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Why Do Gas Prices Rise Quickly and Fall Slowly?

Jun 23, 2012 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Thinking Economically, Uncategorized • 161 Views    No Comments

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 4 weeks to reflect a crude price increase but 8 weeks to respond when price dropped. In other words, many gas stations take twice as long to react to a declining wholesale price.

Why?

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 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 is not even cost effective to drive onward and search for cheap gas. Here is a web site with an “Is it worth it?” calculator that will let you decide.

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.

While this MSNBC article for provides an excellent overview of sticky gas prices, here and here you can read the academic literature on “asymmetric price adjustment.” Also, I checked the price of WTI and gasoline between mid-April and mid-June. Crude has dropped by approximately 20% and the price of gas, 11.9%.

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