Wednesday, August 10, 2005

The Law of One Price Does Not Hold

Or so a drive down University Avenue in Madison, Wisconsin would reveal, with gas prices ranging from $2.43 to $2.50, including a variation from $2.45 to $2.48 at Shell stations alone. I defy you to explain this in terms of, well, anything. Real estate prices? Even way out of the city (in cheap territory), gas was $2.45. Quality of the product? Well, all the Shell stations had the same product, the same service, and differing prices had no geographical regularity. Anything else?

I, of course, waited for 10 minutes to pump gas at the $2.43 station. This was totally irrational. I bought 10 gallons so saved $0.70 over going to a more expensive, and deserted station, implying a shadow price of my time of approximately $4.20 an hour. Yet I wasn't even paying for the gas, my parents were...Ah, economics, how useless art thou.

3 Comments:

Blogger henry said...

I defy you to explain this in terms of, well, anything.

1. Stations with lower prices serve the people who value their time less, the line length acts as an equilibrating mechanism.

2. Information about price fluctuations takes time to travel down the street. Presumably they don't drive around and look at other prices all day, they adjust based on how many people they serve.

3. You didn't take into account some facet of the surrounding geography is different...maybe there is a shopping center by the more expensive ones. Maybe there is variation between more and less populated areas.

4. Stations on different sides of the road charge different prices (as in rush hour when cars head in one direction or the other.) This only works is the street is boulevarded and I forget if University Avenue is.

I like this game!

8:35 PM  
Blogger Isaac said...

I buy explanation (1), in a sense. But I can't believe that "be the only sucker to pay more" is a good business model. But maybe it is.

Explanation (2) isn't true because you have gas stations with different prices right next to each other.

(3) simply isn't true. You can be half way to Mazomanie and still have gas that costs more than at U Pump It. And again, gas stations right next to eachother will have different prices.

(4) University Avenue is a boulevard. But, interestingly, all the gas stations (with maybe one or two exceptions among probably 10 gas stations) are on the same side of the street.

So, yeah, (1) is true, but I have a really hard time believing that that's what is driving different gas prices...

2:40 PM  
Blogger henry said...

Okay...I had'nt realized that there were gas stations *right next to each other* with different prices. Come to think of it, I have observed this before...and been puzzled by it.

So I agree with your assessment, (1) seems the most likely. I don't think anyone's a sucker though. When deciding between two gas stations, you look at price and wait. Sometimes you might get a pooling equilibrium where the prices are the same and the lines are also equal. Other times you might get a separating equilibrium in which prices are different and lines are different lengths. People separate according to how much they value time against money.

This is definitely plausible but I don't know how much it actually explains...wouldn't the price difference have to quite large for the higher-priced station to make a similar profit with less quantity? I guess it would work if they had the price low enough to keep cars at the pumps constantly, but not if it was deserted.

So what is the answer!?!

3:58 PM  

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