Low Price, High Stakes
How the low price of gas is good for the economy, and how it can actually be bad.
By Jeremy Craig
As the American economy recovers from the Great Recession, a seemingly miraculous event gave motorists something to smile about.
At the recession’s 2008 onset, gas was $4 to $5 a gallon in some places. At the end of 2014, fuel prices took a nosedive. For the first time in years, gas was around or below $2 a gallon. But in the first quarter of 2015 prices rose slightly, remaining around $2.45 a gallon.
Motorists may still be celebrating, but gas price fluctuations raise a few serious questions. Why did prices drop? How are lower gas prices good for the economy?
And how might the lower prices actually be a bad thing?
Georgia State professors take a look at all three questions and the some of the answers are simple, but others are surprisingly more complex.
WHY DID THE PRICES DECREASE?
Anyone who has studied basic economics can grasp the simple concept of supply and demand. When there’s a lesser supply of a commodity compared to a much higher demand, prices increase.
In this case, the opposite has happened. There’s more oil than global demand.
“Overall, supply is determined at the global level, because it’s relatively easy to move crude oil and petroleum products like gasoline around the world,” said John Duffield, professor of political science in the College of Arts and Sciences.
The price of a barrel of oil dropped at the beginning of September, and accelerated in late November when the Organization of Petroleum Exporting Countries (OPEC) decided not to cut production, said Rajeev Dhawan, director of the university’s Economic Forecasting Center in the J. Mack Robinson College of Business.
OPEC countries, with Saudi Arabia the key nation leading the way, are dependent on oil revenues, Duffield said, and they seem to be reluctant to cut production.
“I guess the psychology seems to be that they’re more concerned about losing revenue now, rather than getting more revenue later by driving the price back up,” Dhawan said.
And OPEC isn’t the only factor in gas prices. The United States now produces a lot of oil thanks to the use of hydraulic fracturing, or “fracking,” to extract oil from shale, Duffield said.
“We’ve seen U.S. oil production rise by about a million barrels a day for the last several years,” he said. “When you have a supply going up and demand not keeping up with it, you get a glut of oil, and prices drop.”
HOW ARE THESE LOWER PRICES GOOD?
The most immediate answer: consumers have more money to spend on other things instead of gas.
“It’s always great for people who have to spend a lot of their paycheck on the gas tank,” Dhawan said, especially for people with lower incomes who live paycheck to paycheck. Those with higher incomes are simply saving the money.
“So when people have a little bit of extra cash, they usually spend on discretionary things, such as eating out, buying music,” he said.
That discretionary spending helps pump money into the consumer-spending sector of the economy, something on which the U.S. economy is highly dependent.
“As a general rule of thumb, every penny you save on a gallon of gasoline results in about $1 billion of money that can be spent on other things,” Duffield said. “So if the price is down a dollar, that’s $100 billion people have to spend on other goods and services.”
There’s also an advantage for the United States going beyond economics: geopolitics. Some oil-exporting countries, such as Russia, Venezuela and Iran, are not particularly friendly to the U.S.
“As long as oil prices are low, it keeps the pressure on them to presumably be more accommodating in other areas,” Duffield said.
HOW CAN LOWER PRICES BE BAD?
First of all, as gas prices are determined by supply and demand. When the demand is low, it’s a bad sign, pointing to ailing economies in oil-consuming areas such as Europe and China.
“If you are a company focusing on exporting abroad, it may give you a break on the price of shipping, but it also tells you that your customers in Europe and China are probably not going to demand much of the product,” Dhawan said.
Lower gas prices are also contributing to a strengthening U.S. dollar, he said, causing a disadvantage in exporting American goods, because they’ve now become more expensive on the market.
There’s another downside to lower gas prices. North Dakota and other states with high levels of fracking actually boomed, while the rest of the country sagged during the recession, but they’re in trouble now.
There’s simply less incentive to engage in fracking, which takes more effort to extract oil than with traditional wells. That means lower state tax revenues and less money pumped into local economies, about $10 million less per well, according to Duffield, and more unemployment.
“Oil-related companies are cutting back on spending and laying off people in Texas and North Dakota,” Dhawan said.
The silver lining for those states and their citizens is that it doesn’t take very long to ramp up production again if there are higher gas prices, thus more incentive to resume fracking, he said.
And there’s another negative to lower gas prices that hits waistlines.
According to research by Charles Courtemanche, assistant professor of economics in the Andrew Young School of Policy Studies, there’s evidence of a connection between gas prices and obesity.
Looking at inflation-adjusted prices from 1979 to 2004, lower gas prices factored as eight percent of why obesity rose in the United States.
Part of the explanation is that physical activity is higher when gas prices are more expensive. For example, people may decide to bike or take public transportation, which involves more walking, Courtemanche said.
“An equally important part seemed to be on the eating side, where I also found evidence that as gas prices went up, frequency of eating at restaurants dropped, and vice-versa,” he continued.
Restaurants in the U.S. typically serve huge, high-calorie portions of food. But when gas prices are higher, there’s less disposable income to splurge on eating out, Courtemanche said.
“It’s eating out at restaurants that’s probably among the first things to go when you have a tight budget month,” he said, adding that eating out can also involve using more fuel to get to a restaurant in the first place.
Art direction: Basil Iskandrian
Portraits and composite: Steven Thackston