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Questions and Answers
When the price of a barrel of oil increases, why do
gasoline prices go up immediately, when the existing gas was processed
from oil previously purchased at a lower price?
Gasoline pricing is a fairly complex issue, but
ultimately, basic economic fundamentals of supply and demand are at
work. As a bit of background, roughly 45 percent of the final retail
price of gasoline goes to pay for the crude oil used to produce that
gas. The remainder is made up of transportation costs, taxes, and
markups throughout the supply chain. Many of these other components of
the retail price are relatively stable and predictable. Therefore,
changes in retail gas prices are primarily due to changes in the input
costs of crude oil. Further, the changes in the costs for the retailer
are a function of what happens at the wholesale level, and so on moving
backward through the supply chain.
Now, gasoline stations tend to have quicker turnover
rates than is commonly perceived. In other words, the gasoline that has
already been purchased really doesn’t stay in the ground very long.
Stations in metropolitan areas, for example, can see gasoline turn over
many times every week. Therefore, it really does not take very long for
retailers to begin to see shipments that are more expensive. Now, the
nature of pricing means firms should be forward-looking. Retailers are
concerned with how much the next shipment of any good is going to cost,
and if possible would like to adjust prices as necessary to be prepared
to pay for that more expensive shipment.
These kinds of behaviors occur in all kinds of retail
situations. There are, however, a few important differences between
gasoline and most other goods. First, the key input for gasoline – the
crude oil itself – has highly volatile and therefore unpredictable
price movements. Second, we are usually more exposed to gas prices than
other prices – we see them constantly and the media reports on them
whenever there is a price movement. There is a similar volatility for
the prices of agricultural goods. As hurricanes wipe out crops, for
example, prices rise in response fairly quickly. However, not everyone
buys produce as regularly as they buy gasoline, and so these price
changes may go unnoticed.
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