Getting Gassed

Story Highlights:

• Gas prices have increased sharply and are unlikely to decrease significantly in the near term.
• Gasoline expenditures represent a small percentage of consumer spending.
• High prices are annoying, but unlikely to significantly alter consumer spending or send the economy into recession.

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If you go to San Francisco, don't worry about wearing flowers in your hair—worry about whether your debit card will go through at the gas pump. Prices in the Bay Area have zoomed past $4 per gallon, and with the summer driving season looming, don't expect much love for Big Oil in Haight-Ashbury anytime soon.

Of course, San Franciscans aren't alone—gas prices have risen across the land. But in our view the pain is more emotional than anything else. That's because the cost of gas today just doesn't have the impact people think. Let's do some math.

The Math on Gas Prices and Consumer Spending
By Dick Green, Briefing.com
https://www.briefing.com/GeneralContent/Investor/Active/ArticlePopup/ArticlePopup.aspx?SiteName=Investor&ArticleId=NS20080512093747TheBigPicture

High gasoline prices purportedly bring a variety of ills with them. The most feared is consumers, faced with increased expenses at the pump, stop spending on other things. Because consumer spending is by far the largest component of the US economy (about 70% of GDP), the theory goes high gas prices slow spending, likely leading to recession. Yikes!

But what folks miss is gasoline represents only about 4% of consumer spending. Even if prices rise at say 7%, the increase represents only 0.28% of overall expenses.

Put this in perspective—if you drive 40 miles a day, and your rig gets 20 mpg, you're burning 60 gallons of gas each month. Assuming $4.00 per gallon, a 7% (or roughly 28 cents per gallon) increase would mean an additional $16.80 per month. We'd all rather spend $17 on something else, but $17 is unlikely to bust the monthly budget of most Americans. Of course, some of you drive more than 40 miles a day, or drive cars getting less than 20 miles per gallon, but on average the numbers just don't imply a major shift ahead in consumer behavior. And we haven't seen much change (other than a dent in SUV sales and a corresponding lift in those for more fuel-efficient vehicles)—consumer spending continues to chug along just fine. (See our 5/02/08 story, "Inconspicuous Consumption," for more.)

So why all the hubbub over the price for a gallon of gasoline? We've always been a car-loving nation—we may view gas hikes as a threat to our entitled kicks on Route 66. But it's also an election year, and politicians are quick to underscore troubles they claim to be uniquely qualified to fix. Today's cause célèbre appears to be reinvigorating the economy by stamping out high gas prices. The solution this year is a plan to briefly reduce or eliminate gasoline taxes. This "solution" serves only to remind us why gas prices are high in the first place. Recall Econ 101: Folks tend to like to buy more stuff at lower prices, increasing demand, and sending prices right back up. Artificially increasing demand by lowering taxes won't solve any problems. Until demand falls or supply increases, prices will stay high. Easy as that.

But high prices aren't the end of the world. As we've been saying—increasing demand for oil and its products is simply a sign of a healthy global economy.