The Law of Demand

According to a recent University of Michigan transportation study, the average carbon emissions per vehicle decreased 3 percent from October 2007 to April 2009. How did we achieve this emissions reductions? Cap and trade? Command and control regulations? No, the reduction instead occurred as consumers responded rationally to higher gas prices.

As a result of higher gas prices last year, consumers bought vehicles with better fuel efficiency and drover fewer miles. Thus, on average, each driver emitted less carbon. This is exactly how a carbon tax would work. The government levies a Pigovian tax roughly equal to the social costs of pollution and lets the market take care of the rest. As gas prices rise, people drive less and choose fuel efficient cars.

Unfortunately, the current administration seems to think that byzantine fuel economy standards will do the trick. But such standards are much more amenable to rent-seeking behavior. This is clearly demonstrated by the fact that the announced standards are favorable to light trucks, which benefits American producers but hurts the environment.

Real Gas Prices

Gas prices surged in 2008, causing a number of commentators to conclude we would soon run out of oil. Prices, of course, came down. And as I’ve blogged before, we won’t suddenly run out of oil.

I put together a graph of real gas prices (inflation-adjusted) in the United States during summer months since 1990 (data courtesy of the Department of Energy and Bureau of Labor Statistics).

Prices were roughly constant from 1990 until the early 2000s. Speculation, growing international demand, and a booming domestic economy then combined to drive up the price of gasoline. The main reason prices have fallen since last year is that gas demand and speculation has weakened since the onset of the global recession.

Nonetheless, gas prices have been creeping back up. Current prices are lower than they have been during the last three summers, but they’ll probably go up a little more through the rest of June and July. Seasonal gas prices have historically peaked in late July.

I’m predicting prices will peak this year at just under $3.00. Anyone want to bet?