'Protecting consumers' by raising gas prices?

Under "zone pricing," gasoline distributors charge different wholesale prices--known in industry parlance as the Dealer Tank Wagon (DTW) price--to service stations in different areas. Legislators in Connecticut and some other states have criticized

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We have examined Connecticut DTW prices and found that price differences are closely related to demand (as measured by income) and supply (as measured by the number of residents per station). Given this finding and previous research into zone pricing, we conclude that a Connecticut ban on zone pricing would likely result in higher prices at the pump for the majority of the state and no drop in pump prices for the remaining areas. Lawmakers in Hartford and other state capitals should take note of this finding.

ANALYSIS As Econ 101 students know, prices will differ across markets to the degree that goods are imperfect substitutes and transportation costs are present. That is, the price of potato chips will be restrained by the price of corn chips and popcorn and the ease with which consumers can switch from one snack to another if the price of potato chips were suddenly to skyrocket. Beyond that, prices will be determined by supply and demand within each market.

As a measure of supply, we use the number of residents per gas station in Connecticut's various postal zones, which we identify using the last three digits of their ZIP codes. This measure, while imperfect, well captures the dimension of market supply that, in addition to quantity, is relevant for price determination: the number of suppliers and thus the degree of competition. In Figure 1, gray represents a high resident-per-station ratio (i.e., low competition) area and blue the opposite. Clearly, Fairfield County and the Hartford area have the least competition in Connecticut, while the Norwich/New London area is the most competitive.

[FIGURE 1 OMITTED]

We use average incomes as a measure of demand. In Figure 2, gray indicates the highest income areas and blue the lowest. The highest incomes in Connecticut are in Fairfield County and the lowest are in the Hartford area.

[FIGURE 2 OMITTED]

Basic theory predicts that gasoline prices should be highest in Fairfield County where supply is low and demand high. Prices in the Hartford area are indeterminate because of opposing forces--low relative supply, but also low relative demand. The remaining areas (most of the state) should have lower prices than Fairfield Country.

Under a zone-pricing ban, what price will suppliers charge as their uniform, statewide price? The uniform price is unlikely to be either the lowest or the highest in the current distribution of zone prices; gasoline wholesale suppliers would face a general averaged demand curve, and neither of those prices is likely to maximize profits. That leaves some price in the middle of the distribution. Because no state has banned zone pricing and thus we have no real-world examples of uniform prices, we chose the average zoned DTW price as the new uniform price under a ban.

In Figure 3, we estimate the change in DTW price as the difference between the actual and average DTW price. Gray areas reflect the largest fall in DTW price and blue the largest rise. Fairfield County, with the highest demand and lowest supply, was paying the highest DTW price under zone pricing and would see the largest decline in DTW under the ban. The rest of the state was generally paying DTW prices below the average. (We exclude ZIP code zone 062 because of insufficient data.)

[FIGURE 3 OMITTED]

Banning zone pricing would lower DTW prices for Fairfield County and increase them in the rest of the state. The ban would increase prices for stations in the lowest income areas in order to reduce them in the highest income area of the state.

How would the change we calculate for DTW prices translate into retail prices? According to an earlier Regulation article ("Economics at the Pump," Spring 2004), Cary Deck and Bart Wilson used experimental economics to simulate the effects of both zone pricing and a unified DTW price on the behavior of gas stations, with university students playing the role of station operators and receiving compensation based on how profitably they operated their hypothetical gas stations (mimicking the incentives of station owners). Deck and Wilson found that, when a zone pricing prohibition was adopted and a uniform DTW price established, stations that previously paid a lower DTW pricing under zone price quickly raised their pump prices to reflect the higher DTW price, with the increase averaging 10.9 percent in highly competitive areas. In low competition areas, however, where the unified DTW price was lower than the previous zone pricing DTW price, station owners were slow to lower their pump prices; apparently, the station owners preferred to pocket the rents. And when retail prices did fall in those areas, they did not fall far; Deck and Wilson found that in low competition areas, when DTW prices fell in the wake of a zone pricing ban, the change in pump prices was statistically indistinguishable from zero.

We incorporated Deck and Wilson's research into our study of Connecticut. We defined areas as competitive if they currently (under zone pricing) pay DTW prices that are less than the uniform, statewide price we calculated, and we defined areas as uncompetitive if they pay DTW prices above the unified price that we calculated. We then applied Deck and Wilson's retail price findings. The results are shown in Figure 4; in essence we find that the average price at the pump increases and the burden of the increase falls disproportionately on those with the lowest incomes.

[FIGURE 4 OMITTED]

CONCLUSION We carried out this research in anticipation of the Connecticut General Assembly's consideration of legislation to ban zone pricing. Our study helped to persuade legislators to defeat the proposed ban on March 13, 2007.

Proponents of the ban, including Gov. M. Jodi Rell and Attorney General Richard Blumenthal as well as some representatives, have said that they continue to favor the ban and that they will try to reintroduce it in different legislation in the future.

Christopher Ball, Mark Gius, and Matthew Rafferty are economics professors in Quinnipiac University's Business School. They recently authored The Effects of Banning Zone Pricing in Connecticut for the American Petroleum Institute. All opinions expressed in this article are entirely the authors' own.