Thursday, August 11, 2005

Gas Stations

In comments on Isaac's post about gas station price variation I discussed one possible explanation:
1. Stations with lower prices serve the people who value their time less, the line length acts as an equilibrating mechanism.
Seems plausible, no? Well it turns out that Matt Yglesias did a little experimental work on this topic about a year ago:
Now I remember that one of the several economists on my mother's side of the family -- my grandfather, I think, but maybe my uncle Paul -- once said that he thought gas stations should try offering different prices. You've got an Exxon station selling gas at $1.50 a pop and I own the Gulf place across the street and set my price at $2.00 -- am I crazy? Maybe not. Sure, "everyone" will go to your station, except that once everyone's there, you're going to have a very long line. People who are willing to spend more in order to save time will go to my station. You'll have higher volume, but I'll have higher profits-per-unit.

At any rate, I always thought that was an interesting idea -- make people pay for the higher prices. So I tried it out on this blog. Ads on the right cost more than ads on the left. Result -- more people buy the ads on the left. But that makes the right less crowded, and hence more desirable as an advertising medium and some people pay for the more expensive ads. Strange but true.
Did he make as much or more money with this odd pricing scheme? We may never know.

UPDATE: I've found a website that lists gas prices in Madison. It's connected to a similar network for every state and major metropolitan area in the United States. Interesting...


Blogger Isaac said...

It's all about the elasticities...But when you're talking about just a few cents on the gallon...Hmmm...People are, I think, particularly price sensitive when it comes to gas because it is so public what the price is. So perhaps demand is especially elastic? And thus not a good strategy? Or maybe most people really don't care? Maybe I should spend tomorrow watching two adjacent gas stations with different prices and see how different traffic is...

1:10 AM  
Blogger henry said...

Yeah, it depends on elasticity. And if demand is a function of price you have to include waiting time as part of the price. So demand is something like

d = D(w*t + g*p)

where w is your shadow price of time, t is the waiting time, g is the size of your tank, p is price per gallon. Also, t is a function of d. So people are price sensitive, yes, but the true price includes more than just the listed price.

Also, gas stations typically make about $0.09 per gallon (I read this somewhere, don't remember where.) This is at the "market" price. If they raised price by another $0.09 and only lost half of their customers they'd be just as well off.

11:15 AM  
Blogger Isaac said...

Interesting about the $0.09 a gallon. What I have trouble seeing about the "pooling equilibrium" is how you actually arrive at an equilibrium. Well, I won't try to speculate on how you'd solve it (you know how badly my adventures in game theory tend to go), but given that traffic isn't constant (that is, most of the time there aren't lines at gas stations), and you don't know who is the economy provider and who is the premium provider....

Maybe it's some very simple explanation like: different gas stations are buying gas at different prices and, in general, keep their profit margins the same (cartel and all), and while some gas stations consistently get cheaper gas (or have lower fixed costs), for other gas stations the relative price fluctuates. I should pay attention if the cheap stations are always the cheap stations, and if, for the two adjacent stations one is always cheaper....

12:58 AM  
Blogger henry said...

One problem with game theory is that there's usually no process by which economic actors arrive at equilibrium. In Nash equilibrium no one wants to change what they are doing given what the others are doing. But that doesn't say much about why people will act that way.

Thus there is a study of "focal points", which are more psychological constructions than economic. For example, consider the game of trying to be at the same street corner at the same time as another person at 3:00. There are Nash equilibria with people meeting at every street corner, but if you have to guess, the result could be anything. A focal point might be meeting at City Hall or some landmark.

Anyway, if this is indeed an equilibrium arrangement then who knows how it arises...presumably one guy puts up his price in the morning and the other decides to match it, undercut it, or go over it.

3:09 AM  

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