We used the second edition of Hal Varian's textbook, Microeconomic Analysis [3rd ed], in the advanced micro theory courses in graduate school. The word "Varian" still gives me shivers:
Anyway, these days he is writing a monthly Economic Scene article for the New York Times. The latest does a great job of explaining why gas prices move so fast in response to information (The Rapidly Changing Signs at the Gas Station Show Markets at Work, $$$):
THE recent gyrations in oil prices offer a textbook illustration of how financial markets and commodity markets interact.
Oil prices are notoriously volatile, particularly when times are tense in oil-producing countries — just about all the time these days. So when BP announced this month that it might have to suspend as much as 8 percent of the nation’s oil production because of corrosion in pipes on the North Slope of Alaska, the price of crude oil immediately shot up by 3 percent and wholesale gasoline prices simultaneously increased by about 2 percent.
But why? Even if it will cost more to produce gasoline in the future, gasoline being sold today was made with cheaper oil. This must be a rip-off, right?
Actually, no. The reason behind the quick price change is a phenomenon known as storage arbitrage.
To spell out the argument, imagine that you own a storage tank full of gasoline that is currently worth $2 a gallon at wholesale prices. It is widely believed, however, that the price of gasoline will be $2.10 next week.
You would be crazy to sell your gasoline now: just wait a few days and the higher price will be yours. But if everyone waits a few days, there is no gasoline to be sold now and the resulting shortage pushes the price of gasoline up.
How high does it have to go? The answer is $2.10 a gallon. That is the price necessary to induce those who have gasoline to sell it now rather than to wait till next week.
This argument does not depend on whether you think the gasoline market is a paragon of perfect competition or an evil oligopoly. All it requires is that you believe that people who own gasoline, like just about everybody with something to sell, prefer to receive a higher price rather than a lower price.
Even if the price of gasoline were set by a perfectly benevolent conservationist, we would expect to see the same pattern of price movements. If oil will be scarcer in the future because of the BP pipeline shutdown, we would want to conserve the already-produced gasoline that we have now. That means that the price of gasoline has to rise right away to prevent hoarding and to encourage conservation.
That's the main idea. The rest of the article deals with speculation in futures markets and whether that stabilizes or destabilizes spot (today's) prices.
