How Supply and Demand Impact Gas Prices

The most basic law of economics is that of supply and demand. If the supply of any item is larger than the demand, the price will be low. If the supply drops below the demand, then prices increase. When it comes to gas prices, though, it is a bit more complicated.

Perceived Supply and Demand Also Affect Gas Prices

At the moment, there is actually quite a large supply of both tapped and untapped oil reserves on the Earth. Although demand has been increasing every year, the large supply should keep the price you pay relatively low. However, as everyone knows this is not so. That is because there is a perceived lack of supply. People believe that the supply of gas is limited, so they are willing to pay more for it. As soon as enough people are paying more, then the price is no longer artificially set high, it is set by the market.

How Government Policy Affects Gas Prices

Yet with gas, there is much more going on than supply and demand. Gas is made from oil, and every country enacts its own oil policy. Some countries place large taxes on gas. The original point of the taxes may have been to encourage people to use more public transport, but as the tax revenue poured in, it became impossible to remove the tax. Now most gas taxes are simply in place to collect revenue. No government is willing to forgo the revenue by stopping the tax. In the United States, not only do you have a federal tax, but you also have state taxes on gas as well. That accounts for a lot of the difference in prices from one state to the next.

Gas Prices are Connected to Political Stability

Another key factor in gas prices is the state of international political stability. Most of the world's oil comes from the Middle East, a place that is always somewhat volatile. If a war breaks out (and Middle East wars happen every few years), prices at the pump go up. Even if there is the threat of war in the Middle East, the mere suggestion can cause prices to travel up before even a shot is fired. The current stand-off with Iran is an example. Iran's drive for nuclear weapons has created an atmosphere of great tension in the Middle East. If any country were to strike Iran, the Persian Gulf would become blocked and oil prices would double overnight.

Gas Prices and The Fear Factor

On the other hand, should the world allow Iran and its bellicose leaders to obtain nuclear weapons, Iran can pretty much set whatever price it wants for its oil. Countries will pay out of fear. In many ways, while a strike against Iran would result in a brief, temporary spike in oil prices, that would be far more preferable than allowing the world's second largest oil producer to artificially set prices. Fear can be an even more powerful stimulus to oil prices (and the price you pay at the pump) than supply and demand or even government policies.