It is no secret; it does appear that gas will hit a national average of $4.00 a gallon very soon. Over the past year gas prices have increased rapidly, prices have jumped 30 cents from mid-March to mid-April alone to an average of $3.88 a gallon. This has a lot of people scratching their heads. Why do gas prices go up so fast but drop so slowly? Some economists think it is the consumers fault.
Americans have been told that the ongoing turmoil in the Middle East has scared the traders who set the gas prices. The story goes this scare is responsible for gas prices climbing to $1.00 per gallon more than a year ago. Some consumers looks at this situation and factors in the assumption that gluttonous retailers also take advantage of the momentary high prices and bleed a little extra out of the situation to stash away for profit. Thus, prices will rise faster than they fall.
While economists now agree that the retailer’s actions to boost profits during times of increased prices does play a role in price fluctuation, the rise and fall in the price of gas is a bit different. The first study into gas “stickiness” took place in 1997. The conclusion of the study was that gas prices fall twice as slowly as they rise after a price spike.
Ohio State University economist Matt Lewis has a theory as to why gas prices fall so slowly. Middle East turmoil aside—the majority of the blame falls on the consumer. The Readers Digest version of the theory is when gas prices fall, consumers stop shopping around for the best price. This lack of consumer thriftiness eliminates the normal downward stress on gas prices and allows stations to squeeze out a few more pennies to stash away as profit while gas prices slowly decrease. “Consumers shop around more intensely when prices are going up. When they are falling, they don’t shop around as much,” Lewis said.
An interesting theory and one that some might find offensive; with a struggling American economy high prices at the pump do hurt. At the same time oil rigs are exploding off the American coast and large oil companies are taking in record profits. For some Americans to hear that they are in part responsible for the slow decrease in the price of gas, Lewis’ theory might not sit well.
A key element of this, admittedly controversial, theory is something economists call a “reference price.” Once a consumer gets a number in their head all the following consumers choices are impacted by a new price’s relationship to that reference price. If a consumer has been paying above $4.00 a gallon for gas anything less than $4.00 a gallon will be seen as a deal. When a consumer sees this supposed deal the consumer will buy it. The consumer will feel satisfied with self made assertions that they got a deal even if a better deal of still less expensive gas can be found just around the bend.
Lewis used GasBuddy.com to further test his theory in 2008. Consumers can use GasBuddy.com to search for the lowest gas price in their area. Lewis observed that as gas prices raised traffic to the website increased. As gas prices dropped later on in 2008 so did the traffic to GasBuddy.com showing that consumers stopped shopping around for the best deal on gas. With consumers not shopping around for cheap gas, gas stations can level off their prices and gradually decrease the price of gas rather than having to have their gas prices plummet in order to keep up with competition from other stations.
There are a lot of factors that go into the price of gas. Behavioral economists will tell you that people shopping for gas are anything but rational consumers who constantly seek out the best gas price; many consumers just figure that what is offered at the nearest gas station will do. In contrast some consumers overestimate the true value of a cheaper gallon of gas by underestimating the cost of driving to get cheaper gas. All in all, lack of consumer price sensitivity alone does not singlehandedly slow the drop in the price at the pump—but it does play a larger than previously expected role.
Lewis’ theory does have its implications beyond the gas market and in part brings into question the fundamental theories of supply and demand. Yet, to Americans who are feeling the burn at the gas pump the message is clear—do not give up your strong price shopping habits. Laziness and compliance not only contributes to the sluggish decline of gas prices at the pump but it encourages gas stations to rip you off.
Andrew Meggison was born in the state of Maine and educated in Massachusetts. Andrew earned a Bachelor’s Degree in Government and International Relations from Clark University and a Master’s Degree in Political Science from Northeastern University. Being an Eagle Scout, Andrew has a passion for all things environmental. In his free time Andrew enjoys writing, exploring the great outdoors, a good film, and a creative cocktail.