Sunday, August 18, 2013

I thought I would switch gears a little bit, while still keeping in the economic arena.  I want to talk about gas prices for a little bit both from the consumer side and the retailer side. What I would like to consider are the factors a consumer might use in deciding where to purchase fuel, as well as what price an independent dealer might want to set to maximize their profit.  There really is a practical side to this blog for both the consumer and the retailer, so please, read on.

THE CONSUMER

MANY PEOPLE WHO FILL-UP their vehicles care about the price they pay at the pump.  There are, surprisingly, a sizable number who are brand-conscience and will pay about any price; there is another large chunk who are convenience-conscience and who will do the same thing.  I see this every day in my little burg of Keystone Heights, FL when I drive by the two Kangaroo stations, which are about about 100 yards apart; one is selling its regular at $3.66/gal and the other at $3.65.  Five miles down the road at a Citgo, I can get it for $3.45, and 23 miles in another direction, I just filled-up at a Flash Mart for $3.37 per gallon; that is quite a spread!

The question I have is why someone won't drive the extra five miles to get gas that is 20 cents a gallon less expensive?  Well, there are several potential reasons why it might not be a good idea, but there are a few where it might be worth it.  To figure this out though, you need to do a little math (sorry).  First, you have to know the cost to drive one mile in your vehicle at the price you are going to pay for the fuel.  In my case, I get 24 MPG, so my cost per mile is 14.3 cents per mile if I pay $3.45 at the Citgo.  So, from where I work, it cost me nothing to drive to the Kangaroo, but will cost $1.44  to drive to the Citgo, where gas is 20 cents cheaper, and return.  Consequently, my break even is $1.44; I have to save that much to make it worth my while in terms of money.  It has to be more than that if I factor in the inconvenience of driving the 10 miles; but that can be gotten around.

Because I generally fill-up with 16 gallons, I would save $3.20.  If I fill-up twice a  month, then I would save $76.80 per year.  Is that worth the time it takes to drive the 10 miles there and back?  To a skinflint like me, maybe, but, that isn't a decision I have to make because I drive by the Citgo on a regular enough basis anyway, I can just stop in.  In fact, I often drive by the $3.37 stations at the right time to fill-up there instead; like I did the other night.  The point is, so long as I am not tied to a brand, which it appears a lot of people are since those two $3.66 Kanagroos in Keystone seem to always be busy, I can bypass the local retailer whose prices are outrageous.

THE RETAILER

MY ABILITY TO IGNORE the local business can cost that business a lot of profit; just from little ol' me.  Think about it, each time I pass up the Kangaroo, they lose approximately $56 in gross sales, or $1,344 per year, just from me (if their price was $3.50, I would buy there).  I wonder how many more people out there are like me?  I know of one, my wife, so that is $2,688.

"Yeah, that's true", you say, "but how about the 15 cents a sale they lose on everybody else, doesn't that make up the difference?"  If my wife and I were the only two people not shopping there, probably so, for that 15 cents is equivalent to 49 sixteen gallon fill-ups a day.  Well, I know the Kangaroo does way more than 49 fill-ups a day so it wouldn't be worthwhile to drop their prices.  But what if it were 20 people or 200 people?  Wouldn't it become problematic then?

It will if that Kangaroo has capacity left over, meaning they still need my business to make more profit.  The story changes, however, if they cannot service anymore customers than they already get because 1) they don't have the staff, 2) they don't have enough gas and can't get it delivered fast enough, and/or 3) they lack space or equipment to handle all of the customers that may come by.  In that case, the best move for them is to keep raising prices until such time as sales fall off enough where they end up with excess capacity.

ENOUGH OF THE MATH

THE ONLY DIFFERENCE BETWEEN the three mini-marts, that is what they actually are, is the county in which they are located.  The Citgo is in Bradford county, and the Kangaroo in Keystone Heights and the Flash Mart23 miles away, are in Clay county.  I mention this because some of you might guess the tax structures are different between the two counties.  But, if that were true, that would mean the Citgo would generally have the lower prices.  That, however, is not the case, the distant Flash Mart almost always has prices at least 5 cents lower, if not more.  All three are, I believe, independent dealers, meaning the oil company doesn't set the price other than through the wholesale price of the gas (even though admittedly, that is a large part of the final price).

So, what is the difference between the three sellers of gasoline?  I think it is business strategy.  The Flash Mart, in Middleburg, would appear to consider that lowering the price to attract more business is the best course; and for me, at least, that works even though it is far away from me; I will wait until we go to the movies in that direction to fill-up there.  They, and there local competition are at least 5 - 10 cents cheaper than the competitors only a few miles away.  

Next, I would fill-up at the Citgo, because I pass by there a lot.  Now, I am not sure what their strategy is, because their prices get pretty high, but normally they stay on the low side.  I only go to the Kangaroos in Keystone when I have waited too long, and even then only to put a couple of gallons in to tide me over until my next trip closer to the other stations.  They clearly think that charging the maximum possible is to their best interest, but I doubt that it is.

OK, MY APOLOGIES, A LITTLE ECONOMIC THEORY

This simple supply-demand story illustrates a fundamental difference between Keynesian and non-Keynesian economics.  In a very broad sense you can think of the set  of economic theories which are based on the economist John Maynard Keynes as the Liberal's model, and those that aren't as the Conservative's model (often incorrectly referred to the Austrian economic school, thank you Ron Paul).

A fundamental tenant of the non-Keynesian theories is that the "economic actors", the buyers and sellers, act "rationally".  Simply stated, if enough people who buy things and/or companies who sell things do not act rationally, e.g. buy the lowest price product or maximize their profit, then the economy tends to become chaotic.  In a very basic sense, this lack of rationality is what is going on just before recessions.

On the other hand, the various Keynesian theories take into account the fact that people and companies sometimes, in large numbers, do not act rationally.  In those times, Keynes proposes it is the job of government to step in and try to act as a leavening agent in order to prevent the economy from falling into a recession or at least limiting its effects. Experience has shown this works although there are many who deny this empirical truth.

In another platform, I have written a couple of articles discussing the economic history of recessions.  In them, I point out that between roughly 1815 - 1937 and 2001 - 2008, a period when only non-Keynesian economics was practiced, there were 6 small recessions and 18 major recessions, e.g. like 2008 or depressions; that is one every 5.4 years.  Since Keynesian economics became a mainstay, from around 1938 - 2001, there were 9 small recessions and no major recessions or depressions; that is one every 7.1 years

You also might be interested to know there were 19 other recessions which I didn't consider because they weren't severe enough or they were very quick. Further, there were four more recessions, one of them pretty bad, it was our very first one in the late 1700s, that were left out because they were caused by events outside of our control.  To me, that is pretty convincing evidence that having the federal government being an integral part of the economic process is a very good idea because, as you can easily observe, people and companies do not behave as the non-Keynesian economists and supporters think they do.