The Right Coast

May 25, 2004
 
Sticky Prices
By Mike Rappaport

Why do retail gasoline prices seem to fall so slowly, after a wholesale price decrease, but rise so quickly after a wholesale price increase? The ordinary explanation is that oil companies can get away with it because they have a degree of monopoly power.

According to this thesis (as discussed in this post, see also The Idea Shop), the explanation lies not with monopolistic oil companies, but with consumer behavior. Consumers are more likely to comparison shop when prices are rising than when they are falling. When gasoline prices are falling, consumers shop around less and therefore sellers can get away with lowering prices more slowly. By contrast, when gasoline prices are rising, consumers do comparison shop but it does not slow the price increase, because the higher price is actually the real value of the gas and therefore there is no incentive for the oil companies to raise prices more slowly.

The interesting thing about this explanation is how it is cross cutting against the normal political viewpoints. I have listened to free market defenders deny that retail prices fall slowly, while I have often heard market critics assert the oil companies have monopoly power. This explanation allows one to see the issue from a new perspective – one where the policy implications are different and not entirely clear.