Friday, February 25, 2011

Double petrol prices. Do it now.

The stylized facts. First, lots of petrol stations are closed for lack of power. Second, there is a temporary gap in supply such that if folks only filled up normally, all would be fine. But, if everyone is filling up all the time, the stations cannot handle the spike in demand combined with the temporary supply shock. And given that everybody else is behaving badly, it is optimal for each player in the game also to behave badly. If everyone expects that everyone else is panic buying, then everyone will rightly expect queueing and empty stations when they go to fill up. Moral suasion has been tried and has failed to break the bad equilibrium.

The very best way of solving this problem is a temporary price hike. Figure out when normal supplies will be restored. Announce that prices double until that day, at which point they drop by a quarter per day till back to normal.

The usual case for price gouging is it helps draw resources to the area. There is no margin for that here. They're already doing all they can. Instead, the point is purely allocation. Both to current users and over time. We want to make sure that the guy with a half a tank decides to wait instead of filling up. If he knows prices will be cheaper in two days, he will hold off.

And, even better, folks will also decide to cut back on discretionary driving when construction and emergency vehicles need the roads.

Some folks worry about these poor not affording gas. The gains of reduced queueing and reduced congestion massively outweigh equity considerations of this sort. Or, think of it this way. In a crazy emergency like this, are more people screwed by having to queue for hours for gas, or are more screwed by having to pay an extra twenty bucks for enough fuel to see them through the day?

Double petrol prices. Do it now.

So folks don't hate the petrol stations, call it a two dollar per litre earthquake surcharge with proceeds going to earthquake relief. Normally extra profits help bring more resources to the region. I can't believe there's any margin there this time round. Avoiding backlash then more important.

Note: apologies for hasty and likely typo-ridden post. Internet dodgy. Thanks to Bernard Hickey for posting the initial deck.ly version of this up on Interest.co.nz before I hacked a way into Offsetting.

Update: Response to Keith Ng.

15 comments:

  1. Eric, good to see you up again. It is a hard one to swallow but this may work. We have no gas here and the station is cleaned out, have biked over a few times to see huge queues every time. Truth is we are OK for the moment but given the huge queues I have to admit that I will be in the queue as soon as that tanker rolls in, just to have the option to leave / travel / find an open shop etc. Doubling the price would make me think twice - but I wouldn't feel happy about it. Take care.

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  2. The key is getting folks with a quarter tank to wait the couple days till supplies are back up. Temporary price hike does that so long as everybody knows it is coming back down again.

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  3. Pricing will only reduce the entire market - it wouldn't be targeting the right behaviour. Many people with means are still going to be able to afford to horde, but it would put some people with genuine need in a really bad situation.

    The benefit of this is far outweighed by the social consequences - if you price-rationed essential resources, you're jeopardising the communal goodwill, and that has consequences way beyond a single resource like petrol.

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  4. @Keith: You're telling me a poor person whose roof has fallen down and is trying to get supplies is made worse off by going an extra $20 in debt to get enough gas to get to the hardware store than having to wait an hour for gas?

    Two days. The hike only has to last long enough for supplies to be back up to normal. That's kinda how it works, right? Folks who can wait 2 days, do so. That's why you're dead wrong about "just reduces the entire market". If everyone knows the price comes down again in two days, it induces a temporal reallocation of consumption.

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  5. I had the temerity to suggest this sort of thing on Kiwiblog, and have been called all sorts of names.

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  6. What's stopping petrol stations putting their prices up themselves?

    I don't think hiking the price will get rid of the queues. More likely the guy with 1/4 of a tank will simply wait to get the 10 litre his $40 now gets. And be pissed off with it.

    I think people want the mobility and options that petrol gives them. Given what's happened I'd think that people are reprioritising their spending to essentials and probably doubling the pricing would have very little impact on the number of demands, and might not even effect the amount consumed.

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  7. I do not think the guy driving the Jaguar with two large additional containers in the boot (that was ahead of me on the queue two days ago) is that price sensitive. It may be better to impose a quota (say no more than 50 L per purchase) for a few days. Anyway, buying fuel now does not seem to be such a big issue in good part of the city.

    By the way, nice to read that you and your family are doing well.

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  8. I think thinking about this in terms of shifting consumption is fundamentally wrong. The demand that we're trying to reduce is from horders. They are hording because of a lack of confidence that supply will resume soon and uncertainty about demands (e.g. "Will I need this petrol to get myself/my family to safety quickly?").

    They are buying security. That is not elastic. And future security is not a substitute for present security.

    If you're able to price enough people out of the market to reduce the queues, that might partially restore confidence in supply, but the exorbitant prices will have the opposite effect - "what if supply doesn't resume and prices go up even more?".

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  9. Also, I think the authorities are doing the right thing: Appealing to people's sense of public duty to get them to not horde and stay off the roads when possible, and to reassure them that supply will normalise soon.

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  10. @Duncan: What's stopping them is that any that tries it will be pilloried by the likes of the commentators at Hickey's blog, unless they do it in concert and with the surcharge going to earthquake relief. People will drive across town if they hear gas is a couple cents cheaper in normal times; you don't think that folks with a decent amount in the tank or without pressing needs wouldn't wait a couple days for the price to be cut in half? Seriously?

    @Luis: Overall demand elasticity isn't set by the Jaguar guy. There aren't that many of him.

    @Keith: Appeals to sense of public duty have been tried and have failed. Queues persist. Two days of price hike 'till they can run tanker trucks through Lyttelton Tunnel again from the port. That's it.

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  11. You are absolutely right, the absurdity of seeing people waiting in huge lines, (with engine idling I might add) to get fuel shoots the rational 'homoeconomicus' back to the stone age.
    Where the hell are they all planning to drive to? Probably only up the road and back again.

    I also think a designated trucks only route should be implemented so haulage trucks/equipment can get some sort of priority. In this environment the heavy machinery should be valued over the civilian vehicle.

    Classic feedback loops in action.

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  12. @Eric I could have afforded to pay many times the price of petrol and I only drive a crummy car: it is only a small price to pay for the insurance. In addition, as a libertarian would you trust the government if you heard that the price hike was *only for a couple of days*?

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  13. @Luis: How many other things can you afford to pay many times the price, but choose not to because the price seems too high? The insurance is mostly of value because everyone expects that the stations will be empty. Break the expectation, and folks don't need the insurance so much.

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  14. Eric, here is a link to cheer you up. Fuel for another fight (maybe a winnable one). Check this new paper doi: 10.1136/bmj.d671
    Made it to the Beeb.

    Take care

    "..and that is why economists stand alone at parties Russ" - Mike Munger to Russ Roberts

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  15. The idea of having the money go to relief is very clever. This could actually work, and if it was arranged to give it enough publicity the message "Don't buy more gas than you need" could get out more easily.

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