If the first law of supply is that there is a direct relationship between the price of a good and the quantity producers are willing to supply, the second law of supply states that the elasticity of supply is greater in the long run than the short run. That is, an increase in price of a good resulting from a change in demand will increase price more in the short-run. Quantities produced cannot change as fast.

We are seeing an example of this in gas prices today, as the editorial board of the Wall Street Journal makes clear.

A decent portion of the latest run-up in gas prices--and the entire cause of recent spot shortages--is the direct result of the energy bill Congress passed last summer. That self-serving legislation handed Congress's friends in the ethanol lobby a mandate that forces drivers to use 7.5 billion gallons annually of that oxygenate by 2012.

At the same time, Congress refused to provide liability protection to the makers of MTBE, a rival oxygenate getting hit with lawsuits. So MTBE makers are leaving the market in a rush, while overstretched ethanol producers (despite their promises) are in no way equipped to compensate for the loss of MTBE in the fuel supply. Ethanol is also difficult to ship and store outside of the Midwest, which is causing supply headaches and spot gas shortages along the East Coast and Texas.

Many of the items in the WSJ's list of possible cures appears in the White House's announcement today of changes in energy policy to deal with the increase in prices. But these should have been done long ago, and statements that the president "will not tolerate" "fraud or manipulation of the market" are unhelpful. These were illegal before today, and if they were tolerated before one must wonder why.

And if this story that the Democrats will offer a temporary suspension of gas taxes is true, Bush's statement is going to look like half-a-loaf in comparison in the press. Note, though, they are robbing the Highway Trust Fund to pay for the tax relief, and replacing it with a cut in tax breaks to the oil companies that is triple the size of the take-back Bush has proposed.

And yet we continue to subsidize ethanol. Take a look at this chart for the price of E-85 fuel, from a local gas distributor. And remember, Phil and I live in the place where the stuff is made, so there are no transportation costs included.

UPDATE: Deacon attempts to define price gouging. The proper definition, Tom DiLorenzo tells us, is "allowing market forces to set prices". The alternative is to plan gas consumption. DiLorenzo tells us of one guy who tried it, and reported it was a failure:

Your America is doing many things in the economic field which we found out caused us so much trouble. You are trying to control peoples' wages and prices � peoples' work. If you do that you must control peoples' lives. And no country can do that part way. I tried and it failed. Nor can any country do it all the way either. I tried that too and it failed. You are no better planners than we. I should think your economists would read what happened here.

Ms. Klobuchar, Rep. Kennedy? Meet Hermann Goering. (h/t: Craig Westover.)

Categories: economics