Retail gas pricing

“Zone pricing,” is what the gasoline industry calls price discrimination – wholesalers charge less to stations in zones with many stations and more to stations in zones with few stations. Legislators take one look at “zone pricing” and assume that they can lower prices by requiring wholesalers to sell to everyone at the same, “non-discriminatory,” price.

Let’s assume that the legislators are succesful in lowering prices in high-price zones. Do you think that the retailers in these zones will pass the price reductions on to their customers? Of course, not. The reason prices are high in zones with few stations is that stations in these zones have greater market power. It’s this fundamental fact that makes prices higher in these zones – all price discrimination at the wholesale level does is change who gets the profits. With price discrimination the wholesalers get the profits, with uniform pricing the retailers get the profits.

So consumers in high-price zones don’t benefit from ending zone pricing but what about consumers in the low-price areas? If forced to charge a single price do you think that wholesalers will charge the lowest of their zone prices? Of course not – they will charge an average of their zone prices. As a result, consumers in highly competitive zones will face higher prices under uniform pricing.

Thus uniform pricing makes retailers better off at the expense of wholesalers and consumers.

Not sure if the analysis is right? Our colleague, Bart Wilson, is the author (with Cary Deck) of an excellent new paper on retail gasoline pricing. Wilson and Deck setup an experimental market with retailers, refiners and gasoline customers (the latter are computer agents) and find exactly these results. The Wilson and Deck paper is powerful evidence because an experimental market is a real market – it just happens to be a real market under the careful control of an experimenter.

Wilson and Deck also analyze divorcement (requiring wholesalers to divest themselves of retail stations – very bad for consumers because of the double monopoly problem) and the puzzling phenomena called “rockets and feathers” – the tendency of prices to rise faster with costs than to fall with costs. The full paper is here but they have also published a very good “executive summary” in Regulation, one of my favourite journals.