The economics of gas prices

Gas prices at my local gas station have recently dropped to $2.20/gallon. It seems as though back in August I was paying about $3.15/gallon. In that time, gas prices have dropped nearly a dollar a gallon and I am at a loss for understanding it.

Economics was never my strong suit, but I understand the basics of supply and demand, or at least I thought I did. As supply dwindles, and demand increases, price has to increase as well. As inventories loom large and demand falls off, price has to drop. Maybe I’m oversimplifying a bit.

Oil is a primary ingredient of gasoline and in summer months, the demand for oil, in the form of gasoline increases as poeple plan summer vacation. Some people drive and others fly but we are told that the demand for gasoline skyrockets during summer months. If gasoline were more scarce, I could see prices rising rather dramatically, but it seems to me that the demand for gasoline in the summer months is usually met without any kind of supply crisis. So what I don’t understand is if increased supply meets increased demand, price should remain the same, shouldn’t it?

Now that summer is over, demand for gasoline is dropping and supplies can be cut back. Prices therefore can drop with the diminishing demand until they stablize at a lower level. This seems to be what is happening now, but it still doesn’t make sense why the prices increased in the first place. People often point to the oil companies as being the ones who arbitrarily raise prices because people will pay no matter what. I was skeptical of this, but lacking a better explanation, I am beginning to wonder if there isn’t some truth to this. Other products whose price is tied to supply and demand don’t seem to fluctuate nearly as much as the price of gasoline. Take milk for example, or the price of a pound of bananas.

I’m anxious to get to the gas station to pay just abotu $2/gallon to buy gasoline. But I drive so infrequently that I can go a month or more between fillups. With the way gas prices fluctuate, gasoline could be back up over $3/gallon before I need to fill up again.