Profitable Pretext

Here's a counterintuitive article:

Feeling sorry for gas stations as prices plummet? Don't.

Although retail gasoline prices have fallen 55% since mid-July, wholesale prices have plunged even more sharply - 68%, according to the Oil Price Information Service. As a result, retailers have enjoyed record profit margins since mid-September.

"Guess what? They're making substantially more money at $1.89 (a gallon) than they were at $4.29," says OPIS chief oil analyst Tom Kloza.

The article gives three reasons for the increased profits:

  1. The credit card fees the gas stations must pay are charged as a percentage of the sale, so the decrease in price has led to lower fees.
  2. When prices are falling, customers will not fill up completely, hoping to take advantage of further falls in prices. This means they make more trips to the pump, and more importantly, to the convenience store, where gas stations earn most of their profits.
  3. Falling prices give station managers some space to fatten their margins, since consumers aren't as sensitive to price as is the case when prices are high and rising.

There's so much good applied economics here a teacher could fill up a day talking about it. For sake of symmetry, however, I'll content myself to three points as well.

  1. People buying less gas in the hope of getting a better deal tomorrow is a good case study for what happens with deflation. In an economy with deflation, or a general sustained decrease in prices, people will hold off making purchases, which reduces economic activity, which reduces prices, which delays purchases, etc. and possibly leads to a deflationary spiral from which it is difficult to escape (See: Great Depression).
  2. That margins can be thicker at lower prices is a nice lesson about how sensitivity to changes in price is based in part on the price point itself. In gas, just like many other things, people tend to be more sensitive about a change in a high price, and less sensitive when a low price changes (here's a textbook graph). When people are less sensitive, managers can charge a higher price without hurting demand.
  3. The last point is found in the following quote at the end of the article:

Not all retailers are cheering. Shaukat Zakaria, a partner in Lone Star Petroleum, which owns 30 stations in Texas, says the oil bust has dampened local consumer demand, intensifying price competition and cutting margins to 12 cents a gallon recently.

Mr. Zakaria gets the causality backwards. The oil bust didn't dampen demand, the weaker demand caused the oil bust.  This is a similar mistake that is made by consumers when they see high oil prices coinciding with high oil company profits;they tend to see the profits causing the high prices rather than the high prices causing the high profits.

As I finish this post, I realize that to some this post will have been lengthy and tiresome, but I also chuckle to know that you, yes YOU, Dear Reader, will now assuredly think of me the next time you pull into the gas station--just try not to. My aura will be as unquenchable as the stench from a bit of gas dripped carelessly onto a shoe.