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Do you ever have those arguments where you know you are right, but it is not worth arguing your point because either the person is too hard-headed to admit they are wrong, or the concept is so far beyond their knowledge they won’t understand? A situation like this occurred to me today in the lunchroom. We were having a discussion on the price of gas. Gas prices in Seattle are much higher than in the rest of the country. Currently a gallon of regular costs about $3.51 a gallon.

A co-worker was discussing how he used to have a diesel car that got around 50 miles to the gallon and now drives a different car that gets only 35 MPG. He also talked about an SUV he had that got around 14 MPG. He started to go off about how he loved his SUV so much and didn’t care that it got such poor mileage and would be happy to pay even $5.00/gallon because it was worth it to drive that car.

Here comes the good part now. He then started to lecture the whole table that gas prices have been rising because demand has been dropping because of the higher prices. He claimed that when demand for gas dropped, stations would raise their prices so that they could increase their margins so that they can make the same amount of profit on less gas. Part of this is true. If a station increased prices while their costs remained the same, their margin would increase. If gallons purchased decreased by more than the increase in price, then the gas station will be losing money by taking this tactic.

Fortunately there are a few rules of economics that will prevail in a dense city environment such as Seattle. One of the main and most basic economic principles is the law of supply and demand. For instance, if you have a large supply and little demand you can generally conclude one of two things. The first could be that people just don’t want the product. With gas that is not the case since it is a necessity. The other could be that the price is just too high for people to want it. The other important principle is perfect knowledge of market prices. Sometimes stores will buy too much of a certain item. They notice that it is not selling very quickly and need to make room for a new shipment of the latest product. If they can’t get the old item sold, there will be no room for the new item. This is why stores often put items on sale. They have typically bought too much of the good because they anticipated more demand for it, and need to clear out the current inventory for new ones.

Another important economic principle is that all market participants have perfect knowledge of the market prices. This is especially true with gas stations. When a consumer sees two or three stations near each other, they can quickly gather all the price data and make a rational choice of what station will provide them with the best product for the money. If three stations are all near each other, they will tend to all have the same prices so that the consumer will just pick whichever one is the easiest to get to. When companies compete for attractive prices, they lower prices instead of raising them. If Shell is priced at $3.45/gallon and Chevron is priced at $3.51/gallon, people are going to go to Shell all day long because it gives them the best price. The Chevron will not gain by this increase because they will not have any customers. It we assume all consumers make rational decisions, we can assume that all consumers will choose to fill up at Shell.

In order for a station to raise prices in order to improve margins, all satations would have to be in on this pricing scheme in order for it to work. Remember, prices changes demand, and demand changes prices. This endless balancing act will continue until the product supplied is equal to the product demanded.

Anyone who has taken a course in economics knows about the theory of normal and inferior goods. For those new to this theory, here is how it works. People tend to be drawn to consuming higher quality items in times of economic prosperity. Consumers have an abundance of money, and therefore have more money to spend on higher quality items. These items are known as normal goods. In times of economic recession, consumers shift their spending habits towards more cheaply priced items in order to  save money. These cheaper items are called inferior goods.

Food can be used as a great example to show the difference between normal and inferior goods. Suppose a person has a good job and are making a lot of money. They could buy normal goods like steak and seafood for dinner every night because they have the means to do so. Suddenly the economy takes a turn for the worse and they get laid off and are forced to take a minimum wage job to make ends meet for the time being. With a lower income they won’t have as much money to spend on normal goods such as steak and seafood. In order to conserve money they will switch to eating inferior goods like hamburger meat and hot dogs.

In the economy, companies that produce normal goods like steak and seafood will see their revenues decrease because less and less people can afford to purchase them. Companies that produce inferior goods like hamburger meat and hot dogs will see their revenues increase because now more people are forced to buy these products.

In times of recession, like we are currently reported to be heading into, companies producing inferior goods can stand to prosper from this economic environment. In honor of this current economic downturn, I am going to be reviewing some companies over the next few months that are generally considered to be producers of inferior goods. These companies could stand to gain in value while the rest of the market is dropping.