Direct and Indirect Price Control - Report Example

Running head: Free Energy Market Your name Course name Professors’ name Date Introduction The United States has been controlling various sectors of the Economy in numerous ways. One of the approaches is Economic Regulations that seek to control the prices either directly or indirectly. An example of this regulation is prevention of monopolies in electric utilities. The move is towards preventing prices from rising too high. After the great depression, the US government initiated a program to stabilize prices for agricultural goods that tend to respond fast to changing demand and supply. Other industries such as trucking and airlines sought regulations to contain price-cutting. The second form of economic regulation is the use of antitrust laws, which reinforce market forces such that direct regulations become unnecessary. In a different scenario, government control private companies with a goal of achieving social objectives such as safety and environment. This paper seeks to highlight government control in the area of energy. According to Energy Information Administration, the price of gasoline increased by 92 cents between the year 2004 and 2005.1 This price later dropped from $2.79 per gallon to $2.48 at the end of October 31. Recently, the price of the same gasoline and related product increased, consequently prompting people to call for federal price regulation. At the same time, windfall profits tax on oil industry was proposed. Some economist argue that gasoline markets are non-competitive which then makes oil companies to reap large profits at the expense of consumers. This is why price controls and windfall profit taxes would serve the purpose of redistributing wealth from producers to consumers without disadvantaging the supply. Analysis of Gasoline Prices Economists generally hold a view that prices in the market should be left to respond to forces of demand and supply as opposed to governmental interference. In the context of a market, goods and services are allocated to people who value them most and competition comes in to aid the consumer by allocating the lowest possible price. If there is information, that the product is relatively scarce or plenty, it is communicated quickly to buyers and sellers. Where prices are high, conservation and new supply is encouraged. This is why a graphical illustration of demand and supply curve shows a tendency towards equilibrium when an externality acts on the market.2 The market therefore goes through self-adjusting mechanism. Even though government intervention may improve economic efficiency especially if the market is not perfect, generally the control has more economic harm than good. Nonetheless, evidence of market imperfection does not necessitate government intervention. On the contrary, there needs to be tangible evidence to confirm that the supposed intervention measure will have a positive impact on economic efficiency. Oil Price Controls of 1971 – 1980 In the 1970s, there was widespread price control and allocation regulation placed on crude oil and some of the refined products. A study by Kalt revealed that the controls imposed on the oil products had negative effect on producers and consumers of oil.3 President Richard Nixon experimented on the price controls by dividing it into four phases. The first phase lasted for three months from August 1971 to November and the control was applied to wages and prices throughout economy. During this first phase, prices of oil were stable. At the second phase of Nixon’s policy, all firms were allowed to increase their prices above Phase I ceilings to show increases in cost of production. Oil prices heated in early 1973 forcing Nixon administration to issue “special Rule no 1” that sought to impose oil price regulation on 23 major oil companies. The rule, in addition to price control measures in Phase III had substantial impact on market. Given that the 23 largest oil-producing companies were operating under price controls and had been barred from recouping the rising cost of crude oil, these firms had to reduce their imports and output. Further effects of the controls and regulations were apparent among marketers and distributors who found it very difficult to avail fuel for consumers. This led to enactment of the Emergency Petroleum Allocation Act of 1973 to address plight of independent gas stations. The law froze relationship between buyers and sellers and any substantive changes in the relationship between the two parties required federal approval. The effect of this regulation is an entangled market. Moreover, the EPAA enacted a system of control where discovered oil was classified under “old oil” and was placed under strict control. On the contrary, “New oil” was decontrolled. The Emergency Petroleum Allocation Act, EPAA generated an allocation problem. This is evident where imported oil was expensive to satisfy the need in the market. During this period, many refiners could access “old” oil, which was under price control. Those refiners who had access of “Old” oil made more profits compared with refiners dealing with imported oil. This paved way for entitlements adopted by the Federal Energy Administration in December 1974. The entitlement program increased importation of oil since refineries resorted to imports to gain more subsidies following entitlements. Originally, entitlements were meant to equalize profits across refineries but later intervention measures favoured some refineries while others were impaired. An example of such regulation was “Small Refiner Bias” rule that gave small refineries extra entitlements to “old oil.” Energy Policy & Conservation Act of 1975 was an amendment of EPAA and took effect February 1976. This new piece of legislation expanded price control to cover “new” oil thus forming a three-tier price. Average binding price was set at $7.66 per barrel and was allowed to fluctuate by up to 10% per annum in response to inflation and various incentive payments. This new three-tier model called for changes in the old entitlement program given the emergence of less expensive and more expensive “old oil.” Through to 1979, price control on oil and refined products was intense. After 1979, President Jimmy Carter cancelled price control by replacing it with administrative actions. This demonstrates that America’s experience with oil regulations from 1930s to 1970s had negative impact on both producers and consumers. Besides, congress response to oil and petroleum problems by enacting inappropriate legislation led to more regulatory actions. The cure for Oil Prices Bradley presented a study on how market forces can solve the problem of oil prices.4 In his research Bradley argues that price of oil has expanded given the increasing worldwide demand for oil. The literature indicate that high prices of oil acts as an economic incentive to explore, produce, refine, and market prices of oil consequently reducing the prices. According to Bradley, the cure for high prices is high prices, if markets were allowed to convert the present problems into future solutions. Bradley states that a policy to reduce high prices is like an attempt to cure a fever by adjusting the thermometer. The effect therefore is that vital feedback to the consumer and supplier is eliminated. At the low level of regulated oil price, consumers tend to use more of the scarce product while suppliers do not receive a signal to increase their supply in the market. In the short run, the cheap commodity runs short and people resort to burning fuel while waiting. Another strategy employed by the government as aforementioned is “windfall” profits tax. Bradley questions the need to relocate money from those who can remove abnormal scarcity and give it to politicians. To deal with the problem of oil, the solution is to promote capitalism in areas that are rich in resources. The impact of capitalism is that private property rights will be assigned to investment and capital projects. This will promote greater supply and efficiency. It will further remove politicians who are enemies of oil consumers. The move is towards capitalism that empowers citizens, promotes savings, increases investment, and produces wealth among the masses. Federal regulations and subsidies play a chief role in limiting the supply of gasoline in the USA. Population surge over the years in the USA has increased demand whilst refining facilities have not been added. Basic economics indicate that an increasing demand coupled with fixed supply will automatically lead to higher prices. What should be changed is therefore domestic exploration, drilling, and refining to maintain reasonable prices.5 Reducing restrictions placed on coal production, natural gas production, and nuclear power would have the effect of increasing supply of energy sources thus curbing rising demand. To increase reliance on the market, the government of United States ought to reconsider abolishing policy activism. There is a need to replace government intervention with free-market entrepreneurship. The effect is privatization of Strategic Petroleum Reserve, disembarking from the International Energy Agency, reduction of energy taxation and government energy expenditure6. Taxes and government expenditure adds cost to the costumer. Taxes such as motor fuel taxes are regressive and inequitable. On the other hand, embargo tax and war premium has seen the consumer pay government fees either directly or indirectly. Deregulation or rather free market will further lead to exploration of public land in search for more oil. Conclusion It is apparent from the essay that the American economy needs a free market as opposed to government interference that attempts to fine-tune the economy. An example give in the essay is the national energy policy that has always allowed the government to take inappropriate measures as a response to any event in the world energy market. Reliance on free market and improved Middle Eastern Foreign policy will serve the purpose of increasing supply and reducing the price of oil to the benefit of consumers. Works Cited Bradley, L. Robert. “Market Forces Only Cure for Oil Prices.” cato.org, Cato Institute. 26 May, 2006. Web. 7 December 2011. Energy Information Administration, “Weekly Petroleum Status Report,” data for week ending. eia.doe.gov. eia, 16 September 2005. Web. 7 December 2011. Hamilton, James. “Understanding Crude Oil Prices,” Energy Journal, 30. 2 (2009): 179-206. International Energy Agency, “Resources to Reserves: Oil and Gas Technologies for the Energy Markets of the Future.” Paris: Organization for Economic Cooperation and Development, 2005. Kalt, P. Joseph. The Economic and Politics of Oil Price Regulation: Federal Policy in the Post-Embargo Era. Cambridge, MA: MIT Press, 1981. Paul, A. Samuelson. Foundations of Economic Analysis. Cambridge, Massachusetts: Harvard University Press, 1983. Read More