What Incentive Would Oil Companies Have to Lower Their Prices?
Oregon congressman Peter DeFazio was on the Lars Larson show yesterday claiming that oil companies are sitting on drilling leases because the companies are making record profits. “You’ve taken economics classes,” DeFazio told Lars, “what happens when the supply increases? The price goes down. What incentive would they [the oil companies] have to do that?” note: not an exact quote because the show archives are pay only — if any one can provide the exact quote, I’d be grateful
Using this same logic, what incentive does any company have to lower prices? Why do we have sales? Because, as those economics classes would have taught Mr. DeFazio, supply is only one part of the equation. The other is demand. If you can increase your demand, you can increase your revenue beyond the amount you lost by lowering your prices.
For example, let’s say (for the sake of simple math) that each month you sell 1,000 units of a product that sells for $1 per unit. You believe that if you decrease the price of your product by 5%, your sales would increase by 10%. So you would be selling 1,100 units of product at $0.95 per unit, which means total revenue would increase from $1,000/month to $1,045/month.
Now let’s ask DeFazio’s question: what incentive is there to lower the price? Bigger revenues, and if the oil companies are the hideously evil greed machines I’ve been led to believe during my time in Oregon, revenues will give them incentive to do just about anything — including lowering the per barrel price of oil by increasing the supply.
Of course, the more cynical answer would be simply to say that just because there’s more supply and lower overall cost to the companies doesn’t mean they have to pass that savings on to the consumer. I occasionally refrain from being that cynical, however.