All this talk of price gouging (whatever that is) and salting away is hooey. If a servo owns a tank of petrol that they will be able to sell for $1 a litre tomorrow, they won’t sell it for less than 1 a litre less a day's holding costs today. The fact that they bought the petrol for .90 (or $1.10) is neither here nor there.
Cecil hasn’t quite struck the right note with this either:
Suppliers use futures to protect themselves too. And there are speculative elements on both sides of the market.
And you’re going to get in trouble with the poster who hates the use of the term pump for dispenser.
No, it generally doesn’t make sense to stockpile a good so you can sell it tomorrow at the cost of not selling it today when you can just sell it today and buy more. You do this only if future damand and/or margins will fall.
However, Cecil wasn’t clear. If the price of wholesale gasoline prices rise immediately, then yes, it won’t matter too much that a gas station already has gasoline in stock. If replacing a gallon of gas that’s in the tanker will cost 1 today, it doesn't matter that you originally filled it up for .90.
However, if wholesale gasoline doesn’t rise, then price hikes at the pump mostly are price gouging, pure and simple. Now price gouging is not a term I like, because our economy works by people setting the maximum price they can get away with. In other situations, like the oil embargo, price gounging is actually the way the market SHOULD respond to meter out a finite resource. Better to say that there is imperfect competition and suppliers have market power to raise prices more than would be ideal. However, the only industries that have perfect competition are ones whose goods are traded on commodity exchanges or those you can purchase on price-comparison websites (ie plane tickets).
This is a faulty analysis. Remember, the price should be influenced by the present demand as much as by the chance that, by keeping the gas in the ground, the seller could make more money. After all, I can always go BUY more wholesale gasoline and replace what I sell now at the lower price. And if I can do it, someone else WILL do it (taking MY sales by undercutting my prices) if I don’t. The reason that jacking up the price on bad news works is twofold: 1) drivers in America in the short term don’t refuse to buy gasoline just because the price goes up, so there isn’t an immediate downturn in demand with increased prices, and 2) we’ve gotten used to the idea that bad news means gasoline prices will go up, and seem to have forgotten that that didn’t used to happen overnight. Therefore, there is no need to undercut the competition; everyone can raise the price and no one “loses.”
This part is absolutely true. Others have mentioned that they would sell the gas today and buy more to sell tomorrow, which is probably what happens in reality. The holding cost part, however, would take into account opportunity cost of decreased volume sold, which could be substantial. Holding costs are also physical storage costs, time value of money, etc.
In my opinion everybody is right. On a side note, I am extremely disappointed that Cecil used the word “price gouging” in his article.
I don’t understand how you can say we have pure and simple price gouging, whatever that is, and then say the economy works by suppliers charging the maximum price they can get away with (the “market clearing price” if I may) Perhaps we have different concepts of price gouging. In my mind, price gouging doesn’t exist, except as a legal device when laws have been passed to say something like: Price increases over x% in y% days = price gouging. Purely definitional.
Also, how do we know gasoline prices are “more than ideal?” Increased consumer prices in the face of steady wholesale prices are not evidence of a non-competitive industry or collusion.
The point is that the concept of a “free” market doesn’t apply to gasoline. In much the same way that the one-time highly regulated electric and natural gas utility industries supply a basic that you cannot easily cut back on, in our society gasoline is a “must.” With all our people living so far away from work, driving has become a necessity, and that means buying gasoline. So unlike what would happen with, say, milk in the dairy case at the grocers, a spike in gasoline prices doesn’t result in a corresponding sudden valley in purchases of the product. Instead, purchases stay at much the same level in the short term; any adjustment only comes over the long term.
Price “gouging” is, of course, in the eye of the beholder. Still, the main idea behind the concept is a spike in prices occasioned not by a corresponding increase in the cost of the wholesale good, but instead an increase in price to take advantage of some intervening factor at the expense of a buying public that cannot afford not to buy the product. So, if a hurricane hits, and all the area is cut off from outside, and you try to sell your gasoline for $5.00 per gallon, you will rightfully be accused of price gouging, no matter that true market factors could support an even higher price temporarily. In short, retailers aren’t supposed to always take advantage of factors that drive the price of necessary commodities up; society feels it is important to keep the needs of society in mind. Whether or not that kind of dim societal view would apply to those who hike the price of gasoline sitting in their holding tanks simply because the news has said that there is an expected increase in the cost of wholesale oil in the near future is going to depend on your individual ideas about the subject.
Apologies that my earlier reply didn’t address the main issues - life intervened.
One thing to remember is that observing all businesses in a particular industry moving their prices at the same time can mean either of two things: 1. there is strong collusive behaviour; or 2. the market is highly competitive. Nobody undercutting anybody else is exactly what you would expect in a highly competitive market. I’m not saying there aren’t oligopolistic elements in the oil business - just that there is pretty fierce competition at the retail end and that rapid changes in pump prices even petrol already sitting there is nothing out of the ordinary.
That’s why the pump price is so volatile: demand is inelastic - it takes large changes in price to get small adjustments in purchaser behaviour. This is not the same as the utilities, where the concern is about high prices due to natural monopoly, not volatile prices due to both sides of the market being inelastic.
As for “price gouging” and hurricanes, this thread may be of interest.
Utterly wrong. Gasoline is indeed inelastic in the short run, but of course the free market still applies to gasoline and any other inelastic good. In fact, I would guess that milk cited in your example is also short-run inelastic, albeit not as inelastic as short-run gasoline.
That is not true. There is a third possibility that the market is only somewhat competitive and the businesses are “subconsciously” collusive. Ie, they do not talk to each other or explicitly make deals, but they all want the same thing and all end up responding to a trigger in a cohesive way. This is perhaps a tenuous argument, but verifying it is simple. If there is an immediate rise in costs or other rational factors in line with fluent competition, you are right. If it doesn’t seem there are such factors, I must be right (ie, there isn’t perfect competition). Too bad no one has responded regarding the behavior of wholesale prices, but if they take a while to rise then it can’t be competition.
Regarding any theories that future costs get pushed to the present… let’s try a thought experiment. If you bought wholesale gas on the 1st (in the morning) at $.90 and have been selling it for 1 on the 1st and 2nd (say now it is the 2nd at noon and you've still got half a day to go), but learn that wholesale will cost .95 starting on the 3rd (and definately retail for 1.05).... Selling the stuff that's in your tank and buying more tomorrow is pretty much equivalent to saving the stuff you've bought (at .90) for later (at 1.05), and going into the future (the 3rd) to buy gas at .95 to sell today (2nd) at $1.
Hmm… actually i’m not sure what I’m arguing anymore. Maybe the effect really will be that prices rise today but are suppressed tomorrow. Ie, what would happen with speculation. The reason I didn’t think speculation would apply is that it would normally mean that gas station owners would buy extra gas and stock up… raising wholesale prices immediately. But I guess the effect of speculation might also work without them buying any more than normal.
Oh, oh, I get it. In my first post I said “stockpiling the gas will only make sense if the margins in the future will fall.” However, if we do not have perfect competition margins likely WILL fall with a hike in costs. Part of it is owners saying “my loyal customers will be upset with a sudden rise, and might be provoked to find another station.” Part of it is owners saying “aw, I feel bad.” Or “aw, I’ve already got all this cheap gas I’ve bought. No reason to price gouge.” Remember, without perfect competition it’s not just the rational factors which are in play. So if margins will fall in the future, there is reason to be reluctant in selling the gas today (for rational reasons, but unmentioned irrational ones too). Thus, with imperfect competition it might not just be “irrational” price-gouging or collusion (ie not influenced by opportunity costs etc). Interesting. With perfect competition, however, future margins won’t really fall. However, I wonder if my original analogy ($.90 for 1.05 tomorrow and .95 for $1 today) still has any relevance.
With perfect competition, would there still be rational reason to raise retail prices noticeably ahead of wholesale? I would very much like that answered, because it’s starting to REALLY bother me.
Oh, yeah. The retail market is really more like monopolistic competition than perfect competition because each station faces a downward-sloping demand curve due to location. And entry and exit are slowish, so you’d expect returns to be above or below normal profit fairly often.
But under perfect competition you would expect a shock that impacts tomorrow’s wholesale price to be instantaneously reflected in the retail price (abstracting from the interest costs of holding the fuel and the uncertainty about what tomorrow’s wholesale price will be). Remember, all costs are opportunity costs. The opportunity cost of selling a litre of petrol today is what you could get for it if you waited until tomorrow.
Think about the “gas already sitting there” as part of the wholesale supply. It’s an asset that gets revalued as the expected future price changes. Let’s take an extreme example: suppose today you are given a 1000 litre tank of petrol (that doesn’t degrade over time and you store in a magic tank that costs you nothing to run) and that you know for sure that in a year you will be able to sell it for $10 a litre in a perfectly competitive market. You won’t sell it for less than $10 less interest costs. What difference does it make if you know you can buy more at the wholesale price next year (which in a competitive retail market will be $10 a litre less margins including normal profit)? None. Your existing tank - regardless of what you paid for it - is a perfect substitute for buying more wholesale. In opportunity cost terms, it’s the same stuff (again neglecting holding costs).
When there is a shock to the oil system, all oil products including what’s in the tanks in servos and what’s in your car get revalued. If you know it’ll cost you more to fill up tomorrow you don’t wait until you refill to start being more economical with your driving. Of course, with given social plans, size of car and urban planning schemes you don’t adjust much in the short term - and that’s the reason the price changes are so big.
My guess is no, although it’s a fair call. Tacit collusion is possible, but with many players (lots of service stations) and lots of shocks to the wholesale price, I just don’t think it could be sustained.
And besides, why would the service station owners (or for that matter, other - convincingly oligopolistic - elements within the oil business) want volatility? What they want is high margins.