Up Like a Rocket, Down Like a Feather

At your local gas station, you might be seeing some sticky prices.

Although barrels of West Texas Intermediate (WTI) and Brent Crude have steadily gotten cheaper, the price at the pump has had a less steep downward trajectory. One economic study observed that it took four weeks to reflect a crude price increase but eight weeks to respond when price dropped. In other words, many gas stations take twice as long to react to a declining wholesale price.

Sticky Gasoline Prices

Below, you can see that retail gasoline had a 13% price drop from $3.53 to $3.07. Meanwhile, for WTI, decreasing from $100.29 to $82.76 a barrel, and for Brent, $104.88 to $84.42, the fall was close to 20%.

The U.S. national average price per gallon of regular gasoline in dollars from April 7, 2014 to October 20, 2014:

From: U.S. Energy Information Administration

Meanwhile, looking at Cushing, OK WTI Spot Price in dollars per barrel from April 3, 2014 to October 20, 2014, you can see a bigger decline:

From: U.S. Energy Information Administration

And, for the Europe Brent Spot Price in dollars per barrel from April 3, 2014 to October 20, 2014, the decrease resembled WTI’s:

From: U.S. Energy Information Administration

Why is the retail gas price falling so slowly??

On the demand side, a possibility is reference pricing. When the price of gas is rising, consumers, used to spending less, have a lower “reference price,” like $3.50, and actively try to adhere to it. By contrast, when prices fall, the reference price is higher, maybe $4.00. Consequently, we are delighted that the price is below that level and do less comparison shopping.

On the supply side, some stations might have relatively small competitive pressure. If no other nearby station is lowering prices, then everyone can delay. And, if that delay is supported by customer loyalty, then the retailer’s market power becomes even stronger. Sometimes, though, it’s not even cost effective to drive onward and search for cheap gas.

And finally, gas prices are not alone. Looking at 77 consumer items, University of Chicago economist Samuel Peltzman concluded that sticky prices are a common phenomenon.

Our Bottom Line: Monopolistic Competition

A market in which there are many firms that sell goods and services that they can distinguish from others, monopolistic competition gives retailers like gasoline stations some price control. The result? Gas prices go up like a rocket but drift down like a feather.