortage of gas mean to our society?  Tourism would tank and American drivers would spend their days waiting in line for available gas.  Sound like a picnic to you?  If you're going to vote for Newt, that's fine, just don't tell your friends it's because you want a gallon of gas for $2.50.  You're smarter than that.