INCOME EFFECTS PAPER

Substitution and Income Effects Paper

Substitution and Income Effects Paper

gasoline prices

Projected Cost

Actual Cost

Difference

drove less and purchased less

$1,000

$1,000

$0

ate out less often

$54

$100

($46)

spent less to maintain your automobile

$44

$56

($12)

took public transportation more often

$22

$28

($6)

bought a bicycle

$8

$8

$0

did not take a vacation away from home

$34

$34

$0

bought fewer clothes

$33

$33

$0

Subtotals

$1,195

$1,259

($41)

The marketplace forces of supply and demand determine the price of fuel. If demand grows or if a disruption in supply occurs, there will be upward pressure on prices. By the same token, if demand falls or there is an oversupply of product in the market, there will be downward pressure on prices.

Continued high diesel and gasoline prices are putting the squeeze on the bottom line on trucking and other industries that rely on vehicles to conduct their business, though so far most are managing those costs well enough to stay profitable.

“Fuel expense, after considering fuel surcharge collections and the cost impact of owner-operator fuel reimbursements and lower miles per gallon due to the new truck engines, had a one-cent negative impact on our earnings per share in first quarter of 2005 compared to the first quarter of 2004,” said Clarence Werner, chairman, CEO & president of Omaha, NE-based truckload carrier Werner Enterprises. “However, the strength of our fuel surcharge programs helped to limit the impact on our first-quarter earnings.”

Those principles apply at the service station level as well. If a retailer prices its gasoline too high, and without regard to competition, the retailer's customers may take their business to another station with lower prices. If a retailer loses enough volume, the retailer may then reduce prices in order to retain its customers.

Competition among retail outlets thus affects pricing. You may notice that sometimes there are price differences between two gasoline stations on a busy street corner and between those outlets and the only station on a long stretch of highway. More choices generally mean more competition for business.

And although retail outlets may sell gasoline carrying the brand of a major oil company, most dealerships are owned and operated by independent business people who are free to set the prices for their products and services.

While crude oil is traded in a global market, gasoline is part of a regional market. Crude oil prices are important in determining gasoline prices because crude is the primary raw material used to produce ...