Bryan Caplan  

Gas Price Variance Up!

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With the whole country bemoaning the rise in the average price of gas, a far more economically surprising change has been almost overlooked: The massive rise in the variance of the price of gas. Before the hurricane, the spread between the highest and lowest price of gas in Northern Virginia was about 10 cents. Now a half hour drive to Manassas revealed a four-fold increase in the spread, with prices ranging from $2.99 to $3.39.

Basic supply-and-demand of course predicts that a foreseeable decrease in gas production will instantly raise the price of gas. But I don't know of any theory that predicts a rise in variance.

My best guess is that the hurricane reveals substantial heterogeneity in the values and/or beliefs of whoever sets prices in local gas stations. (The owners, I guess, but correct me if I'm wrong).

Values story: Some price-setters are actually willing to give up some profit to feel like they are pricing "fairly"; others are happy to "gouge." Most are somewhere in the middle.

Beliefs story: Some price-setters believe that customers will get really angry and hold it against them if they price "unfairly"; others figure that customers will forget any gouging grudges pretty quickly. Again, most are somewhere in the middle.

During normal times, these differences in values and beliefs are dormant. But a disaster gives them a chance to show themselves. Of course, if the disaster goes on indefinitely, then fairness norms of both owners and customers are likely to change. Owners won't be willing to lose money forever, and customers are unlikely to permanently boycott a convenient gas station for doing what every other station does too.

On balance, I'm glad that there are some firms run by people who freely gouge. When the gas runs out at the $2.99 station, I know where I'm going to fill up.


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TRACKBACKS (9 to date)
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The author at ishkabible in a related article titled Price gouging? writes:
    If you cap the price (as some people are making noises about), rationing will take the form of queuing: people will have to wait in long lines for gasoline. This sounds just fine to some activists and academics, apparently ones... [Tracked on September 5, 2005 10:18 PM]
The author at Grandinite in a related article titled Gas Price Variance Up! writes:
    A little something interesting from the Econlog: With the whole country bemoaning the rise in the average price of gas, a far more economically surprising change has been almost overlooked: The massive rise in the variance of the price of gas. Before... [Tracked on September 6, 2005 10:59 AM]
The author at matthewstinson.net in a related article titled Price gouging … isn’t writes:
    I missed it a week ago, but evil capitalist exploiter, er, liberal social scientist Mark A.R. Kleiman wrote a solid post debunking the “price gouging” meme. “The natural result” of damage to the Gulf Coast’s oil infrastr... [Tracked on September 8, 2005 9:06 AM]
COMMENTS (7 to date)

Another reason for a wide price spread is that after a supply shock of uncertain magnitude, individual businesses have trouble estimating the market-clearing price. The higher variance that you have observed might have been the result of imperfect and incomplete information.

Bill Stepp writes:

The reason for the increased variance in the price of gas is the increased uncertainty in the market. Will controls be introduced? Will the SPR be tapped? How long will refining capacity be reduced? When will it return to its pre-Katrina level?
None of these questions were on the table until recently.

There's another reason: supply disruptions may be very localized.

On a national scale, this is obvious, since southeast states saw significant supply disruptions when their pipelines from New Orleans shut down; while those of us in the Midwest saw little disruption (most of our oil and gas comes from Canada).

But even on a local scale, when refineries and gas terminals go on allocation, they may give higher priority to certain stations (those with contracts and owned by the same parent), while other stations go to the end of the line. The result can be that one gas station has plenty of fuel, while another across the street has a hard time keeping its tanks from running dry.

Dale writes:

Another explanation is that many stations continued with their existing pricing policies, which are probably based on either the price paid for the last shipment they received, or more likely, the price they have already negotiated for the next shipment. For stations that negotiated a price before the price from their suppliers went up, there is less immediate pressure to raise prices.

Furthermore, they certainly know that many customers will continue to buy from a familiar station unless they have an incentive to switch. Thus, if they don't have to increase their prices above their competitors at a later date, they may capture some new customers by not raising their prices immediately.

Simply put, some stations are probably making very rational decisions about foregoing immediate profits in anticipation of increased volume in the coming months. That may be a very important factor in sustaining their businesses if consumers cut back on their use of gasoline. If we assume that the demand for gasoline is relatively inelastic in the short term, which intuitively seems likely, consumers may cut back on other purchases. Those could easily include other items purchased at gas station convenience stores.

dsquared writes:

It is more likely that the station owners are using mark-up pricing on inventories of differing vintage.

jameson writes:

I will have to agree in part with dsquared by saying that I believe the reasoning is based largely on remaining inventory. In the case of the Centreville Shell station that made its way to the national news hour, the gas station was using price to make its existing inventory last. The lower the level, the higher the price. Those stations expecting to have received their inventory replenishments earlier than others were like to raise their prices higher.

Jon writes:

Prices would only be very close to each other in an equilibrium. When there is a shock, it takes time for a new equilibrium to be set.

Free markets don't keep businesses from making bad decisions, they just insure those that make too many bad decisions disappear.

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