A common quandary that perplexes many folks is fluctuating gas prices. Whenever gas prices increase quickly, I typically hear something like the following:
- The cost of the current stock of gas in the underground tank at the gas station was bought at a lower price.
- Rising gas prices do not change what the gas station paid for that current stock.
- The gas station could keep the lower pump price and still have cleared a nice profit on that stock of gas.
- Why do they raise the price? It must be greed.
I have something for folks who have not got past this quandary to think about.
Let’s say you bought a rookie baseball card for pennies. Years later, that rookie develops into a future hall-of-fame player and is loved by a large fan base.
Ten years from when you bought that rookie card, you discover you have it and look up the market value and find that it is now worth $50.
You tell a friend that you have the card. He wants it. What do you consider to be a fair price?
You tell your friend the price is $50 since that’s the market value. He might argue that it only cost you a few cents and even with inflation, the cost of the card to you in today’s dollars is $1. He might offer to pay you a storage fee of $0.10 per year, which brings the total offer price to $2. Does he have a fair argument? Are you motivated by greed for not agreeing to sell it for $2 and wanting $50 instead?
While you are negotiating a price with your friend, the player tragically dies in a car accident and you find out the next day that demand for his memorabilia has increased substantially. You see his rookie card is now selling for $400 on eBay.
Remember, you only paid a few cents for the card and you have not agreed to a final price yet. Do you accept your friend’s offer of $2? Do you stick with your original asking price of $50? Do you raise the price to $400?
If you choose the second or third option, you are behaving identically to the gas station owner and you are not being motivated by greed, but rather by your opportunity cost.
By selling the card to your friend for $2 you would give up the opportunity to sell it for $400 and you are giving your friend that opportunity. You recognize that what you paid has little bearing on the situation. You also recognize that you would be giving your friend $398.
Now, let’s revisit the gas station. The gas station owner fills his underground tank for $10,000 and sets a price that will earn him $11,000 once all that gas is sold – a tidy $1,000 profit.
A fire takes out a major refinery and the price of gas on the commodity market jumps. The gas that cost the the owner $10,000 last night is now going for $15,000 on the commodity market.
Let’s say there’s a local law that requires the gas station owner to not change his price until he sells out of this batch. He can sell the gas to his customers and make $11,000 or he can call his supplier and have them come pump the gas out of his tank and sell it back to them for $15,000. Which would you do?