The scapegoat problem: What’s missing in the gasoline price debate

Every time the prices at the gas stations are way up, there is (at least here in Germany) the same discussion. 

That discussion goes along with the following question: Are the oil companies taking advantage of their customers, charging extra high prices to maximise their profits?

The correct answer to this question is probably: Of course, mineral oil companies take the highest possible price – like all companies. But the real question is: Is this highest possible price also the lowest possible?

Few sentences of economic theory to begin with: If there is intense competition in a market, companies can hardly set the prices themselves. They are price takers. The competition is so intense that anyone who tries to push through higher prices will lose their customers. Conversely: The less intense the competition, the greater a companies’ market power, the more likely it will have a say in price without losing (too many) customers. 

In addition to this market power, there is a second reason why customers can suffer from too high prices: price agreements between companies. Instead of wooing customers with low prices, the providers prevent such competition and pocket higher profits. To prevent such price-fixing cartels, they are strictly forbidden and carry heavy penalties.

How does it look at the gas station nowadays in terms of market power and price agreements?

First. I don’t know of any product where the price is more important to customers than gasoline. Before customers enter the store, they are already informed about the price on large display boards. If the price is too high, the potential customer drives to the next provider. In contrast to almost any other product like butter, vegetables, and living room sets, for petrol, the price is practically the sole purchasing criterion. That means: The market power of the individual oil company tends toward zero. 

Second. True, identical prices can be the result of price agreements. But they don’t have to. We intuitively think of such a price agreement when we see the exact same prices from different providers. It’s just an obvious explanation. The possibility that the same prices are instead a result of fierce competition does not come to mind easily. But it’s at least no less likely. Every gas station operator knows that if they don’t match their price with the competition, they will lose customers immediately. – By the way, economists often have the opposite explanation problem: There is only one (equilibrium) price in the basic model of (perfect) markets; therefore, economists are sometimes surprised by the reality that there is significant price differentiation in almost any market.

Third. Suppose you were the owner of a petroleum company, and you could set prices within limits. When would you use this pricing freedom most: when prices are exceptionally high (and the public is discussing them all the time) or when prices are moderate? Right, if the prices were rather low. The idea that oil companies are exploiting potential market power right now just doesn’t make much sense.

So there is little to suggest that the high prices result from exploiting a lack of competition or because of price agreements. More likely, the public is looking for someone to blame for the current high prices. But the truth is, there is no one to blame. It is just the result of supply and demand.