As consumers in the marketplace, most of us think we have little power. The seller makes the product, sets the price, and we take it or leave it. Even bargaining, especially in our society, is shunned.
So it’s no surprise that most people think gas prices will continue to rise. In fact, when I do personal presentations across the state, the typical question I get about gas prices is, “How high will they go?” not “will they ever fall?”
This is understandable, because most of us operate on a “straight line” method of predicting the future. This way of forecasting says to expect the future to be like the past. So if gas prices have increased in the past, they will increase in the future.
While straight-line forecasting is appealing, it often isn’t correct. Trends do change. The housing market is a great example. From 2003 to 2007 housing prices skyrocketed. Now, in many markets, they’re falling.
Indeed, a large part of the training professional economists receive is devoted to more complicated, and hopefully, more accurate, forecasting methods than the straight-line theory. The good news, for consumers, when these methods are used is that there is a reason for gas prices soon to fall, perhaps for several years.
Here’s why. The twin pillars of economics are demand and supply. Demand tells us how much of a product consumers want to purchase at any price, and supply gives us the corresponding amount of the product sellers will offer. The price of the product is stable when demand and supply are equal.
But when demand is greater than supply, or, in a dynamic sense, when demand is increasing faster than supply is increasing, there will be upward pressure on the price.
This is exactly what has happened to oil — and by extension, gas — prices this decade. The worldwide demand for oil, and gas, has been increasing faster than the worldwide supply. Most of the increased demand has come from developing economies in China, India, the Middle East, and Eastern Europe.
Now, straight-line forecasting would assume demand would continue to outstrip supply and oil and gas prices would continue to surge. Economic forecasting doesn’t. Economic forecasting says that, rather than being pawns in the price game, consumers are active participants. The biggest way consumers can affect the price is by taking their business elsewhere. That is, if in response to higher prices, consumers purchase less of the product, these actions will eventually cause prices to fall.
For something like gasoline, which is so essential to our everyday economy, changing usage is very difficult. In fact, as gas prices climbed higher this decade, most drivers altered their gasoline consumption very little.
But this year’s rapidly rising gas prices — up by more than 30 percent — combined with the slow economy and stagnating incomes, have motivated drivers to make big changes. They’re driving less, carpooling and using mass transit more, and buying fewer gallons of gas. These actions can turn a situation of “demand greater than supply” into “supply greater than demand” — which, in turn, switches the trend from rising prices to falling prices.
It’s the potential for this kind of switch that has caused many energy forecasters to predict a pattern of falling gas prices for several years. While the price pullback won’t last forever, it will give consumers a welcome respite.
So we might have an upcoming test of two competing forecasting techniques, between the straight line and the economic. With oil and gas prices down recently, it’s looking good for “team economics.”
Dr. Michael L. Walden is a William Neal Reynolds distinguished professor at North Carolina State University.