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Experimental Gasoline Markets. Cary A. Deck University of Arkansas. Bart J. Wilson George Mason University. Evidence-Based Public Policy Conference Fall, 2005. Motivation. Few industries evoke such strong sentiments by consumers, retailers, wholesalers, and policy makers as gasoline. Why?

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experimental gasoline markets

Experimental Gasoline Markets

Cary A. DeckUniversity of Arkansas

Bart J. WilsonGeorge Mason University

Evidence-Based Public Policy Conference

Fall, 2005

  • Few industries evoke such strong sentiments by consumers, retailers, wholesalers, and policy makers as gasoline.
  • Why?
    • Consumer and business demand for gasoline is inelastic.
    • Modern economies depend on a large volume of gasoline.
    • Retail prices are posted nearly everywhere we drive.
  • The practice of zone pricing has been a particularly contentious topic in the public policy debate.
    • Zone pricing is the industry term to describe the practice of refiners setting different wholesale prices for retail gasoline stations that operate in different geographic areas or zones.
    • Chevron contends that they “price our wholesale gasoline to our dealers at prices that will allow them to be competitive in relation to their nearby competition.”
    • Connecticut Attorney General Richard Blumenthal proposed legislation to ban zone pricing claiming that it “only benefits the oil industry, to the detriment of consumers.”
  • Another issue is divorcement, the legal restriction that refiners and retailers cannot be vertically integrated.
    • Maryland was the first state to pass such legislation in 1974 with a handful of other states following suit.
    • Bill Lockyer, California Attorney General, in a task force report states that “the key to enhancing competition at the retail level is to eliminate vertical integration by petroleum companies.”
    • However, this runs counter to basic economic theory and evidence from field studies [Barron and Umbeck (1984) and Vita (2000)].
  • Yet another topic that has led to much public debate is a “rockets and feathers” phenomenon in retail prices.
    • This is the perception that retail gasoline prices rise faster than they fall in response to cost shocks.
    • Beyond gasoline, Peltzman (2000) finds the phenomenon in 2/3 of industries he tested.
      • Using monthly national prices, he finds that “rockets and feathers” is uncorrelated with concentration.
    • For gasoline, Borenstein et al. (1997) presents a collusive theory based upon trigger strategies.
    • Other explanations posited include inventory costs, menu costs, and consumer search costs (e.g., Johnson 2002, Castanias and Johnson, 1993).
industry background
Oil Field

World Market Price


Unbranded Rack Price

Branded Rack Price



Transfer Price

Dealer Tank Wagon

Unbranded Stations

Company Operated Stations (Branded)

Lessee Stations


Dealer Owned Stations (Branded)

Retail Customers

Industry Background
environment and institution
Environment and Institution


  • Each buyer has a value v for one unit of gasoline.
  • A fractionwi of buyers have a preference for brand bi, i.e., these buyers gain additional utility if they consume brand bi.
  • Each buyer has an initial location on a “city grid” and incurs a quadratic travel cost to reach a station.
  • All retail prices are public information.
  • Consumers purchase one unit from the station offering the greatest net utility, assuming it is positive.
  • Robot buyers operate in the market.
environment and institution1
Environment and Institution


  • Only refiner i can sell its branded gasoline bi at a cost per unit of ci.
  • Refiner i sets wholesale per unit prices (DTW)for K units of gasoline.


  • A retailer j is contractually obligated to carry a particular brand and only observes the DTW for that refiner.
  • Each retailer has an exogenously determined location in the “city grid.”
  • Retailer j sets the retail price pj for a unit of gasoline and its costs include DTWj and an operating cost of ej.
  • Zone Pricing (4 Refiners and 4 Lessee Dealers)
    • Refiners set DTW prices for each retail location carrying its brand.
    • Each retailer observes two location specific DTW prices but cannot shift inventory between locations.
  • Uniform Pricing (4 Refiners and 4 Lessee Dealers)
    • Refiners must set one price for both retail outlets carrying its brand.
  • Company Operated (4 Retailers)
    • Retailers and refiners merged so that DTW for brand i outlets is ci.
experimental design and procedures2
Experimental Design and Procedures
  • Twelve laboratory sessions, four in each treatment.
    • Each session lasted no longer than 90 minutes. - a period lasted about 2 seconds.
    • Subjects were undergraduate students.
    • The average payoff was $18.25, including $5 for showing up on time.
  • World oil prices
    • First 600 periods ci constant.
    • Last 600 periods ci followed a random walk with changes occurring every 34 to 60 seconds.
results zone wholesale pricing
Results: Zone (Wholesale) Pricing

Wholesale Prices

Posted Retail Prices

results uniform wholesale pricing
Results: Uniform Wholesale Pricing

Corner Retail Prices

Center Retail Prices

Zone Treatment

Zone Treatment

Uniform Treatment

Uniform Treatment

who benefits from uniform pricing
Who Benefits from Uniform Pricing?

Zone Pricing

Uniform Pricing

results company operated
Results: Company-Operated

Corner Retail Prices

Center Retail Prices

Zone Treatment

Zone Treatment

Company-Operated Treatment

Company-Operated Treatment

which buyers benefit
20.1% increase in utility

24.4% increase in utility

50.6% increase in utility

Which Buyers Benefit?
price dynamics center stations
Price Dynamics: Center Stations

Zone Pricing: Prices and Costs are Cointegrated

Uniform Pricing: Prices and Costs are Not Cointegrated

price dynamics corner stations
Price Dynamics: Corner Stations

Zone Pricing: Prices and Costs are Cointegrated

Uniform Pricing: Prices and Costs are Not Cointegrated

price dynamics company ops
Price Dynamics: Company-ops

Corner Stations: Prices and Costs are Cointegrated

Center Stations : Prices and Costs are Cointegrated

policy conclusions
Policy Conclusions
  • Banning Zone Pricing
    • When zone pricing is banned, consumers in the clustered area pay 11% higher prices than when zone pricing is permitted.
    • Consumers in isolated areas pay the same prices with zone pricing as they do when it is prohibited.
    • Banning zone pricing nearly triples average station owner profits, but has no effect on refiner profits.
  • Divorcement
    • Consumers in the clustered area and isolated areas respectively pay 13% and 17% lower prices with vertical integration than with divorcement.
rockets and feathers conclusions
Rockets and Feathers Conclusions
  • Station prices in the clustered area adjust quickly with zone pricing, but still rise faster than they fall.
  • Station prices in the isolated areas adjust more slowly than in the clustered area, but rise as fast as they fall.
  • With company-owned stations, station prices adjust symmetrically to changes in station costs, but this response is much slower than with vertical separation.
  • With uniform wholesale pricing, station prices and costs are not cointegrated.