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  • People in the Northeast are Economically Insane

    Posted by Shannon Love on May 19th, 2009 (All posts by )

    In a stunning display of economic illiteracy Connecticut is mulling a bill to force all gasoline wholesalers to sell gas at the same price to all retailers in the state. [More here] This is a form of price fixing that will drive down prices for rich people, drive up prices for poor people, cause shortages for everyone and not alter the wholesale price structure in the long run. Why do the people of Connecticut think such an idea can possibly work? 

    It’s called zone pricing because instead of negotiating a price with every retailer separately, wholesalers have traditionally calculated prices based on the price levels of an entire area. This practice has its roots in the early days of gasoline retailing when one guy in a gas truck went around doling out varying amounts of gas to each retailer and recording the transactions on a clipboard. It was an easier information-management solution to just set the same price for all of the truck’s customers. Given the enormous competitive pressures on the price of gas, most retailers in the same general area charge the same price anyway, so setting up independent negotiations was a waste of everyone’s time. 

    I suppose that with computerized accounting today they could pretty simply break down pricing to the individual retailer, but this would have little effect on the prices that consumers pay or the profits of the retailers. Most retailers sell gasoline for cost and make their profit on secondary items or services. They have no incentive to compete with one another on the price of gas. All the individual retail locations that compete with one another will end up charging roughly the same price regardless of how the wholesalers negotiate their pricing. 

    If wholesalers have to charge the same price to everyone in the state, they will simply average the prices from all areas. This means the prices at the top and bottom of the price scale will converge to the middle. Currently-high prices will go lower and currently-low prices will go higher. Since rich people currently pay high prices they will get a discount and since poor people currently pay lower prices they will pay a premium. The system will subsidize the gas use of the rich with the money of the poor, but won’t provide lower gas prices to the state as a whole

    And I thought it was libertarians that don’t care about the poor? 

    The market’s response to this will be to segment the wholesalers into those that supply upscale areas and those who supply downscale areas. The upscale wholesalers will charge all of their customers more than the downscale wholesalers charge all of their customers, and the system will end up with zone pricing again. 

    In the end this policy will screw over the poor short-term without altering the price structure of wholesale gas sales long-term. Why would they even bother?

     

    14 Responses to “People in the Northeast are Economically Insane”

    1. John Burgess Says:

      Well, if the people of CN can repeatedly re-elect Chris Dodd, I think we have adequate proof that they actually don’t think very much. Or very rationally.

    2. methinks Says:

      Ah, Shannon. Progressives care very much about the poor. Where would they be without them?

      The states around Connecticut have been slowly committing suicide with plans even more stupid than this one. The nutmeg state just doesn’t want to be left out. I’m learning this the hard way.

    3. peter jackson Says:

      My in-laws live in Connecticut, it is a very beautiful state, but their government is a horror. Property taxes there are punishing. You pay property taxes on the cars you own, etc. I think it was sometime in the ’90s when the state legislature convinced the population to vote in an income tax on the pretext that property taxes would be rolled back. After the income tax passed, the legislature renegged on the the property tax rollback, so now they have punishing property taxes and an income tax.

      Dispicable.

    4. fred lapides Says:

      Put aside the badmouthing of my state for a moment. Here is what the bill is about. I visit a cousin that lives in a wealthy area of Connecticut. I take route 15 (the Merritt Parkway) to and from my home, about 45 miles away. The exact same gas stations 9same company owns them) charge increasingly more per gallon as you get closer and closer to the wealthier towns. This is clearly done because people can pay more in wealthy areas and so are forced to. To end this gouging of the wealthy (!), the state wants to ensure that people pay the same price, no more, no less. That is called fairness and actually it is people in richer areas that will benefit from the bill. Perhaps we ought not be so fast in shouting The Left Out to Get Us! no. the gas stations are the ones doing that: same road; same company; same gas–different areas along the way.

    5. methinks Says:

      I think Shannon’s point is that this won’t work because wholesalers will become segmented. However, if they are forced to sell at the same price to every station in CT, then I don’t see how that can happen.

      I live in one of those famously wealthy towns in CT and our gas prices are so high (thanks, in part to the insanely high CT gas tax) that it’s just cheaper to jump the border into NY to buy petrol. But, Fred, the state deserves the bad reputation it gets. The state has been steadily making living here more expensive and unbearable over the past two decades and more productive people have been leaving and taking jobs with them. You certainly don’t want to die here as your estate will be promptly raped by the state.

    6. Da Says:

      Fred,

      You have a point there. Only last week I was at the beach and someone was selling popsicles there for two dollars each. But the exact same brand of popsicles could also be purchased at the supermarket in a six pack for four dollars. Obviously the government has to step in and setup some sort of cabinet position or popsicle czar.

    7. Shannon Love Says:

      Fred Lapidies,

      The exact same gas stations 9same company owns them) charge increasingly more per gallon as you get closer and closer to the wealthier towns.

      And it couldn’t bet that operating cost in wealthier areas are higher due to higher land cost, taxes, land use restrictions and even ambiance? Do you seriously think that it’s just as cheap to run a connivence store in a wealthy neighborhood than it does in a poor one. Beyond that you also have the very economic effect that wealthy consumers are less sensitive to the price of commodity goods than are poor people. A wealthy person’s time is more valuable so they will pay a premium for convenience. Poor people’s time is less valuable so they will trade time for money.

      All these factors combine to mean that a gas station in a wealthy neighborhood can charge more for gas in a wealthy neighborhood than they can in poor neighborhood. This in turn means the wholesaler can charge more as well.

      This is clearly done because people can pay more in wealthy areas and so are forced to.

      They’re not forced to do anything. They can always drive out to the poor side of town and fill up. It’s just if they want to the convenience of buying gas in an upscale neighborhood, then they have pay the premium that requires.

      Your basic conceptual problem here is that you think that a specific set “fair” price exist for every product. You think that price is a function of the effort taken to create and distribute the product. However, this is not the true price of the product. The true price of the product is a function of its value and the value of the product is determined solely by what the buyer is willing to pay for it. For example, if you find a long lost Picasso in my grandmother’s attic after she passes on, then the Picasso cost you nothing to obtain. According to you, the fair price of the Picasso would be an immediate function of just the time and effort it took you to bring the Picasso to market. In reality, the fair price of the Picasso is best set by the value that the buyer places on the work. Moreover, one millionaire might pay you a great deal just so they can own the painting but another equally wealthy has no interest in it. If you stumble onto a product that is highly valuable, you have an intrinsic right to sell it for whatever someone else is voluntarily willing pay you.

      Gas works the same way. There is no intrinsic universal price for gas. The fair price of gas at any particular location or time is purely a function of what motorist will pay for it at that place in time. The price the motorist will pay is a function of all the dozens of tradeoffs that they will prefer to make instead of driving to where the gas is cheapest. It’s fair to charge wealthy people more per gallon for the same gas in their neighborhoods because they will pay you to schelp it up there instead of making them drive across town to where stations can operate more cheaply. Rich people like to have expensive homes in places with expensive land so they pay for that. Rich people like to shop at well maintained places so they pay for that. And so on…

      You really have to upgrade the sophistication of your model of how pricing works.

      Personally, on a moral level, I find the whole idea of rich people bellyaching that they’re getting ripped off compared to poor people nauseating. They’re not but even if they were pitching such an hysterical fit over it is disgusting. I find your defense of this practice an act of hypocrisy of the highest order. You claim moral superiorty because you are willing to sacrifice for the good of the poor yet when you find a circumstance in which the rich subsidize the poor, you want to end to save a $100 bucks a year.

    8. karrde Says:

      Fred:

      I live in the Detroit Metro region. I regularly notice that gas-stations next to a highway interchange charge more than competition two or three miles from the interchange.

      I also notice a general increase in gasoline price as I travel away from the border of Detroit and out into the suburbs. (Same for housing, which I am shopping for in the area.)

      As Shannon says, this is not price-gouging. This the price point, based partly on demand, partly on the cost of doing business, and partly on what people will pay.

      There’s also incremental cost of supply. Outside of the Detroit Metro area, gas prices tend to increase with distance from the Metro area, and with distance from Interstates. The other large cities tend to have islands of lower gas prices, with the same Highway Interchange Effect that Detroit has.

      Are there any such patterns in CT? If so, what are the dominant factors?

      Lastly, when you say these gas stations are the same company: do you mean they all display the same oil-company-marquee, or are all owned by the same local business? Most gas stations in my area are franchise operations, owned and operated by a local businessman. Sometimes one businessman will have a chain of gas stations (not necessarily all the same oil-company marquee), and other times a single businessman will own the local retailer for BP/Shell/Citgo/Marathon/etc.

      On my Visa statement, sometimes the gas stations are labelled “Marathon Store NNNNN”, and sometimes it’s “CITY_NAME Fuel Stop” or “INTERSECTION_NAME Sunoco”. I’m never even sure if “Marathon Store NNNNN” is an accout that Marathon set up for a franchisee, or whether the location is directly-owned by Marathon Oil.

    9. Jaime Roberto Says:

      I think Fred has a point. We should extend this nationally. I’m tired of paying high gas prices here in California. It’s just not fair.

    10. Shannon Love Says:

      Methinks,

      I think Shannon’s point is that this won’t work because wholesalers will become segmented. However, if they are forced to sell at the same price to every station in CT, then I don’t see how that can happen.

      They’re not going to fix the price of gas such that every wholesaler has to charge the same price. They’re just going to require each individual wholesaler to charge the same price to all its customers. In this case, wholesalers will respond by specializing in different areas. One wholesaler will sell to rich areas, another will sell to middle-class areas and yet another will sell to poor areas. They will stay within the law but the price structure will revert to the exact same tiered system they have now.

      What such a system will do is destroy competition between wholesalers in any particular area. Now if you have three wholesalers each competes for retailers at every price level across the entire state. Any particular retailer can choose from three different wholesalers. After the law has been in effect for a while, each retailer will specialize in an area based on income. Each retailer will only be able to buy gas from one retailer.

    11. methinks Says:

      Shannon,

      They’re not going to fix the price of gas such that every wholesaler has to charge the same price. They’re just going to require each individual wholesaler to charge the same price to all its customers.

      Ah. I missed that. Thank you.

    12. TMLutas Says:

      Gasoline is priced tax included so prices will still be higher in rich CT towns because the municipalities do have differing local gasoline taxes and it’s likely that the pressure to keep taxes down abates when you have a lot of rich people who can afford to pay an extra few nickles on a gallon and don’t care enough to oversee how their local government spends their money until things get grossly mismanaged.

    13. tehag Says:

      “If wholesalers have to charge the same price to everyone in the state, they will simply average the prices from all areas.”

      If wholesales have to charge the same price to everyone, they will charge everyone the price from the highest area.

    14. Shannon Love Says:

      Tehag,

      If wholesales have to charge the same price to everyone, they will charge everyone the price from the highest area.

      Not quite. There will be factors which will limit the price to something just under the highest price now. High price reduce consumption and since there are more non-rich than rich, raises prices could cause a loss of income overall. Therefore, wholesalers will probably settle on a price of something like 75% of the price in the richest areas.

      But that is only the short term effect. Long term, the wholesalers will segment the market by each specializing in an areas that supports a specific price range. You might also see wholesalers bypassing the law by breaking their companies into multiple companies or by creating proxy companies. So, a wholesaler might first divide his company into two giving responsibility for the fuel farm to one company and responsibility for the trucks to another. Then he would segment the truck companies by area price. The fuel farm company would legally sell the gas at different prices to each truck company who would then sell gas at a fixed price to all their customers.

      In the end, the rich would pay slightly less than they do now while the non-rich would pay significantly wrong.