Redistributive Effects of Gasoline Prices
One sentence summary: There are significant redistributive effects of gasoline price changes among U.S. consumers, where the main determinant is shown to be the consumer income.
The corresponding paper by Demet Yilmazkuday and Hakan Yilmazkuday has been accepted for publication at Networks and Spatial Economics.
Free access to the published paper is available at https://rdcu.be/bfNqu
Abstract
Consumers face significantly different gasoline prices across gas
stations. Using gasoline price data obtained from 98,753 gas stations
within the U.S., it is shown that such differences can be explained by a
model utilizing the gasoline demand of consumers depending on their
income and commuting distance/time, where the pricing strategies of both
gas stations and refiners are taken into account. The corresponding
welfare analysis shows that there are significant redistributive effects
of gasoline price changes among consumers where the main determinant is
shown to be the consumer income; e.g., welfare costs of an increase in
gasoline prices are found to be higher for lower income consumers.
Non-technical Summary
Gasoline prices have significant effects on an economy, because higher energy prices can slow economic growth and affect individual welfare in many ways. As one example, gasoline prices have increased before any historical economic downturn in the U.S. As another example, consider the survey reported by Bankrate.com in May 2012, which depicts that, from the end of December 2011 through mid-April 2012, the price of regular gas rose from a national average of $3.30 per gallon to $3.94 (an increase about 19%), and, as a result, 59% of consumers cut back on nonessential spending on things such as vacations and dining out, only because of gasoline price changes. These macroeconomic examples provide an average picture of the gasoline price effects, but is the magnitude of these effects the same across consumers? The answer to this question is essential to understand the redistributive effects of gasoline prices, especially when gasoline prices differ across consumers.
Consider the following figure where each circle represents the location of a gas station. The colors of the circles represent the prices in U.S. dollars per gallon. Price intervals represent the intervals corresponding to the first, second, third, fourth and fifth 20th percentile of average of daily gasoline prices obtained from 98,753 gas stations between September 8th and September 14th, 2014. As is evident, while the gasoline prices are more expensive in the Northeast and the West (including Alaska and Hawaii), they are relatively cheaper in the Southeast.
To better understand the magnitude of gasoline price differences across consumers, consider a typical day (of September 14th, 2014) when the retail-level gasoline price difference between any two gas stations within the U.S. was as high as $2.28 per gallon of regular gas. If you think that this price dispersion was due to differences in state-taxes per gallon, which ranged between 42.75 cents (for New York) and 8 cents (for Georgia) in 2014, you are only partially right, because, for a typical day (of September 14th, 2014), the price difference between any two gas stations within any given state of the U.S. was as high as $1.68 (for the state of Massachusetts) followed by $0.99 (for the state of New York). Therefore, a detailed analysis is required to understand gasoline price dispersion at the gas-station level, which is the key to the investigation of the redistributive effects of gasoline price changes.
This paper achieves such an investigation by modeling the gasoline consumption of individuals and the pricing strategy of gas stations and refiners. The optimization in the model results in the gasoline demand of consumers depending on their income and commuting requirements as well as the price of gasoline. Gas stations take this demand into consideration while maximizing their profits, which results in a linear gasoline price expression due to having Leontief production functions. Refiners take into account the demand coming from gas stations to maximize their own profits. When the behavior of all agents in the model are combined, a final expression for gasoline prices is obtained at the gas station level, which depends on the income and commuting behavior of consumers as well as refiner-related costs.
Using data on gas-station level gasoline prices, zip-code level income and zip-code level commuting within the U.S., the implications of the model are estimated. The results show that most of the variation of gasoline prices (across gas stations) is explained by the proposed model. As a supplementary result, the average (across gas stations) markup per gallon is estimated about 16 cents, which is consistent with the surveys achieved by independent organizations.
After showing that the implications of the proposed model are consistent with gasoline price data, together with other supplementary data, we move to the welfare analysis to investigate the redistributive effects of gasoline price changes across consumers within the U.S.. The implications of the model combined with the results coming from the empirical investigation suggest that 1 percent of an increase in gasoline prices can lead to a reduction in consumer utility ranging between 0.08 percent and 2.76 percent (with an average of 0.82 percent) within the U.S.. Therefore, there are in fact significant redistributive effects of gasoline price changes. When the sources of these redistributive effects are further investigated, it is shown that consumer income is the main determinant; i.e., welfare costs related to a gasoline price increase are higher for lower-income consumers. It is implied that, in order to minimize the redistributive welfare effects of gasoline price changes, special policies should be conducted for lower-income consumers, especially when gasoline prices increase significantly.
Although gasoline prices can be affected by income, commuting distance/time, oil prices, and refiner costs according to the proposed model, they can also be affected by local or national taxes that have not been modeled here (nevertheless, they have been controlled for in the empirical investigation). Therefore, a change in any of these variables would change gasoline prices, and, thus, any policy conducted on such variables would result in redistributive welfare effects among consumers according to the analysis, above. Accordingly, one policy suggestion would be to provide gasoline tax cuts for neighborhoods with lower-income consumers. Providing tax reimbursements for lower-income consumers depending on their gasoline consumption and/or the gasoline (or oil) price changes over the preceding year can also be considered. Another one would be to promote/subsidize fuel-efficient cars for lower-income consumers that would effectively reduce the share of gasoline in their expenditure. Even though the formal investigation of such suggestions is out of the scope of this paper, future research can focus on the public policy implications of a more local analysis based on the insights of this study.
The working paper version is available here.
Gasoline prices have significant effects on an economy, because higher energy prices can slow economic growth and affect individual welfare in many ways. As one example, gasoline prices have increased before any historical economic downturn in the U.S. As another example, consider the survey reported by Bankrate.com in May 2012, which depicts that, from the end of December 2011 through mid-April 2012, the price of regular gas rose from a national average of $3.30 per gallon to $3.94 (an increase about 19%), and, as a result, 59% of consumers cut back on nonessential spending on things such as vacations and dining out, only because of gasoline price changes. These macroeconomic examples provide an average picture of the gasoline price effects, but is the magnitude of these effects the same across consumers? The answer to this question is essential to understand the redistributive effects of gasoline prices, especially when gasoline prices differ across consumers.
Consider the following figure where each circle represents the location of a gas station. The colors of the circles represent the prices in U.S. dollars per gallon. Price intervals represent the intervals corresponding to the first, second, third, fourth and fifth 20th percentile of average of daily gasoline prices obtained from 98,753 gas stations between September 8th and September 14th, 2014. As is evident, while the gasoline prices are more expensive in the Northeast and the West (including Alaska and Hawaii), they are relatively cheaper in the Southeast.
To better understand the magnitude of gasoline price differences across consumers, consider a typical day (of September 14th, 2014) when the retail-level gasoline price difference between any two gas stations within the U.S. was as high as $2.28 per gallon of regular gas. If you think that this price dispersion was due to differences in state-taxes per gallon, which ranged between 42.75 cents (for New York) and 8 cents (for Georgia) in 2014, you are only partially right, because, for a typical day (of September 14th, 2014), the price difference between any two gas stations within any given state of the U.S. was as high as $1.68 (for the state of Massachusetts) followed by $0.99 (for the state of New York). Therefore, a detailed analysis is required to understand gasoline price dispersion at the gas-station level, which is the key to the investigation of the redistributive effects of gasoline price changes.
This paper achieves such an investigation by modeling the gasoline consumption of individuals and the pricing strategy of gas stations and refiners. The optimization in the model results in the gasoline demand of consumers depending on their income and commuting requirements as well as the price of gasoline. Gas stations take this demand into consideration while maximizing their profits, which results in a linear gasoline price expression due to having Leontief production functions. Refiners take into account the demand coming from gas stations to maximize their own profits. When the behavior of all agents in the model are combined, a final expression for gasoline prices is obtained at the gas station level, which depends on the income and commuting behavior of consumers as well as refiner-related costs.
Using data on gas-station level gasoline prices, zip-code level income and zip-code level commuting within the U.S., the implications of the model are estimated. The results show that most of the variation of gasoline prices (across gas stations) is explained by the proposed model. As a supplementary result, the average (across gas stations) markup per gallon is estimated about 16 cents, which is consistent with the surveys achieved by independent organizations.
After showing that the implications of the proposed model are consistent with gasoline price data, together with other supplementary data, we move to the welfare analysis to investigate the redistributive effects of gasoline price changes across consumers within the U.S.. The implications of the model combined with the results coming from the empirical investigation suggest that 1 percent of an increase in gasoline prices can lead to a reduction in consumer utility ranging between 0.08 percent and 2.76 percent (with an average of 0.82 percent) within the U.S.. Therefore, there are in fact significant redistributive effects of gasoline price changes. When the sources of these redistributive effects are further investigated, it is shown that consumer income is the main determinant; i.e., welfare costs related to a gasoline price increase are higher for lower-income consumers. It is implied that, in order to minimize the redistributive welfare effects of gasoline price changes, special policies should be conducted for lower-income consumers, especially when gasoline prices increase significantly.
Although gasoline prices can be affected by income, commuting distance/time, oil prices, and refiner costs according to the proposed model, they can also be affected by local or national taxes that have not been modeled here (nevertheless, they have been controlled for in the empirical investigation). Therefore, a change in any of these variables would change gasoline prices, and, thus, any policy conducted on such variables would result in redistributive welfare effects among consumers according to the analysis, above. Accordingly, one policy suggestion would be to provide gasoline tax cuts for neighborhoods with lower-income consumers. Providing tax reimbursements for lower-income consumers depending on their gasoline consumption and/or the gasoline (or oil) price changes over the preceding year can also be considered. Another one would be to promote/subsidize fuel-efficient cars for lower-income consumers that would effectively reduce the share of gasoline in their expenditure. Even though the formal investigation of such suggestions is out of the scope of this paper, future research can focus on the public policy implications of a more local analysis based on the insights of this study.
The working paper version is available here.