Making the Grade

Weirdly, in the past dozen posts or so I've had a proclivity to pen successive posts on the same topic. I haven't planned it at all, but for some reason one post on my traffic troubles spawned several more over the next few days and less than 24 hours after writing a post touching on the difference between finance and economics I decided to write a lengthy post doing present value calculations of gym pricing plans.  And now, here I am about to write another post on gas prices--my blog has its reasons of which reason knows not. Anyway, let's get to it, shall we?

It seems consumers who buy mid-grade fuel are missing out on an arbitrage opportunity, as mixing regular and premium will give you the same fuel for a cheaper price (.pdf):

Midgrade is a redundant product offering, easily and almost costlessly replicated by mixing existing regular and premium products. Indeed, this redundancy is widely known and exploited by ... just-in-time mixing at the retail pump from separate underground regular and premium storage tanks. ... It is rare to see a consumer create a midgrade by buying from two retail feedstocks at a single retail gas station. This is true despite the overwhelming evidence that consumer midgrade mixing is almost uniformly the least costly way to buy retail midgrade.

It's puzzling that midgrade prices remain inflated when such an easy cost-saving measure could be adopted by consumers. The authors suggest at the end of the paper that for some reason competition across octanes in the retail market is not equal. I would suggest it's a simple information asymmetry: people like me have no idea you can mix fuels at all, much less that you can approximate a medium grade by mixing regular and premium. If the information became more widely known, prices would fall.

As for me, the way I saved money when gas was four bucks a gallon was to downgrade from premium to regular, despite my car manual's recommendations and my father's protestations. Some deft working of the Google machine quickly revealed the truth:

The main advantage of premium-grade gas is that it allows automakers to advertise a few more horsepower by designing and tuning engines to take advantage of premium's anti-knock properties. But auto engineers generally agree that if you use regular in a premium engine, the power loss is so slight, most drivers can't tell.

"I go back and forth, and I'm hard-pressed to notice" whether there's regular or premium in the tank, says Jeff Jetter, principal chemist at Honda Research and Development Americas. He drives an Acura designed for premium.

HT: OB