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Wednesday, May 23, 2007

Iran teaches us supply and demand

Iran is - ironically - providing the United States with a supply-and-demand lesson, if anyone's paying attention. Yesterday the Iranian government increased gas prices 25% (from the ridiculously low 40 cents per gallon) to help reign in surging demand for fuel. It's not sufficient, of course, when the rest of the world is paying 6-10 times that price, which is why Iranian fuel rationing will begin in two weeks.

So when Americans worry about price gouging, we need to consider the alternative. If we artificially limit the price of fuel, demand will stay artificially high, and we will run out. As R-Squared Energy blog puts it:
In times of shortage, price needs to rise to choke off demand. I may like to go visit my Aunt Bettie in the midst of this emergency, but I can put that trip off. However, if you have a dying relative, the price is not going to stop you. But you will be glad that it stopped me, and others whose need was not critical, from draining supplies.
The Iranians are going to learn very quickly that in a supply-constrained world, charging less than market price means there's not enough to go around.


Anagram Mirth said...

But isn't the problem that the supply here is global and the prices are local? Saying that Iran is going to quickly learn about a waning supply if it keeps its prices low doesn't seem to make a lot of sense.

Rather, Iran will just be able to use more of a global resource faster than the rest of us (if price is the consideration)--i.e., their supply and ours is the same, and since price isn't a limitation for them, then they can consume more of it.

So I'm not sure Iran will learn anything from keeping its prices low, other than that they will get a bigger share of the pie.

jff said...

While the government sets a domestic price, they still have to buy oil on the world market. In other words, the rationing is domestically imposed, probably because the government can't afford to buy enough oil to keep up with domestic demand when prices are artificially low.

Unless Iran comes up with more cash, I doubt they'll be expanding their part of the pie, especially since oil revenue makes up a large portion of their government budget.