Inventory Theory

Inventory theory says that the amount of total inventory that needs to be held to satisfy demand is proportional to the number of inventory stocking points.  The most efficient (from purely an inventory size standpoint- there are other efficiency issues that mitigate against this) is one big single shared inventory.  The least efficient is every individual holding his/her own inventory.  Glen Reynolds points to this effect in food:

I SAW A FEATURE BY TONY CAVUTO last night on food stockpiling, in which
one of his correspondents explained how he'd spent $1500 at Costco
stocking up against shortages. You know, if you have stories like this
on TV regularly, you'll get food shortages at stores even if there's no
actual shortage in supply, because today's just-in-time inventory
practices mean that there's no real slack for sudden increases in
demand. The empty shelves will then promote panic and more stockpiling,
setting the stage for the equivalent of a bank-run on grocery stores
even if there's no actual reason.

The exact same thing happened in the early 1970s with gasoline**.  Imagine that there are 100 million cars, and each fills up when the tank is 1/4 full.  On average, then, every tank is 5/8 full.  If tanks are all 16 gallons, then there are a billion gallons of gas in people's personal gasoline "inventory."  Now imagine due to some perceived crisis everyone changes their policy and fills up when the tank is only half empty.  Then, on average, every tank is 3/4 full, giving a total inventory of 1.2 billion gallons.  If this panic occurs over a period of a few days, suddenly there is an incremental demand, above and beyond normal demand, of 200 million gallons to expand personal inventories.  That as much as 30,000 tanker truck loads of extra demand at retail in a few days.  When stations run out, and people change their policy to fill up at 3/4 (as many did in those times, in panic) then that causes another 200 million gallons to disappear into personal inventories.  Logistics systems are not built to handle these demands.

By the way, don't let the US government off the hook.  In the wake of the 1972 oil crisis, the main Congressional "contribution" was to pass a law that mandated oil companies deliver gasoline to each geographic area (probably by county, but I am not sure) in the same proportion as they did in the previous year.  A sort of directive 10-289 for gas distribution.  Well, we all know that things change, and among the biggest changes was the fact that with uncertain supplies and higher prices, a lot fewer people were driving on highways.  Because of Congress's action, rural interstate gas stations were swimming in gas, and the cities were out.  In a cruel but totally predictable twist, a number of the Congressmen who voted for this law later demagogued against oil companies for their poor distribution of gasoline that summer. 


  1. Mike:

    I work nights. When the gasoline pipeline from Tucson to Phoenix ruptured a few years ago, I didn't buy gas any more than I normally do. I normally fill up each and every time my tank reaches empty (on the gauge).

    What I did was cut out leisure travel. I often enjoy night drives, so I stopped during that time.

    One night on my way to work I stopped for a red light next to a gas station. I saw a couple of college age guys filling a 55 gallon drum with gas. What a couple idiots. I don't know if they planned to re-sell that gas or what.

    I remember all my co-workers complaining of "price gouging". The talk of the plant was a (single) station rumored to be selling gas for $4 a gallon. Of course, with my understanding economics, I suggested that that station probably wasn't selling gas, as gas was still available from other stations cheaper. I then compared that $4 station to the others which had run out of gas.

    I suggested that if your tank was on empty, and you needed gas, which would you prefer, that station with $4 gas, or no gas? After "himing and hawing" they agreed that expensive gas is better than no gas. I also convinced them that the higher price stops hoarding dead in its tracks. Those idiots with the 55-gallon drum would never have considered buying $4 gas. Raising prices ensures a product remains available to those that truly need it. (Someone with 1/2 a tank of gas will pass the station by, whilst someone on empty will stop for gas).

  2. Corky Boyd:

    Your reference to the gasoline allocation system during the Arab oil embargo brought back some old memories of government allocation of resources gone amock.

    I lived in the Washington DC area at the time. As you point out states were allocated their quotas in proportion to what it was the year before. Metro Washington is part of three "state" area, Maryland, Virginia and DC. Each state had control of distribution within their boundaries.

    The first miscue occurred when both MD and VA shorted distribution to their counties adjoining DC to protect their supplies from out of staters. Baltimore and Richmond had plenty. In metro Washington long lines developed in July and August, when the heat normally drives large numbers to beaches and mountains. People were staying in the city out of fear of being stranded in the resort areas. This exacerbated the demand problem in metro Washington where supply was already short. Then MD and VA responded to political pressures from the resort communities by allocating more to them and launching massive advertising campaigns about the availability of gas there.

    The odd-even mandate caused its own problems by forcing many to fill up sooner than needed. Gas stations needlessly pumped slowly to keep lines backed up. Lines were like a magnet to fearful motorists.

    Congress was immune to all of this. The congressional garages were well stocked.

    I love how the Democrats scream about the eeevil speculators. We are all specuators when we top off sooner than needed. Airlines buy product futures to protect themselves from anticipated price spikes, as do chemical companies. They would be derelict in their duties if they didn't.