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Study: Consumers Become Complacent When Gas Prices Fall

September 29, 2005
Although gasoline prices at the pump rise quickly as wholesale costs rise, prices tend to drop much more slowly -- and consumers themselves may be partly responsible.

A recent study suggests that while consumers hunt for the lowest possible prices when costs are rising, they don't shop around as much when prices start falling. The result is that gas stations don't have much incentive to drop prices quickly when wholesale costs drop.

“If a consumer sees that gas prices at one station have fallen since the last time he bought gas, he may not look to see if there are even lower prices,” said Matthew Lewis, author of the study and assistant professor of economics at Ohio State University. “When gas prices are falling, consumers aren't searching as hard for the best price.”

In fact, when gas prices are going up -- and consumers complain the most -- gas stations are generally making the least profit on sales, according to the study. Profits on gasoline are generally up to five times higher when prices are falling, and consumers are no longer so upset about the prices they pay.

For the study, Lewis used data on prices at about 420 gas stations in the San Diego area from January 2000 to December 2001. The data was collected by a consumer group called the Utility Consumers' Action Network. Data on wholesale gas prices paid by the stations was obtained from the U.S. Department of Energy.

With this data, Lewis was able to examine how prices at the pump changed along with wholesale gasoline prices.

As expected, he found that prices at the pump went up quickly to match increases in wholesale costs, but took much longer to drop back to near wholesale price.

Profit margins varied widely as prices increased and decreased, findings showed. In periods when gas prices were rising quickly, the average profit margin for stations was about 4.8 cents per gallon.

But when prices were going down quickly, profits averaged 29.9 cents per gallon. When prices changed little, profits averaged about 13.4 cents per gallon.

Lewis believes consumer behavior has a lot to do with these differing profit margins.

When prices are going up, consumers shop around, so stations don't dare increase prices too much over their wholesale cost, at the threat of losing customers.

“For the most part, when there are increases in gas prices, it is because oil refineries can't keep up with demand. In those cases, it is the refineries that are profiting most from price increases,” Lewis said. “The gas stations themselves get pinched because consumers pay attention when prices go up and will search out bargains.”

But when prices fall, customers have no way of knowing how much wholesale prices have gone down, he said. They are happy to see any decrease in price and are less inclined to continue searching.

“When customers aren't searching, it doesn't do any good for one station to lower prices further than their competitors because it may not even attract many additional customers. Drivers aren't looking for a better price.”

The variation in prices across stations does not increase significantly when profit margins are high (or when wholesale costs are falling quickly). As a result, one consumer won't gain much by choosing to search, even though gas stations would significantly lower their prices if all consumers were searching, he explained.

Lewis said other explanations for why gas prices rise quickly and fall slowly don't fit the data as well as his consumer search model.

The most common alternative explanation would be collusion among gas stations to keep prices high, Lewis said. Such an explanation would be hard to prove, he said. Moreover, some of the data doesn't fit the theory that stations are engaged in this anti-competitive behavior.

If stations were colluding to keep prices high, Lewis said some stations would hold on to high prices for as long as they could, but there would nearly always be one or more stations that would drop prices to try to get a competitive advantage.

Then, nearby competitors would drop prices to match. The result is that prices would drop at different rates in different areas in the city.

But that is not what Lewis found.

“One of the things I documented is that the spread of prices in the city didn't change much. The lowest prices in the city fall just as slowly as the highest prices do, “ Lewis said. “So there isn't the breakdown in collusion that you would expect to see.”

Lewis noted that this study was done in California , where there is a greater volatility in wholesale gas prices than there is in other parts of the country. So while the overall findings are applicable nationwide, the magnitude may be smaller in some areas.

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