Sunday, April 16, 2006

Satisficing more and optimizing less for gas prices

A quick and light comment -- there are innumerable studies that examine gasoline wholesale and crude oil prices and asymmetric price move relationships betwixt the two. I'm not interested in bringing those up. Instead, I'm focusing on your everyday filling station.

I recently read a paper that proposed a behavioral economics explanation (w/empirical analysis) for why pump prices rise with wholesale gas prices, but lag significantly when gasoline prices are falling. It seems fairly plausible that people are loss averse, and therefore, they search vigorously for the best possible deal among filling stations, sometimes even driving further than would be optimal given gas prices, especially when prices are in the process of rising. I suspect people have a mental benchmark for the "proper" price of gas, and the upwards moves in price are all losses relative to that benchmark price (which only very gradually shifts up as gas prices continue to rise, but tends to lag actual prices).

However, when prices begin to fall, the consumers' mental benchmarks make them feel as if they're gaining money as prices fall -- and as a result, they don't search as diligently for the best deal.

Not sure what to do with this, except maybe:
1.Don't search too hard for the cheapest gas when prices are up -- the filling station market is likely fairly efficient because of the way most people behave.
2.Spend more time searching when prices are falling, because stations can get away w/less competitive prices when people are not feeling loss aversion and hence, search less diligently. (To some degree, if prices fall enough, you'll be spending the same amount of effort to save fewer $'s, as the average tankful of gas gets cheaper and cheaper.)
3.Overall, free ride the efforts of others -- search hard when others don't, and search less when others do.
3.Pick up a 5% gas rebate Discover or Citi credit card.

Then again, I don't even have a driver's license because I live in NYC...

A quick fyi -- if you're not interested in and other betting exchanges that let you take on 20 million kinds of risk (but may potentially have legal issues for US residents, though no enforcement has yet occured to my knowledge), check out for cool (though maybe not very efficient/liquid) CFTC approved mini-mini futures and options on stuff like drug presecription price cost moves, housing indices (though the Chicago Mercantile Exchange is now offering these in non-retail size for the first time), and gas costs.


At 4/21/2006 7:19 AM, Blogger Miserly Bastard said...

I dont think that most consumers price-shop for gasoline, except at a very macro level.

What I mean is that there is a certain point where consumer preferences are indistinguishable between price points. For instance, consumers cannot notice the difference between $2.33 a gallon and $2.34 a gallon, unless the information is presented to them simultaneously and truly all other factors are held equal (e.g., gas stations across the street from each other).

As a practical matter, most consumers won't know the difference between how much gas costs on the upper west side vs. downtown, even though price discrepancies probably exist. Only the most saavy consumers of gasoline (e.g., NYC cabbies), can probably make price distinctions for gasoline between filling stations in a local area, and even then, they probably rely on proxies for price information such as the "reputation" that a particular station or brand may have as offering lower prices. (Think Wal-Mart's brand proxy of "Everyday Low Prices" as a substitute for actual price information).

Only at the very macro levels can consumers distinguish between price differences in gas stations, such as "it is cheaper to fill up in Jersey than in the city, so I better tank up before the tunnel."

At 4/21/2006 8:43 AM, Blogger cellardoor said...

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