Gas Hoax

A friend of mine has posted the following urban myth on his myspace blog:

"NO GAS...On May 15th 2007

Don't pump gas on MAY 15th

In April 1997, there was a "gas out" conducted nationwide in protest of
gas prices. Gasoline prices dropped 30 cents a gallon overnight.

On May 15th 2007, all internet users are to not go to a gas station in
protest of high gas prices. Gas is now over $3.00 a gallon in most
places.

There are 73,000,000+ American members currently on the internet
network, and the average car takes about 30 to 50 dollars to fill up.

If all users did not go to the pump on the 15th, it would take
$2,292,000,000.00 (that's almost 3 BILLION) out of the oil companies
pockets for just one day, so please do not go to the gas station on May
15th and lets try to put a dent in the Middle Eastern oil industry for
at least one day.

If you agree (which I cant see why you wouldn't) re-post this as ''Don't pump gas on May 15th""

I responded in an effort to educate the simple economics of the situation.

1. Even if this were possible (which it isn't, see point 2) this would only affect demand (false demand) in a temporary fashion. People still need to buy gas - so while gas consumption could thoretically be reduced and prices follow suit in the span of a day, the NEXT day or the week would see an increase in demand to compesate for the short-term "loss" of gas - which would serve to increase prices until equilibrium was re-established.

2. Such schemes are obvious hoaxes when one thinks of the game theory behind it. For this to work, mass coordination on a grand scale would have to occur. Let's say it did initially - then you'd see a price drop - which would just act as an incentive for drivers to increase their consumption back to normal levels - instantaneously killing any effect of the gas-out. In essence, the incentive to "cheat" the gas-out would be too great such that people would very quickly 'wake up' and get back on the reality-based demand curve.
(the pic is blurry until you click on it)

IN approves 44 cents increase in cigarette tax

http://www.insideindianabusiness.com/newsitem.asp?id=23058.

Prices of a pack of cigs vary of course in IN, but let's make the reasonable assumption that a pack on average costs $3.60. Let's also assume elasticity of demand for cigs in inelastic (but not terribly so) is around -.3 (which is also reasonable given research). That means a 44 cent tax hike would reduce consumption of cigs by about 3.6% - not much, but better than nothing.

Paul Ormerod and revising textbooks

He notes in a recent publication of Post-Autistic Economic Review:


"The problem, and it is a very big one, is that most economists continue to act as if very little has changed and that the rational agent postulate remains generally valid. Game theory, for example, has come to dominate much of economics. But outside the realms of auctions designed by economic theorists, it has few practical applications. The prisoner's dilemma, one of the most famous games where individually rational actions can give rise to an outcome that no one would choose, has been studied intensively for over 50 years. Yet, except in wholly trivial cases, the "optimal" - a word beloved by economists - strategy remains unknown. "

I second that feeling. Game theory really did cause a whole paradigm shift in microeconomics - but hasn't imop been used to its fullest potential. Game theory, like most of econ, is still stuck under the weight of its own assumptions of rationality. Still, teaching something like game theory which at least leads to the possibility of using boundedly rational (or even irrational agents) has got to be more useful that teaching just pure mainstream theory to our students.

Pretty much everything that standard micro texts teach can be thought of in terms of game theory, and yet, Prof. Mankiw - whose textbooks are the best at teaching mainstream econ, devotes a 'whopping' 12 pages to game theory in his "Prinicples of Microeconomics" text. And most of that is just with regards to Oligopoly behavior. There are no pages, to my knowlege on behavioral economics. Any econ student wanting to go 'beyond' the same old utilitarian framework has to take a completely separate course (if their school even offers it) in experimental econ, or game theory, and the like.

This means two things, to me:
1. Economists by and large are in love with form over substance, in the sense that utility theory and perfect rationality offer elegent models with little variation in behavior, but perhaps are limited in terms of real world application

2. Game theory, experimental econ, etc, have not done an adequate job of better formulating a consistent model to compete in the field - this may be largely due to the fact that perhaps "modeling" behavior is a somewhat futile effort at least at the extremes. The fact is, it is perhaps best to keep the models we have currenly in mainstream econ, but understand and appreciate that they situationally stray from reality and we need to incorporate other things.
I think textbooks are going to need more than 12 pages to really stress that point to students.

Interestingly, I think Macro (the younger of micro/macro) has come a longer way in terms of this. In macro we still talk about rational, equilibrating behavior, but we also talk about sticky prices, market failure, etc. Micro, sadly, tends to gloss over those things in favor of workable mathematcis.

[UPDATE]
I stand corrected. 1 commenter noted (my only one???) that in Mankiw's most recent micro text, he devotes part of his last chapter called "frontiers of microeconomics" to the study of behavioral economics. I would say that is too little too late, and that we should be incorporating these things into what we teach and learn, and notjust adding it on as an addendum for all practical purposes. I don't have a copy of this newer text, but I HAVE downloaded the powerpoint slides. I'm less than impressed. There are a total of 2 slides on the subject which say the following (if I may quote the publically accessible ppt slide):

•"Recently, a field called behavioral economics has emerged in which economists make use of basic psychological insights to examine economic problems.

•People aren’t always rational:

•People are overconfident

•People give too much weight to a small number of vivid observations

•People are reluctant to change their minds.

•People care about fairness as demonstrated by the ultimatum game

•People are inconsistent over time."

Pigovian calculation with a government

The continued discussion on Karl's website leads me to draw a distinction between textbook pigovian taxes and the fact that government response is all too often ignored in these textbook frameworks. It seems to me that the revenue generated from the pigovian tax which was used to pay for the social cost of pollution etc could in and of itself be used to pay for (as a tax cut etc) a social benefit to the environment - a postive externality not as of yet taken into account, whatever that might be. Or, the revenue could just go directly to bettering the environment.... That investment would act to reduce the level in which the tax must be raised in the first place - thereby making it more politically feasible.

This brings up yet another problem in applying textbook pigovian taxation to the real world. Textbooks assume no changes over time and therefore assume a fixed social cost to an activity (Carbon useage), and therefore apply a fixed tax to it. Yet, depending on how revenues are used etc, the marginal social cost of environmental damage caused by marginal carbon useage can in fact be lowered over time. For example, with signifcant investment in technology aimed at reducing emissions from a unit of carbon, the social cost of buying a given unit of gas etc may fall significantly over time. Another way of looking at that is to say that the social benefit of certain investments reduce the NET social cost of gas consumption over time.

I of course still do not support gas taxes, because the downside to the above scenario, as I'm sure Greg Mankiw is aware, is that you would not have new revenues with which to compensate the 'losers' of the gas tax - which would be poor consumers relatively speaking.

In terms of how to use the increased revenue, You are damned if you do and damned if you don't with Pigovian taxation.

My response to Karl Smith

Karl Smith writes:

"A few people have complained in the comments on Greg's site that we shouldn't increase the gas tax because we don't know the elasticity of gas or how much consumption we should give up in exchange for saving the envrionment.

There are two points about this. First, we do have estimates of the price elasticity of gas.Secondly, however, the beauty of Pigouvian taxes, unlike cap-and-trade by the way, is that we don't have to know that much. We don't need to know elasticities. We don't need to know the "right" amount of pollution. We don't even need to know whether or not people should be driving less.We do have to an estimate of the envrionmental damages that gasoline brings. Admittedly that might be hard to pin down exactly. The nice thing about taxes, however, is that if we are off by a bit the economic harm isn't that great.See the price of gasoline is basically the cost of making it plus some reasonable profit for the refinery. There is the messy issue of OPEC but that has become increasingly less important in recent years.

So when people decide to fill up their tank they are implicitly asking themselves, "Is the benefit to me of taking this drive greater than the cost to the driller of drilling the well, plus the tanking company for transporting the crude oil, plus the refinery for turning it into gasoline plus the retailer for operating this store plus the tax the state charges for building the roads." If it is then the motorist fills up her tank content in the knowledge that she has maximized social welfare. She imposed a cost on all of those people, but the benefit to her was greater and she proved it by paying the going price for gasoline.

But wait! We forgot someone. We forgot the child who will be born just one day to late ever see a glacier because our motorist added just a little bit more carbon to the atmosphere and speed up the rate of global warming by a teeny-tiny amount.The little child did not get paid and so our motorist can no longer be confident that she is maximizing social welfare. We can she do!? Should she shun gasoline forever? Feel guilty until the day she dies?Well, she could just pay him. The one problem is that since our kid isn't born yet we don't know exactly what his asking price will be. We have to take a guess.

But, once we make that guess we add it to the price of gasoline and our motorist is once again happy in the knowledge that she has made the world a better place.In this entire story we didn't say how much gasoline our motorist was buying, where she was going or even what kind of vehicle she's driving. Thats because we don't really need to know. All we need to know is that she was willing to compensate that little boy for the cost she was imposing upon him."

My reply:

You said,"we do have estimates of the price elasticity of gas."Which is true...the problem is they vary from an insignificant amount (-.0X to about -.5 or so). The lateset paper I read, using recent data, has elasticity so miniscule (-.04 in the short run and not much better in the long run) as to make any gas tax policy either farily worthless, or politically ridiculous....The notion that elasticities aren't important in determining the gas tax is flawed:You can determine the cost of the externalities beyond the private cost - true. And yes, we may even be able to pinpoint a value. And from that value, we may be able to set a gas tax to compensate the future loser.

And all that would be fine IF the gas tax were to go to the future losers as compensation.But it doesn't. There are two options to compensate the losers:
-put the revenue from the tax directly into bettering the environmentor
-put the revenue in a trust fund to provide future generations as an outlay

Either way you do the compensation, the current users suffer via higher (regressive) taxation. The whole notion of :"But, once we make that guess we add it to the price of gasoline and our motorist is once again happy in the knowledge that she has made the world a better place."
...is wrong. They are not "happy."

If they were happy to pay the higher price, you would not have had to tax them in the first place!!!

That leaves us with two problems: how can we compensate both the losers in the present (due to higher taxes) and the losers in the future (environment). We do this by taking the revenue from the tax hike to repay the current losers, and we ASSUME the elasticities are such that carbon consumption falls by enough to provide the adequate benefit to the future. So you see, the assumption of elasticity IS important if you intend to compensate the current losers (as Mankiw would want to do)

Cap and Trade v. Carbon Taxes - Definitive

Previously discussed benefits of Cap and Trade (CAT) over tax hikes include:

1. Politically feasible due to the fact that the tax incidence on consumers is less
apparent than under a tax system.

2. Revenues generated from taxes must go to whatever the politicos want them to be. There is no guarantee money will flow back to the best place (to compensate consumers who now pay a higher price via the tax). (Sold) Cap and trade of course can have that same problem, and while “freely given” cap and trade permits can get around that problem, there is of course a lost revenue in doing so. So in some sense, this “benefit” is not a net benefit over a tax system

3. A large benefit of CAT over tax hikes is that it incents polluters directly to find alternatives AND it rewards low polluters because they can receive payment by trading their cap permits. Depending on how the tax revenue is distributed, this may not be the case with a tax system.

4. The most important is of course, simply put: CAT sets the quantity of pollution and varies the price (unknown), taxes set the price and vary the quantity (unknown). This is a benefit of CAT in some sense since under a tax, we don’t really know what, if any, benefit we are getting from a given tax increase. Under CAT, we may not know the full cost, but we know we are reducing emissions by X.

Another benefit of CAT not talked about is the psychology differences between that and taxation:

With a gas tax hike, consumers KNOW their gas price is being manipulated by a government that is taking their revenue and doing who knows what with it. This is problematic because people FEEL less wealthy in this case because their price increase is tangible. This may mean consumers fail to internalize this cost as much thinking that the price is mandated by the government. Consumption may hold more constant relative to a CAT system because consumers may think “the gas price hasn’t reason more than other substitutes, it’s just that the gov’t has intervened, so either way I go I’m screwed – I guess I’ll stick with gas.”

With a CAT, all prices (increase) fluctuate with the market for the permits, so any increase in price is not artificial to consumers. It seems more likely then that consumers can internalize this increase in price easier – perhaps leading to a greater reduction in carbon consumption than under a tax policy for any given price hike. Consumers may think in this case, “Wow, the carbon market prices are skyrocketing. I better substitute to something else.

Of course, this whole idea of relative elasticities based on psychology of the SOURCE of price changes is not found in economics anywhere. Economics says the source doesn’t matter….but it just might in this case.

I don’t know if this means CAT is a good policy overall – I’m still concerned about its regressivity and the inability to compensate the losers. But it seems a better system than tax hikes.

Benefits of Cap and Trade over Tax hike....

http://gristmill.grist.org/story/2007/2/12/102851/837