Regulation to Control Gasoline Price Increases Would Likely Spur Costs Higher, Research Shows

FAYETTEVILLE, Ark. - When gas prices go up, consumer groups often suggest that prices would fall if wholesale prices were the same at every gas station. But a University of Arkansas researcher found that uniform wholesale prices are more likely to increase the retail price of gas than reduce it.

Cary Deck, assistant professor of economics in the Sam M. Walton College of Business, used experimental economics to research the effects of legislation on gas prices. He and Bart W. Wilson, an associate professor of economics at the Interdisciplinary Center for Economic Science at George Mason University, completed a study for the Federal Trade Commission (FTC) on gasoline pricing.

While the paper is currently in review, an article about the results, "Economics at the Pump," was published in the spring issue of "Regulation." The article also has been posted on the Web site of the United States' Embassy to Germany.

Critics often claim that one reason gas stations offer such widely differing prices for fuel is that they are divided into different wholesale zones. In practice, refineries can set different prices for different zones. Zones can cover a wide geographic area including many gas stations, or can consist of just one station. The zone boundaries are proprietary information kept by the refineries.

"A gas station on one side of a street may be in a different zone from the one across from it," Deck said.

The oil companies argue that zone pricing is necessary to accommodate gas stations' different characteristics, such as accessibility for vehicular traffic, traffic counts and location, etc.

Some consumer groups, Deck explained, want to do away with zone pricing. They are in favor of anti-price gouging" legislation that would mandate one price for all outlets.

In the study, Deck and Wilson developed a model to simulate both zone pricing and uniform pricing. They developed the parameters for their model, such as travel costs, location of outlets and value to consumers, with consultation from the FTC.

The experiment was based on a geographic layout with four refiners or wholesalers. Each of the wholesalers supplies a retailer that operates two locations, one in a competitive area and one in a more isolated area. The total number of retailers was four, and the number of retail outlets was eight.

The researchers enlisted subjects to take the role of either a refiner or a retailer. The participants could set prices in two different scenarios. In the first scenario, the refiners could charge different wholesale prices - simulating zone pricing. In the second scenario, they all had to offer the same price - simulating imposed legislation on prices. Retailers were then able to set prices for consumers. The computer generated a reaction to the prices as the subjects set them and the participants collected the resulting profits. The results indicate that prices were actually higher with uniform pricing.

With zone pricing the refiners could set low prices to remain competitive in the concentrated area while extracting profits through higher prices in less concentrated areas where the retailers were charging high prices.

When the refiners had to choose one price for both stations, however, they tended to choose the higher price, which had been offered at the less competitive station.

"If you go with the lower price, you reduce your profits in the less competitive and thus more lucrative area," Deck explained. "It's better for the refiner to go with the higher price and forgo the relatively small profits from the highly competitive area."

He and Wilson hope the model will help people understand that there may be unintended consequences associated with enacting anti-price gouging legislation, as well as other policies.