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Asymmetric Price Adjustment and Consumer Search: An Examination of the Retail Gasoline Market

  • Matt Lewis

    (Department of Economics, University of California, Berkeley)

It has been documented that retail gasoline prices respond more quickly to increases in wholesale price than to decreases. However, there is very little theoretical or empirical evidence identifying the market characteristics responsible for this behavior. This paper presents a new theoretical model of asymmetric adjustment that empirically matches observed retail gasoline price behavior better than previously suggested explanations. I develop a "reference price" consumer search model that assumes consumers' expectations of prices are based on prices observed during previous purchases. The model predicts that consumers search less when prices are falling. This reduced search results in higher profit margins and therefore causes a slower price response to cost decreases than to cost increases. I then develop testable implications that distinguish my model from two alternative explanations of asymmetric adjustment. The first is a model in which firms temporarily collude using past prices as a focal price. The second theory suggests that increases in wholesale cost volatility reduce consumer search behavior. Using a panel of gas station prices, I estimate the response pattern of prices to a change in costs. Estimates are consistent with the predictions of the reference price search model and contradict the previously suggested explanations of asymmetric price adjustment.

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File URL: http://128.118.178.162/eps/io/papers/0407/0407010.pdf
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Paper provided by EconWPA in its series Industrial Organization with number 0407010.

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Length: 55 pages
Date of creation: 21 Jul 2004
Date of revision:
Handle: RePEc:wpa:wuwpio:0407010
Note: 55 pages, Adobe.pdf
Contact details of provider: Web page: http://128.118.178.162

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  1. Severin Borenstein & A. Colin Cameron, 1992. "Do Gasoline Prices Respond Asymmetrically to Crude Oil Price Changes?," NBER Working Papers 4138, National Bureau of Economic Research, Inc.
  2. Steven Salop & Joseph Stiglitz, 1977. "Bargains and ripoffs: a model of monopolistically competitive price dispersion," Special Studies Papers 94, Board of Governors of the Federal Reserve System (U.S.).
  3. Benabou, Roland & Gertner, Robert, 1993. "Search with Learning from Prices: Does Increased Inflationary Uncertainty Lead to Higher Markups?," Review of Economic Studies, Wiley Blackwell, vol. 60(1), pages 69-94, January.
  4. Enders, Walter & Granger, C. W. J., 1998. "Unit Root Tests and Asymmetric Adjustment with an Example Using the Term Structure of Interest Rates," Staff General Research Papers 1388, Iowa State University, Department of Economics.
  5. Kiviet, Jan F, 1986. "On the Rigour of Some Misspecification Tests for Modelling Dynamic Relationships," Review of Economic Studies, Wiley Blackwell, vol. 53(2), pages 241-61, April.
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  8. Rothschild, Michael, 1974. "Searching for the Lowest Price When the Distribution of Prices Is Unknown," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 689-711, July/Aug..
  9. Jeffrey D. Karrenbrock, 1991. "The behavior of retail gasoline prices: symmetric or not?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 19-29.
  10. Daniel S. Putler, 1992. "Incorporating Reference Price Effects into a Theory of Consumer Choice," Marketing Science, INFORMS, vol. 11(3), pages 287-309.
  11. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  12. Sam Peltzman, 2000. "Prices Rise Faster than They Fall," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 466-502, June.
  13. Barry K. Goodwin & Matthew T. Holt, 1999. "Price Transmission and Asymmetric Adjustment in the U.S. Beef Sector," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(3), pages 630-637.
  14. Stock, James H, 1987. "Asymptotic Properties of Least Squares Estimators of Cointegrating Vectors," Econometrica, Econometric Society, vol. 55(5), pages 1035-56, September.
  15. James M. O'Brien, 2000. "Estimating the value and interest rate risk of interest-bearing transactions deposits," Finance and Economics Discussion Series 2000-53, Board of Governors of the Federal Reserve System (U.S.).
  16. Andrew Eckert, 2002. "Retail price cycles and response asymmetry," Canadian Journal of Economics, Canadian Economics Association, vol. 35(1), pages 52-77, February.
  17. Hastings, Justine, 2000. "Vertical Relationships and Competition in Retail Gasoline Markets: An Empirical Evidence from Contract Changes in Southern California," Competition Policy Center, Working Paper Series qt0bw767hm, Competition Policy Center, Institute for Business and Economic Research, UC Berkeley.
  18. Ronald Johnson, 2002. "Search Costs, Lags and Prices at the Pump," Review of Industrial Organization, Springer, vol. 20(1), pages 33-50, February.
  19. Duffy-Deno, Kevin T., 1996. "Retail price asymmetries in local gasoline markets," Energy Economics, Elsevier, vol. 18(1-2), pages 81-92, April.
  20. Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-59, September.
  21. Gurumurthy Kalyanaram & Russell S. Winer, 1995. "Empirical Generalizations from Reference Price Research," Marketing Science, INFORMS, vol. 14(3_supplem), pages G161-G169.
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