Econ in the News: Gas Price Variation from Pump to Pump

Have you ever wondered why gas prices can vary significantly, even when the gas stations are within a block of each other? There are a lot of factors in play that cause these price differences, and with a few economic models and methods, we can start to tease out reasons for the variation.

Focusing on the United States, and starting at the nationwide level, gas prices differ the most dramatically. In an article from November 2018, Marketplace reported the cheapest gas in the United States as $1.84 at Empire XPress in New Orleans, Louisiana. The most expensive gas was a whopping $5.95 for a regular gallon at Suncoast Energys in Orlando, Florida. Even interstate and intrastate variation in gas prices can be substantial: Marketplace also reported the average cost for a gallon of gas was $2.24 in New Orleans, $2.32 in Louisiana overall, and $2.48 in Florida overall.

The price differentials we see at the national level are the result of an array of factors. The price of crude oil, and the ease of which it can be transported to a gas station, add the bulk of the cost. Places that are located closer to refineries, or ports where oil is delivered, can avoid higher transportation costs and serve cheaper gas. Additionally, gasoline makeup can differ from place to place. Gasoline in the US is about 10% ethanol, meaning that coastal states face a cost of a few cents/gallon more to ship ethanol from corn-rich states.

Beyond basic cost accounting, policy decisions add significant variations in additional costs. Taxes are a good example: there’s a federal excise tax on gasoline, and each state charges its own gas tax. Alaska has the lowest gas tax at 14.7 cents/gallon, while Pennsylvania is the highest at 58.7 cents/gallon. Laws in 18 states mandating reformulated gasoline (to reduce air pollution) add about 30 cents/gallon more compared to conventional gas.

What about at the local level? Even if the gasoline in each station is truly considered an identical product, we can model consumers as incurring some cost for additional travel. Using the Hotelling model as a base, there might be stable equilibria where a second gas station chooses to set up close to the first one, but charges slightly different prices due to their respective locations. Think of two gas stations where one is less than one block closer than the other on a busy lane of traffic. The extra cost of checking the other gas station’s price then factors into consumers’ decision making, which means that gas stations have to price accordingly. If both gas stations’ signs are easily visible to incoming traffic, and one gas station’s price is cheaper, it makes sense that more drivers would divert to that gas station.

Another way to think about this is through Hamilton Helmer’s 7 Powers framework, specifically Brand power. Consider two gas stations: one a Shell station, the other a local brand. Even if the Shell station is substantially more expensive than the local brand across the street, consumers may gravitate towards Shell, a brand they’re familiar with and have used many times before. This avoids any “risks” they may associate with the other brand (Is it trustworthy? Will the gasoline be worse for my car?), even if they know that the gasoline is essentially identical between the two.

Gas station proximity, brand, and “cash discounts” can all affect gas prices beyond input costs.

Adding in a little behavioral economics with loss aversion – people tend to weight “losses” more than “gains” – and you get even more clever tricks at the pump. Gas stations often have a “cash price” and a “regular price” advertised (with the lower cash price given more visibility).When customers stop by, they may be more likely to use cash, seeking to avoid the “loss” of having to pay the higher credit card price. Interestingly enough, there’s an even more effective way for gas stations to get people to pay with cash (and thereby avoid credit card processing fees): call cash the “normal price”, and add a “credit card fee” for use. This instantly flips the dynamics to more strongly make the use of a credit card feel like a “loss”, since discounts can be mentally tied to “gains”. Thanks to current legislation and wordsmithing created by credit-card companies decades ago, however, you’ll be far more likely to find “cash discounts” instead of “credit card fees” at the pump.

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