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12 May 2011May 12, 2011

Gasoline: a price ceiling would not help consumers

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Gasoline: a price ceiling would not help consumers

We learned recently that the Quebec government is considering capping the price of gasoline. Contrary to popular belief, this measure would in practice be bad for consumers.

In actual fact, the measure proposed by the Association québécoise des indépendants du pétrole (AQUIP) is not a price ceiling in the strict sense of the term. The maximum price of gas would continue to vary as a function of the cost of a barrel of crude oil on world markets. Rather, the independent retailers want to establish minimum and maximum profit margins. While it is possible that this proposal might reduce sudden price fluctuations at the pump, it would in no way reduce gasoline prices.

Indeed, such a measure already exists in the Atlantic provinces, and it does not lead to consumer savings. On the contrary, according to a study to be published in the American Law and Economics Review, consumers in those provinces lose the equivalent of $17.4 million a year thanks to the maximum prices that prevail there. This loss is due to the fact that retailers seem to fix their sale prices at the maximum price, which therefore serves to limit competition just as it does in cases of collusion.

History repeating

If we wanted to establish a price ceiling in the strict sense of the word without regard for the price of crude oil, as certain politicians seem to want, what would be the impact on the gasoline market? The answer is simple: if the price ceiling were fixed below the market price, supply would no longer meet demand. On the one hand, the quantity demanded would increase, since consumers are less motivated to conserve gas when the price is lower. On the other hand, the quantity supplied would decrease, since producers and retailers would be less interested in selling it. In other words, the province of Quebec would run the risk of having to deal with gasoline shortages.

A good example of this phenomenon occurred in the early 1970s, when the price of crude oil tripled on the world market. In Canada, governments allowed the price of crude oil and gasoline to rise, and supply and demand were balanced. In the United States, then-President Nixon imposed a price ceiling, and both crude oil and gasoline had to be rationed. Photographs of long line-ups at service stations circled the globe. Gas was indeed cheaper – for those who succeeded in buying it by lining up! The problem was only resolved when the price controls were finally abolished. Those who forget the past are doomed to repeat it, and Quebec especially, with its “je me souviens” motto, should not make this mistake.

What can the government do?

The price of gas might not have climbed so high if the Quebec government did not already impose a price floor, supported by AQUIP, which wants to reinforce this control. The irony of the situation must be noted: the government imposes a minimum price to please the least competitive producers, which limits price wars that would, however, benefit consumers. If it adds a maximum profit margin to the current system of controls, gas prices will vary between narrower limits, but will generally be higher, too.

The majority of the price of gasoline is attributable to the price of crude oil. In fact, the price of crude oil has risen by 116% since February 2009 (after a conversion to Canadian dollars). The price of regular gasoline in Montreal has only risen 59% in that same period, though. Nearly 40% of the retail price of gas in Montreal is made up of taxes, the greater portion of which – over 20% of the total price of gas – comes from three provincial taxes. If the Quebec government really wanted to limit price hikes and ease consumers’ burdens, it would begin by reducing these taxes.

At any rate, it is preferable to let the market determine prices rather than entrust bureaucracies and pressure groups to fix them. Let’s hope the Quebec government resists the pressure from those who support a price ceiling, whatever its form, as such measures fly in the face of basic economic theory.

Jasmin Guénette is Vice President of the Montreal Economic Institute.


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