How might California be responding to $5.00 gas?
Let’s start with bread machines.
Behavioral economist Dan Ariely explains that when one of the first sellers of bread machines placed it on the shelf, few people were interested because they could not judge the price. At that point, market researchers suggested selling a much higher priced, larger model nearby. The result? As Ariely said, “Since one was clearly much larger and much more expensive than the other, people didn’t have to make their decision in a vacuum. They could say, ‘Well, I don’t know much about bread makers, but I do know if I were to buy one, I’d rather have the smaller one for less money.’ And that’s when the bread makers flew off the shelves.”
For the price of gas also, relativity matters. Called reference pricing, we judge the price of regular by where it has been. If the price of gas is rising, used to spending less, consumers have a lower reference price, like $3.50, and respond negatively to $3.75. However, when prices descend, the reference price is higher, maybe $4.00 and $3.75 sounds rather good.
Giving his interpretation of relativity, economist James Hamilton believes that most of us ignore rising gas prices until they move beyond their high for the previous 3 years. It appears that, at an average of $4.66 (graph, below), California is there.
Here is where average gas prices have been in California and the US for the past 36 months (from gasbuddy.com):
Sources and Resources: I recommend Predictably Irrational, the source of my Dan Ariely quote (p. 15) and a good read. For more on “framing,” a phenomenon that resembles reference pricing, Daniel Kahneman’s Thinking Fast and Slow is fascinating. And, for the academic perspective on gas and oil James Hamilton’s blog, Econbrowser provides a wealth of information. Finally, econlife tells more about gas prices here.