Rockets, Feathers and Gasoline Prices

Among the ten cheapest gas stations in my hometown, gasbuddy.com said that nine had prices that ended in a 5 or a 9 ($2.05, $2.15, $2.29…). One economist from Ohio State believes that odd number pricing helps to keep gasoline prices higher.

Where are we going? To the connection between gasoline and crude oil prices.

Rockets and Feathers

Especially with Brent crude touching a recent low of $41.59 a barrel, I wondered whether gas prices would quickly respond. In the following graph it appears that gasoline and Brent crude move in tandem.

From: St. Louis Federal Reserve

The St. Louis Fed tells us that we can expect a $10 to 25 cents ratio–a $10 increase or decrease in crude results in a 25 cent difference at the pump. But it does not always happen so quickly. On the upside the connection can unfold like a rocket. However, when price falls, its descent can be more like a feather.

Trying to explain the delayed response, economists have suggested the following:

• Odd digits: Selecting prices that end in a 5 or a 9 lets retailers retain a higher price longer because competitors are behaving similarly.
• Brand loyalty: A retailer has less incentive to cut prices knowing consumers are less likely to switch to a competitor.
• Framing: If price is trending lower, happy consumers use the previous price as a reference and feel less of an incentive to do comparison shopping.

And sometimes it does not make sense to search for cheap gas:

“Working” from XKCD

Our Bottom Line: Monopolistic Competition

Firms like gasoline stations that compete in monopolistically competitive markets sell identical products and experience relatively east entry and exit as in perfectly competitive markets. But then, like monopoly, each seller has something unique that provides some control over price. That price control could come from service, branding, location or some other attribute…or the ability to select a 5 or a 9 as the last price digit.

Finally, I thought you would find the following breakdown interesting: