Price Dispersion in the Gasoline Market Chandra and Tappata (2009) Beia Spiller Search Lunch Group October 2009 Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 1 / 26
Why do we see price dispersion in gasoline markets? Di¤erent search protocols: Nonsequential search (Varian, 1980) Sequential search (Stahl, 1989) Di¤erent consumer types: Commuters: Nonsequential search Occasional Drivers/ Tourists: Sequential search Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 2 / 26
Model Homogenous good n …rms: compete on prices, constant unit production cost c unit mass of consumers: inelastic demands, valuation v λ 2 ( 0 , 1 ) : zero search cost consumers- Shoppers µ 2 ( 0 , 1 ) : search intensity Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 3 / 26
Equilibrium Given µ , unique symmetric NE of mixed strategies. Firms draw simultaneously from price distribution: � ( 1 � µ ) ( v � p ) � 1 ( n � 1 ) F ( p ; c , v , n ) = 1 � µ n ( p � c ) where: � � p � = cn µ + ( 1 � µ ) v p 2 1 + ( n � 1 ) µ , v as µ ! 1: p * = c (competition) as µ ! 0: p * = v (monopoly) Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 4 / 26
Equilibrium Amount of search is consistent with …rms’ pricing strategies Consumers calculate gains from search: GS = E [ p � p min j µ , c , v , n ] = Z v h 1 � n [ 1 � F ( p ; c , v , n )] n � 1 i p dF ( p ; c , v , n ) p � Gains from search is a concave function of µ (GS=0 if µ = (0,1)), and increases with number of …rms. Search costs are drawn from distribution G ( s i ) with s i 2 [ 0 , s ] Equilibrium: 1. Indi¤erent consumer: GS = e s 2. Search intensity: µ = λ + G ( e s ) Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 5 / 26
Search Intensity, Price Dispersion and Number of Firms Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 6 / 26
Search Intensity and Price Dispersion b µ : search intensity that maximizes GS µ < b µ : (+) search intensity = ) (+) price dispersion µ > b µ : (+) search intensity = ) (-) price dispersion Any relation between search costs and price dispersion is consistent with search. Need to compare price dispersion for products with di¤erent search costs Can identify e¤ect of number of …rms, production costs, and consumer search on price dispersion and price levels. Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 7 / 26
Entry and Exit on GS If search intensity is exogenous: As n increases: fraction of uninformed consumers decreases probability of being lowest price decreases ) …rms more likely to set extreme prices: price dispersion increases with n gains from low prices < gains from high prices = ) price distribution shift towards higher prices Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 8 / 26
Entry and Exit on GS If search intensity can change: As n increases, price dispersion increases If µ < b µ : (+) search = ) (+) price dispersion If µ > b µ : (+) search = ) (-) price dispersion, but can’t o¤set (+) e¤ect of n . However, increased search decreases price, so cannot sign total e¤ect on average prices. Final sign: relationship between average price and n is non-monotonic Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 9 / 26
Production Costs and Price Dispersion Holding µ constant: As costs increase, p m -p * decreases = ) …rms set higher, less dispersed prices Allowing µ to change: As costs increase, searching decreases. New equilibrium: higher and less dispersed prices Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 10 / 26
Search Costs and Price Dispersion Higher search costs: less shoppers; change in distribution of search costs. Di¤erent fuels have di¤erent search costs: Premium fuels SC > Regular fuels SC Greater SC = ) (-) µ = ) (+) Prices � � µ Q b Price dispersion depends on initial equilibrium µ If initial equilibrium µ < b µ : higher search costs = ) (-) dispersion If initial equilibrium µ > b µ : higher search costs = ) (+) dispersion Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 11 / 26
Search Costs and Price Dispersion Need to identify local equilibrium of price dispersion and search intensity Use the di¤erence in search costs between Regular and Premium to identify equilibrium Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 12 / 26
Data Gasoline Data: Oil Price Information Service Daily service station data for 120,000 stations, in 4 states Station-date-fuel-type triple Costs: Spot prices from Energy Information Administration Proxy for changes in wholesale costs faced by stations Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 13 / 26
Data Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 14 / 26
Data Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 15 / 26
Data Market de…nitions: Market center: gas station reporting prices on a given date Entire market: center station plus all surrounding stations falling within a speci…ed region. Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 16 / 26
Results: Price Dispersion and Search Intensity Observed data: price dispersion is 43% higher for Premium Fuel than for Regular Fuel This implies µ > b µ Thus, gasoline market is closer to a competitive outcome than monopoly Search intensity decreases price dispersion Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 17 / 26
Temporal Price Dispersion Consumer search models predict sales because of mixed strategies. Look at price ranking over time: sales and price dispersion would ‡ip ranking of stores. Rank reversals between stations i and j: T ij r ij = 1 ∑ I f p jt > p it g T t = 1 > 90% of all station pairs have positive rank reversals Cheaper station charges higher price � 15% of the time High average price spread, increases with rating: intensity of price competition is di¤erent across fuel types. Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 18 / 26
Temporal Price Dispersion Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 19 / 26
Imperfect Information and Price Dispersion Test: is imperfect information driving observed price dispersion? Natural Experiment: compare separate stations with kitty-corner stations 1. Kolmogorov-Smirnov Test: F 1 ( r ) > F 2 ( r ) Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 20 / 26
Imperfect Information and Price Dispersion 2. OLS/Quantile Regression: r ij = β 0 + β 1 I ( corner ij ) + β 2 X ij where X ij are controls Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 21 / 26
Results: Price Dispersion and Key Parameters How do costs a¤ect price dispersion? PRICEDISP jt = β 0 + β 1 MC t + β 2 AVPRICE jt Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 22 / 26
Results: Price Dispersion and Key Parameters PRICEDISP jt = β 0 + β 1 STATEAVERAGE t + β 2 AVPRICE jt Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 23 / 26
Results: Prices and Number of Firms More …rms = ) more price dispersion Test the concavity of this relationship How do number of …rms a¤ect markup? MARKUP it = β 0 + β 1 MC t + β 2 STATIONS i Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 24 / 26
Robustness Checks Work with cleaned prices rather than actual/raw prices Regress prices on station FE, then run the original regression with residuals Assign single price observation to many overlapping markets = ) correlation in regressors and error term Run model on non-overlapping markets Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 25 / 26
Conclusion Price dispersion and …rms’ markups are non-monotonic functions of: Search costs Number of …rms in market But, only if allow consumers to adjust search intensity Production costs: Decrease price dispersion Decrease markups Consumers could save 5% by shopping around for 1 mile Sources that alleviate imperfect information will reduce prices and price dispersion Beia Spiller (Search Lunch Group) Price Dispersion in the Gasoline Market 10/09 26 / 26
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