Macroeconomics and Gas Stations Essay

Tags: gross domestic product business cycle international trade fiscal policy

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.....gas station owners have no control over the price that they pay for petroleum, and only limited control over what they will end up charging the customer. The base price for crude oil is set on the basis of global supply and demand. Local prices reflect a variety of factor -- the crude price, cost of refining, cost of transportation, oil company markups and taxes (EIA, 2016). The price that consumers pay therefore reflects a variety of factors, almost none of which either the consumer nor the gas station owner has control over. This paper will discuss these factors in further detail, in order to clarify the dynamics of the oil market to better prepare to make a decision on buying four gas stations.

GDP Growth Rate



There are two dynamics at play here. First, the GDP of the area in which the stations are located influences gasoline consumption, by influencing how much people use, and how many people live and work in the area. On a bigger level, economic growth on the global scale is a driver of demand for oil products, and will therefore influence the price of oil.



The GDP growth rate for the third quarter of 2016 was 3.2%, up from 1.4% in the second quarter (BEA, 2016). The GDP growth rate fluctuates quarter by quarter, so long-run trends are more important for analysis. The GDP growth rate reflects the rate at which the economy is growing. GDP is gross domestic product, which is the value of goods and services produced domestically. This includes consumer consumption, government spending, business investment and foreign inflows. The GDP does not include the value of American investment abroad. A growing GDP typically reflects a higher demand for fuel, and gasoline is one of the most predominant types of fuel used in the United States. For example, if the GDP is this city is growing, that will typically mean more people driving to work and more delivery drivers. The gas station will have more customers if there is more economic activity in the area.



One of the ideas that was expressed was that growing demand for oil internationally -- such as in China and India -- will spur higher prices in the global market. This is generally true, though supply forms an important counterpoint to demand. Rising demand only results in increased prices when supply grows more slowly than demand does. In recent years, OPEC has kept oil supplies high in order to suppress the price of oil, despite increasing demand (Plumer, 2016).

The Business Cycle



The concept of the business cycle is important to some economic theories. Basically, the business cycle is "the fluctuation in economic activity that an economy experiences over time" (Investopedia, 2016). The cycle is expansion, peak, recession and recovery. In general, the American economy has been in slow recovery for several years following the last recession. It is not known when a full-blown expansion will take place; there are few economists who are expecting one imminently. But regions can also experience business cycles. One of the important ramifications of this is that the gas stations purchased should be in different areas. If one area is struggling, then maybe another will be doing well. Geographic diversification can help offset the impacts of local business cycles.

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It is worth considering the national-level business cycle, however. At the national level, a recovery period sees slow growth, and the next stage is expansion. If this expansion occurs, it will drive growth and therefore demand for oil. If it does not, then demand will remain static. There is also risk of further recession, but business cycle theory argues that this would only occur following another expansion-peak stage.



Fiscal policy is uncertain right now with a new president coming into office. There are apparently mixed signals with respect to fiscal policy and what governmental priorities are going to be, making this a tough time to predict which direction the economy is going to go in. So it might be best to think of business cycle in local terms -- what will happen with the local economy? Will unemployment rise or fall? If it looks like it is trending the wrong way, or will trend the wrong way with a new government, that might help make a "go/no-go" decision with respect to buying gas stations in this particular market.

Monetary Policy



There are a few reasons why monetary policy should be evaluated separately from fiscal policy. First, it is run by a different body (the Federal Reserve, rather than Congress). The Federal Reserve's most recent signals to the market are the higher interest rates will be required. This has implications for both the overall health of the economy and for the decision to buy a gas station. First, higher rates are likely because the economy is nearing full employment and thus inflation is going to be more of a concern going forward (Matthews, 2016). Second, high rates affect the cost of debt.



If inflation is a risk, higher rates will arrive, and they will serve to put a cooling on the U.S. economy. Yet, growth is not that high, so this cooling effect could be quite negative, especially in regions that are not yet growing strongly. It matters where these gas stations are. Furthermore, if Edgar is thinking about borrowing to finance this gas station, he should looked at fixed rate products. They will have already priced in some increase, but a floating rate exposes Edgar to much more risk. He should base his decisions on financing in part based on what sort of financing costs he is going to pay over the life of the loan, and those are changing with the changes in monetary policy.

International Trade



International trade matters for a couple of reasons. First, it drives the oil market, and second because of the influence that it has on the U.S. economy. First, the oil issue. Oil demand globally is driven by economic growth rates, and these are closely tied with increased trade. Knowing the overall strength in global trade is important. Will higher gas prices and higher U.S. interest rates cause global trade to slump? They could, and Edgar will have to take that into consideration. Strong trade has bolstered many economies -- a good example being China -- and those economies are helping to drive more demand in global oil prices. While….....

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References


BEA (2016) National economic accounts. Bureau of Economic Analysis. Retrieved December 4, 2016 from https://www.bea.gov/newsreleases/glance.htm

EIA (2016) What drives petroleum prices? U.S. Energy Information Administration. Retrieved December 4, 2016 from http://www.eia.gov/finance/markets/products/

Investopedia (2016) Business cycle. Investopedia. Retrieved December 4, 2016 from http://www.investopedia.com/terms/b/businesscycle.asp

Matthews, C. (2016). Get ready for higher rates, Fed minutes say. Fortune Retrieved December 4, 2016 from http://fortune.com/2016/11/23/fed-interest-rates-5/

Plumer, B. (2016) Oil prices keep surging after OPEC hashes out a deal to cut production. Vox Retrieved December 4, 2016 from http://www.vox.com/2016/11/30/13792788/crude-oil-prices-opec-cuts

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