Rockets and Feathers

Michael Giberson

Which business would you rather be in, one in which the price of your product is rocketing upwards, or one in which the price is slowly drifting down? “Rockets” and “feathers” are names characterizing a pair of stylized facts about the usual behavior of retail gasoline prices: when prices are going up, they go up quickly, but when prices go down, they tend to drift down slowly.

While the phenomena leads some critics to castigate gasoline companies for not passing along the savings when crude oil or wholesale gasoline prices fall, it turns out that the pricing phenomena may be more appropriately pinned on gasoline consumers. When retail gasoline prices are rising, consumers search harder for the best price; when prices are falling, consumers ease up on search.

So let’s take another look at our question, now rephrased as: Which business would you rather be in, one in which your customers obsess about the price of your product, shop around compulsively, and will ditch you for the guy around the corner to save a penny a gallon, or one in which customers don’t do so much price comparison?

Matthew S. Lewis has a paper on the effects of consumer search behavior on retail gasoline prices [Link to PDF]. One result, obvious to me now that it has pointed out, is that retailer profit margins are higher when prices are falling (and consumers do less shopping around) and lower when prices are rising. So which business would you rather be in, on with low profits and unhappy customers or high profits and happy customers?

Richard Morin described the Lewis research in his Unconventional Wiz column in Sunday’s Washington Post (you’ll have to scroll down past the discussion of Playboy centerfolds). An Associated Press story by reporter Brad Foss reports that retail margins on gasoline are almost twice the usual level:

Motorists may appreciate the recent decline in fuel prices, but not as much as gas station owners do.

When pump prices skyrocketed after Hurricane Katrina, gasoline retailers were caught in an uncomfortable paradox they were accused of gouging at the same time their profits were being squeezed by runaway costs at the wholesale level.

Now the reverse is true. The outrage from consumers and Congress has died down just as gas stations around the country are reaping some of their best returns at the pump in years by passing along huge savings at the wholesale level as slowly as possible.

Richard Posner blogs about price gouging laws at The Becker-Posner Blog, but seems to drift off into ancillary issues. Becker’s comment is better.

2 thoughts on “Rockets and Feathers

  1. I think this industry could be one where
    Edgeworth price cycles might be observed.
    (Bertrand oligopoly with output constraints)

  2. I should note that I have not (yet) read the article, but “falling” prices must occur after prices have gone “higher”, whatever that means. I’m assuming that profits are highest when falling just after a peak? If prices fell after a long plateau at some level, I wouldn’t expect much substantial margin increase….. would I be wrong?

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