A Simple Case Of Supply And Demand

JollyOn August 8, BP unexpectedly shut down part of its Whiting, Indiana refinery where crude oil is turned into gasoline and transported throughout the Midwest. As a result, gas prices jumped – in the Traverse City region from $2.54 to $2.99 per gallon. Consumers were suspicious and public officials were quick to act. A state senator and a few congressmen demanded answers, and Attorney General Bill Schuette sent a letter to BP demanding an explanation and full transparency. He also warned gas station owners that he would be on the lookout for gouging at the gas pumps.

It’s unlikely that foul play is involved. It’s more likely simple economics, the law of supply and demand. Oil prices have been low all summer. Refinery profits have been healthy as they buy the cheap oil, turn it into gasoline and send it to market. Consumers react to low pump prices by driving more, which gradually lowers the supply, then … boom! The BP refinery, largest in the Midwest, has a problem with a distillation unit used to convert crude oil into gasoline and other fuels. BP has to operate at 50 percent capacity, producing less gasoline, which brings down the supply. Meanwhile, demand continues to increase from consumers growing accustomed to low gas prices. Low supply + high demand = higher prices.

There are suspicions this is a ruse to jack up oil company profits. One problem with that theory: as a result of the faulty refinery, BP is selling less gasoline! They can’t make money on gas they can’t sell.

Imagine a northern Michigan hotel operator in the middle of January who has few reservations and little tourist traffic, and a lot of empty hotel rooms (low demand + high supply). The operator is likely to lower room rates – it happens every year. In July the sun is shining, the water is warm, the festivals are festive and room rates escalate. Everybody understands this. They may not like it, but they understand it – you never hear Congressman Benishek or Attorney General Schuette calling for an investigation into hotel room rates. Lots and lots of tourists + the same number of hotel rooms that we had in January = higher room rates.

I believe the same laws of economics apply to college tuition: more students attending college (increased demand), but the number of colleges and universities is not growing (low supply), and that equals rising prices. There are other reasons for out-of-control tuition, but a big part of it is heightened demand.

Consider the University of Michigan, which receives 50,000 applications for about 16,000 openings. Talk about supply and demand!

Tuition rates reflect the escalating demand: resident tuition at Michigan this year is four times higher than it was in 1980 (today’s dollars). If the average price of a car rose as fast as college tuition over the past 30 years, the cost would be $80,000. (The average price for a car today is a little over $32,000.)

In its never ending quest to come to the rescue, the federal government has exacerbated the problem by forcefully encouraging young adults to attend college, while offering a variety of student loans and grants as an incentive, hence the huge supply of college applicants. A frequent message to young adults: college grads earn more money than high school grads.

So the rush is on to get a college degree, but now our fearless leaders have realized there’s a shortage of workers to take skilled trades jobs, which don’t require a four-year degree. Some leaders and elected officials, including Michigan Governor Rick Snyder, are engaged in public relations campaigns to make skilled trades jobs more desirable. By the time public policy and conventional wisdom change that perception, we’ll probably have robots replacing skilled trades workers.

According to the New York Federal Reserve, student loan originations grew from $53 billion to $120 billion between 2001 and 2012. During the same period, average tuition increased by 46 percent (2012 dollars).

The law of supply and demand is simple and predictable whether applied to commodities such as gas and oil, or the price of tuition. The law of supply and demand is not affected by big hearts and good intentions. When the government attempts to make college more affordable by offering easy loans, it creates a bigger pool of applicants with more money chasing fewer openings, backfiring into higher tuition rates.

I don’t know why we don’t have new universities and colleges answering the huge demand for higher ed. It would be nice to see a few Hillsdale College clones open across the country. Hillsdale does not accept any state or federal funds (not even students using federal student loan dollars), so it’s not subject to unpredictable government subsidies, nor does it have to comply with expensive state and federal mandates attached to those subsidies. And, they have a great economics program!